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THE  LIBRARY 

OF 

THE  UNIVERSITY 

OF  CALIFORNIA 

LOS  ANGELES 

SCHOOL  OF  LAW 


I 


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CORPORATION    ^^2. 
PROCEDURE 


LAW,   FINANCE,  ACCOUNTING 


By 

THOMAS   CONYNGTON 

R.  J.  BENNETT 
PAUL  W.  PINKERTON 


Edited  By 
HUGH  R.  CONYNGTON 


Fourth  Printing 
NEW  YORK 

THE  RONALD  PRESS  COMPANY 
1923 


}  1  >i  U  kJ 


7"' 


Copyright,  1922,  by 
The  Ronald  Press  Company 


All  Rights  Reserved 


^<J^h 


TAi^} 


PREFACE 

The  small  businesses  of  the  country  are  still  largely  conducted 
as  partnerships  or  sole  proprietorships.  Some  few  of  the  large 
businesses  are  conducted  as  joint-stock  companies  or  express 
trusts.  The  great  proportion  of  the  business  of  the  country 
is,  however,  conducted  under  the  corporate  form,  and  the 
corporation  is  by  far  the  most  important  form  of  business 
organization  now  in  use. 

The  latest  available  figures  show  over  320,000  corporations 
making  income  tax  returns,  with  invested  capital  of  more  than 
$66,000,000,000.  All  of  these  corporations,  in  their  organiza- 
tion and  subsequent  corporate  existence,  are  confronted  with 
many  problems  of  procedure.  It  is  the  purpose  of  the  present 
work  to  furnish  in  a  single  volume,  an  accurate,  practical,  and 
conveniently  arranged  manual  that  will  answer  as  nearly  as 
possible  these  constantly  arising  problems  of  corporate  pro- 
cedure— a  work  that  will  give  the  information  so  essential  in 
the  organization  of  a  corporation — that  will  assist  the  secretary 
and  other  executive  officers  in  its  technical  conduct  after  it  is 
organized — that  will  help  the  corporation  treasurer  in  the  solving 
of  his  financial  problems  and  outline  the  accounting  procedure 
that  must  be  followed  by  the  comptroller  or  other  accounting 
official  of  the  corporation  in  establishing  an  effective  and  ade- 
quate system  of  accounts.  The  book  is,  in  short,  intended  to 
meet  the  practical  needs  of  all  those  concerned  in  corporate 
•  affairs — lawyers,  bankers,  accountants,  corporation  officers,  and 
business  executives  generally. 

A  work  embracing  so  wide  a  field  as  "Corporation  Pro- 
cedure," must  of  necessity  require  the  services  of  specialists 
in  its  preparation.  Accordingly  the  various  phases  of  corpora- 
tion procedure  have  been  treated  by  the  following  authors: 

iii 


667425 


iv  PREFACE 

"Corporate  Law"  by  Thomas  Conyngton,  of  the  New 
York  Bar,  author  of  "Corporate  Organization  and  Management," 
"Business  Law,"  and  co-author  of  "Wills,  Estates  and  Trusts." 
Mr.  Conyngton's  discussion  of  the  legal  and  technical  problems 
involved  in  the  organization  and  management  of  the  corpora- 
tion has  been  developed  directly  from  his  previous  work,  "Corp- 
orate Organization  and  Management."  The  treatment  is  here 
brought  up  to  date  and  enlarged  by  the  addition  of  a  detailed 
discussion  of  stock  without  par  value,  and  also  of  the  new  form 
of  business  organization,  closely  allied  to  the  corporation, 
known  as  the  "express  trust."  The  very  practical  collection 
of  corporation  forms  which  concludes  the  volume  has  also  been 
supplied  by  Mr.  Conyngton. 

"Corporate  Finance"  is  based  directly  on  the  very  excellent 
work  "  Business  Finance"  by  William  H.  Lough,  President  of 
the  Business  Training  Corporation,  and  formerly  Professor  of 
Finance,  New  York  University,  School  of  Commerce,  Accounts, 
and  Finance.  Mr.  Lough  is  a  writer  of  long  experience  and 
standing,  and  in  adapting  his  material  to  the  requirements  of 
this  manual,  the  original  text  has  been  adhered  to  as  closely  as 
the  requirements  of  a  co-ordinated  and  up-to-date  treatment 
would  permit.  The  discussion  of  "stock  rights"  appearing  in 
this  part  of  the  volume  is  new,  having  been  supplied  by  Thomas 
York,  formerly  of  the  staff  of  The  Wall  Street  Journal,  and 
author  of  "Foreign  Exchange." 

"Corporate  Accounting"  by  R.  J.  Bennett  and  Paul  W. 
Pinkerton.  Both  Mr.  Bennett  and  Mr.  Pinkerton  are  certified 
public  accountants  of  wide  experience  and  active  practice.  Mr. 
Bennett  is  a  member  of  the  American  Institute  of  Accountants, 
and  also  of  the  Ontario  Institute  of  Chartered  Accountants. 
During  the  war  he  was  chief  accountant  in  the  Division  of  Audit, 
State  of  Pennsylvania,  for  the  United  States  Food  Adminis- 
tration. He  is  also  author  of  "Corporation  Accounting," 
"C.  P.  A.  Questions  and  Answers,"  "Accounting  for  Executives," 
etc.     Mr.  Pinkerton  is  an  Associate  Member  of  the  American 


PREFACE  V 

Institute  of  Accountants,  manager  of  the  Commercial  Depart- 
ment of  Coffield,  Sanders  and  Company,  of  Indianapolis,  and 
co-author  of  "Wills,  Estates  and  Trusts."  The  treatment  of 
"Corporate  Accounting"  is  based  directly  on  Mr.  Bennett's 
work  "Corporation  Accounting,"  co-ordinated,  revised  and 
brought  up  to  date  by  Mr.  Pinkerton  and  the  author. 

In  the  discussion  of  corporate  law  and  general  procedure 
are  given  principles  and  also  working  details  as  far  as  can  be 
done  in  a  work  intended  to  be  used  in  every  state  of  the  union. 
It  must  be  remembered  that  some  of  these  matters  are  liable 
to  be  affected  by  the  continually  changing  legislative  enactments 
of  the  different  states,  which  are  too  voluminous,  too  divergent, 
and  too  unstable  to  be  brought  into  the  present  valume.  Such 
variations  from  general  practice  must  be  obtained  from  the 
statutes  of  the  particular  state. 

Corporate  finance  is  one  of  the  most  important  and  least 
understood  responsibilities  confronting  the  corporate  officials. 
The  aim  here  has  been  to  give  as  clear  and  practical  a  statement 
of  both  principles  and  procedure  as  possible,  introducing  theory 
only  where  necessary  to  explain  the  usual  practice  or  some 
divergence  ^from  the  usual  practice.  Many  of  the  matters 
discussed,  as  the  proportion  of  fixed  and  working  capital,  the 
requirements  and  methods  of  borrowing,  the  distribution  of 
profits,  accumulation  of  reserves,  etc.,  are  general  in  their 
nature,  applying  to  any  other  form  of  business  organization  as 
well  as  to  the  corporation.  They  are,  however,  so  fundamental 
and  so  necessary  to  an  understanding  of  practical  corporate 
finance  that  they  could  not  be  omitted. 

The  presentation  of  accounting  procedure  has  been  based  on 
the  best  modern  practice,  and  where  good  practice  is  not  entirely 
uniform,  or  not  fully  established,  the  different  methods  are 
given,  the  reasons  for  divergencies  are  pointed  out,  and  the 
advantages  or  disadvantages  of  the  various  possible  courses  are 
indicated. 

The   concluding   portion   of   the   volume   containing   over 


vi  PREFACE 

250  forms  used  in  corporate  procedure  contributes  largely  to  the 
usefulness  of  the  book  as  a  whole.  These  forms  have  been  given 
for  the  most  part  as  precedents,  i.e.,  in  completed  shape,  so  as 
to  avoid  the  usual  blanks  for  variable  matter.  This  gives  a 
better  idea  of  the  form  as  a  whole.  At  the  same  time  the  changes 
necessary  to  adapt  the  form  to  any  special  need  are  more  readily 
made  from  the  completed  instrument  than  from  one  broken  up 
by  frequent  and  sometimes  puzzling  blanks. 

All  those  who  have  assisted  in  the  preparation  of  "Corporation 
Procedure"  have  written  before  on  the  same  or  closely  connected 
subjects,  and  it  is  their  hope  that  this  result  of  their  combined 
efforts  will  meet  with  the  same  friendly  and  appreciative  recep- 
tion that  was  accorded  their  respective  corporate  writings 
when  published  as  independent  volumes. 

Hugh  R.  Conyngton 
New  York  City, 
May  10,  1922 


^aT'.'Ai!  > 


CONTENTS 


BOOK  I— CORPORATE  LAW 
Part  I — The  Corporate  Form 

Chapter  ad-^a  a  m.  .  Page 

I    Introduction 3 

II    Business  Organizations 7 

III  Advantages  of  the  Corporate  Form 13 

IV  Disadvantages  of  the  Corporate  Form      ....  22 

Part  II — Pre-incorporation  Considerations 

V    Subscription  Lists  and  Contracts 5^ 

VI    Contracts  Prior  to  Incorporation 42 

VII    Where  to  Incorporate 50 

VIII    Cost  of  Incorporation 60 

Part  III— The  Stock  System 

DC    The  Capitalization .69 

X    Stock 79 

XI    Preferred  Stock 87 

XII    Full-Paid  Stock i.     .     .  99 

i'      )  I  I  V 

XIII  Treasury  Stock ^     ,.  104 

XIV  Shares  Without  Par  Value .  iii 

XV    No-Par  Value  Shares — Advantages 120 

XVI    No-Par  Value  Shares — Procedure 124 

Part  IV — Corporate  Control 

XVII    Stockholders      .     .     .    ^^^^^^^\     ....  131 

XVIII    Directors 147 

XIX    Officers 157 

vii 


vm 


CONTENTS 


Chapter 


XX 

Charter- 

XXI 

Charter- 

XXII 

Charter- 

XXIII 

Charter- 

XXIV 

Charter- 

XXV 

Charter- 

XXVI 

Charter- 

XXVII 

Charter- 

Page 
Part  V— The  Charter 

-General  Considerations 165 

-Incorporators  172 

-The  Corporate  Name 177 

-The  Corporate  Purposes 182 

-Stock;  Location  and  Duration      .     .     .  187 

-The  Board  of  Directors 192 

-Special  Provisions 199 

-Execution  AND  Filing;  Amendment      .     .  208 


Part  VI~The  By-Laws 

XXVIII    By-Laws — General  Consideration 215 

XXIX    By-Laws — Stock 222 

XXX    By-Laws — Stockholders 228 

XXXI    By-Laws — The  Board  of  Directors 235 

XXXII    By-Laws — Standing  Committees 245 

XXXIII  By-Laws— Officers 252 

XXXIV  By-Laws — Dividends   and   Finance;    Sundry   Pro- 

visions    260 

Part  VII — Organization  Meetings 

XXXV    First  Meeting  of  Stockholders 267 

XXXVI    First  Meeting  of  Directors 277 

Part  VIII — Stock  Records  and  Stock  Transfer 

XXXVII    The  Stock  Records 287 

XXXVIII    Transfer  OF  Stock 296 

XXXIX    Transfer  of  Stock  (Continued) 302 

XL    Transfer  of  Stock — Rules 312 

XLI    Stock  Transfer  Taxes;  Corporate  Taxes      .     .     .  327 


Part  IX — Meetings  and  Records 

XLII    Annual  Meeting  of  Stockholders 335 

XLIII    Special  Meetings  of  Stockholders  ......  352 

XLIV    Meetings  of  Directors 358 

XLV    Minutes  of  Meetings 369 


CONTENTS 


IX 


Chapter  Page 

Part  X— The  Treasurer 

XL VI    Treasurer's  Duties  and  Powers 377 

XLVII    Treasurer's     Relation     to     Other     Corporate 

Authorities 385 

XLVIII    Treasurer's  Liabilities 393 

XLIX    The  Treasurer's  Bond 401 

L    The  Treasurer's  Reports 412 

Part  XI — The  Corporate  Fmances 

\ 

LI    The  Corporate  Funds 415 

LII    Dividends 420 

LIII    Dividends  (Continued) 431 

LIV    Bonds 447 

LV    Bonds  (Continued) 457 

Part  XII — Corporate  Arrangements 

LVI    Voting  Trusts 467 

LVII    Holding  Companies 473 

LVIII    Protection  of  Minority  Stockholders      ....  483 

LIX    Incorporating  a  Partnership 497 

LX    The  Management  of  Close  Corporations             .     .  510 

LXI    Consolidation,  Reorganization  and  Dissolution      .  516 

Part  XIII — Allied  Forms  of  Organization 

LXII    Joint-Stock  Companies  and  Partnership  Associa- 
tions        525 

LXIII    Express  Trusts  as  a  Form  of  Business  Organization  532 

LXIV    How  an  Express  Trust  is  Organized 545 


BOOK  II-CORPORATE  FINANCE 

Part  I — The  Corporation 

I  Principles  of  Finance 555 

II  Organization  for  Business 563 

III  The  Corporate  Organization  573 

IV  The  Corporation  in  Modern  Business;    Holding 

Companies 583 


CONTENTS 


Chapter 

V 

VI 

VII 

vni 

IX 
X 

XI 


XII 
XIII 

XIV 
XV 

XVI 

XVII 
XVIII 


XIX 

XX 

XXI 

XXII 

XXIII 

XXIV 

XXV 

XXVI 

XXVII 


XXVIII 

XXIX 

XXX 

XXXI 


Page 
Part  n — Corporate  Securities 

Common  Stock 595 

Preferred  Stock 601 

Bonds 612 

Secured  Bonds 624 

Unsecured  Bonds 634 

Short-Term  Notes 647 

Redemption  of  Bonds — Sinking  Funds 653 

Part  III — The  Financial  Organization 

Capitalization — Basis 'f.tl  .11..  663 

Capitalization — Good-Will,    Surplus   and   iNlTiAt 

Expenses 676 

Fixed  and  Working  Capital 686 

Working    Capital   Requirements — Time,  Turnover 

AND  Terms  of  Purchase 697 

Working   Capital  Requirements — Terms  of  Sale, 

Special  Problems 708 

The  Financial  Plan 720 

Combinations 737 

Part  IV — Securing  Capital 

Promotion — Preparatory  Work 753 

Promotion — Methods  of  Finakceng 765 

The  Promoter 772 

Promoters'  Profits 784 

Sources  OF  Capital  Funds 791 

Selling  Securities  Direct — To  Business  Associates  799 
Selling  Securities  Direct — To  Outsiders       .           .  814 
Selling  Securities  Through  Dealers;    Stock  Ex- 
change Methods 823 

Underwriting 837 

Part  V — Internal  Financial  Management 

Borrowed  Capital "  849 

Net  Income 867 

Dividends 883 

Payment  of  Dividends 898 


CONTENTS 


XI 


Chapter 

XXXII 

XXXIII 

XXXIV 

XXXV 

XXXVI 


XXXVII 

XXXVIII 

XXXIX 

XL 

XLI 


Page 

Surplus 908 

Budgetary  Control 922 

Expansion 936 

Financial  Standards 947 

Analysis  Based  on  Financial  Standards    ....  960 

Part  VI — Financial  Abuses  and  Involvements 

Exploitation  by  Officers 967 

Exploitation  by  Directors  and  Stockholders     .     .  979 

Insolvency  and  Receivership 992 

Reorganization loio 

Ends  Attained  by  Reorganization 1018 


BOOK  III-CORPORATE  ACCOUNTING 

Part  I — Surplus  and  Reserve  Accounts 

I  The  Corporate  Records  and  Accounts      ....  1033 

II    The  Surplus  Account 1038 

III  Reserve  Accounts 1047 

IV  Classification  of  Surplus 1056 

Part  II — The  Original  Capital  of  the  Corporation 

V    Par-Value  Stock  of  Original  Issue — Full-Paid  at 

Once 1065 

VI    Par- Value  Stock  of  Original  Issue — Not  Full-Paid 

AT  Once 1076 

VII    Stock  Subscription  System 1086 

VIII    Sale  of  Stock  Below  or  Above  Par 1096 

IX    Treasury  Stock  With  a  Par  Value iioi 

X    Par- Value  Donated  Stock 11 06 

XI    Capital  Stock  Without  Par  Value 1113 

XII    Non-Stock  Corporations 11 28 

Part  III — Special  Cases  in  Capital  Stock  Transactions 

XIII  Miscellaneous  Stock  Transactions 1133 

XIV  Dividends 1142 

XV    Typical  Corporate  Organizations 1156 


xu 


CONTENTS 


Chapter  Page 

XVI  Incorporation  of  Sole  Proprietorship       ....  1165 

XVII  Incorporation  of  Partnership 11 72 

Part  IV — Bonds  and  Funds 

XVIII  Bond  Records  and  Accounts 1185 

XIX  Bond  Sales 1194 

XX  Bond  Interest 1202 

XXI  Bond  Discount  aistd  Premium 12 13 

XXII  Principles  of  Fund  Accounting 1225 

XXIII  Entry  of  Fund  Transactions 1236 

XXIV  Redemption  of  Bonds 1247 

Part  V — Corporate  Combinations 

XXV  Combination  by  Lease 1259 

XXVI  Holding  Companies 1268 

XXVII  Combination  by  Merger  or  Purchase 1278 

Part  VI — Dissolution,  Reorganization,  Receivership 

XXVIII  Voluntary  Dissolution  of  Corporations  ....   1297 

XXIX  Reorganization  by  Agreement 1307 

XXX  Receivership  and  Reorganization 13 12 

XXXI  Receivership  and  Sale 133 1 

Part  VII — Corporation  Statements 

XXXII  Closing  the  Books 1349 

XXXIII  Forms  of  Statements 1354 

XXXIV  Consolidated  Statements 1373 

XXXV  Consolidated  Statements  (Continued)        ....   1384 

XXXVI  Preparation  of  Federal  Income  Tax  Returns    .     .  1399 


BOOK  IV-CORPORATE  FORMS 


Part  I — Forms  Relating  to  Organization 


Charter  Forms    . 

Form 

1.  New  York  Charter 

2.  New  Jersey  Charter 


1425 


CONTENTS  xiii 

Chapter  Page 

3.  Delaware  Charter 

4.  Delaware  Charter — No-Par- Value  Shares 

II    Special  Charter  Clauses 1442 

Form 

5.  Advertising 

6.  Amusement  Devices 

7.  Automobiles 

8.  Automobiles  and  Garage 

9.  Bonds  and  Securities 

10.  Brick  Machinery 

11.  Building  Materials 

12.  Cloaks  and  Garments 

13.  Contracting  and  Building 

14.  Cotton  and  Textile  Fabrics 

15.  Dairy  and  Farm  Products 

16.  Department  Store 

17.  Drugs 

18.  Dry-Goods 

19.  Electrical  Supply  Company 

20.  Engineering — Mechanical 

21.  Express  and  Delivery 

22.  Films  and  Motion  Pictures 

23.  Furniture 

24.  Gas  and  Electric  Fixtures 

25.  Hardware 

26.  Heating  Apparatus 

27.  Hotel 

28.  Ice  Company 

29.  Inventions  and  Patents 

30.  Inventions  and  Patents 

31.  Jewelry 

32.  Leather 

33.  Lighting  and  Heating 

34.  Locks 

35.  Lumber 

36.  Manufacturing  (General) 

37.  Meat  and  Cattle 

38.  Metal-Working 

39.  Mining 

40.  Oil 

41.  Opticians 

42.  Paints  and  Painters'  Supplies 

43.  Periodical  or  Newspaper 

44.  Photographic  Apparatus 

45.  Pianos  and  Musical  Instruments 

46.  Printing 

47.  Railroad  Construction 

48.  Real  Estate 

49.  Refrigerating  Company 

50.  Schools 

,  SI.  Securities  Company  (New  York) 

52.  Smelting  and  Allied  Operations  (New  Jersey) 

53.  Textile  Fibers 


xiv  CONTENTS 

Chapter  Page 

Inclusive  Clauses 

54.  To  Buy  and  Hold  Real  Estate 

55.  To  Conduct  Any  Other  Business 

56.  To  Acquire  Other  Enterprises 

57.  To  Carry  on  Business  in  Other  States 

58.  To  Promote  Other  Undertakings 

59.  To  Enter  Into  Contracts 

60.  To  Borrow  Money 

61.  To  Acquire  the  Company's  Own  Stock 

62.  To  Acquire  Stock  of  Other  Companies 

63.  Strengthening  Clause 

64.  Interpretation  Clause 

III  By-Laws  Forms 1463 

Form 

65.  By-Laws — Short 

66.  By-Laws — Extended 

IV  Subscription  Lists 1474 

67.  Subscription  List — Simple  Form 

68.  Subscription  Blank — Individual 

69.  Subscription  to  Bank  Stock — Individual 

70.  Subscription  List — Trustee's 

71.  Subscription  List — Agreement  with  Promoters 

V    Subscription  Receipts  and  Records 1479 

Form 

72.  Trustee's  Receipt 

73.  Treasurer's  Receipt  for  Instalment 

74.  Treasurer's  Receipt  for  Stock  Subscription 

75.  Stock  Scrip 

76.  Indorsement  Form  for  Stock  Scrip 

77.  Assignment  of  Subscription  and  Payments 

VI    Stock  Certificates 1484 

Form 

78.  Stock  Certificate — Common  Stock 

79.  Stock  Certificate — No-Par- Value  Shares 

80.  Stock  Certificate — Preferred  Stock 

81.  Assignment  of  Stock  Certificate 

82.  Voting  Trustees'  Certificate 

83.  Voting  Trustees'  Certificate — Simple  Form 

84.  Assignment  of  Voting  Trustees'  Certificate 

VII    Stock  Books 1493 

Form 

85.  Stock  Transfer  Book 

86.  Stock  Book  or  Stock  Ledger 

87.  Broker's  Stock  Book  (New  York) 

88.  Corporate  Stock  Book  (New  York) 

VIII    Organization  Meetings  op  Stockholders     ....  1498 

Form 

89.  Minutes  of  Stockholders'  First  Meeting 


CONTENTS  .  XV 

Chapter  Page 

90.  Call  and  Waiver  of  Notice — Stockholders' 

91.  Proxy — First  Meeting  of  Stockholders 

92.  Inspector's  Report 

93.  Waiver  of  Notice  of  Assessment 

IX    Organization  Meeting  of  Directors      .     .     .     .     .  1504 
Form 

94.  Minutes  of  Directors'  First  Meeting 
_    »,                     95.  Call  and  Waiver — Directors' 

''^  96.  Secretary's  Oath  of  Of&ce 

97.  Proposal  to  Exchange  Property  for  Stock 

98.  Assignment  of  Subscriptions 

99.  Call  for  First  Directors'  Meeting 

X  Options  and  Voting  Trust  Agreements      .     .     .     .1512 

Form 

100.  Option  on  Capital  Stock 
loi.  Option  on  Business  and  Property 
102.  Option  on  Real  Estate 
.    .  103.  Assignment  of  Option 

104.  Voting  Trust  Agreement 

Part  II — Forms  Relating  to  Corporate  Meetings 

XI  Calls  and  Waivers  for  Special  Meetings     .     .     .1519 

Special  Meetings  of  Stockholders 
Form 

105.  Call  and  Waiver  for  Special  Meeting  of  Stockholders 

106.  President's  Call  for  Special  Meeting  of  Stockholders 

107.  President's  Call  for  Special  Meeting  of  Stockholders — 

Formal 

108.  Directors'  Call  for  Special  Meeting  of  Stockholders 

109.  Directors'  Instructions  for  Special  Meeting  of  Stock- 

holders 
no.  Directors'  Resolution  for  Special  Meeting  of  Stock- 
holders 

111.  Stockholders'  Request  for  Special  Meeting 

112.  President's  Indorsement  of  Stockholders'  Request 

113.  Stockholders'  Call  for  Special  Meeting 

Special  Meetings  of  Directors 

114.  Call  and  Waiver  for  Special  Meeting  of  Directors 

115.  Agreement  for  Consent  Meeting  of  Directors 

1 16.  President's  Call  for  Special  Meeting  of  Directors 

117.  Directors'  Call  for  Special  Meeting  of  Directors 

XII    Notices  of  Meetings •  ,     .     .1529 

Stockholders'  Meetings 

118.  Notice  of  Special  Meeting  of  Stockholders 

119.  Publication  Notice  of  Special  Meeting  of  Stockholders 

120.  Publication  Notice  of  Special  Meeting  of  Stockholders 

121.  Notice  of  Annual  Meeting 


xvi  .       CONTENTS 

Chapter  Page 

122.  Publication  Notice  of  Annual  Meeting 

123.  Publication  Notice  of  Annual  Meeting ' 

124.  Publication  Notice  of  Annual  Meeting 

Directors*  Meetings 

125.  Notice  of  Special  Meeting  of  Directors 

126.  Notice  of  Regular  Meeting  of  Directors 

XIII  Proxies  for  Meetings 1535 

Form 

127.  Proxy — Simple  Form 

128.  Proxy — Unlimited 

129.  Proxy — Time  Limited 

130.  Proxy  for  Particular  Meeting 

131.  Proxy — Limited  as  to  Stock 

132.  Proxy  for  Annual  Meeting — Formal 

133.  Corporate  Proxy 

134.  Revocation  of  Proxy 

XIV  Motions  and  Resolutions 1543 

Form 

135.  Motion  Instructing  Secretary  to  Cast  Vote 

21  136.  Motion  Instructing  Secretary  to  Cast  Vote — Formal 

137.  Motion  to  Amend  By-laws 

138.  Motion  to  Pay  Bills 

139.  Motion  to  Employ  General  Manager 

140.  Motion  to  Appoint  an  Investigating  Committee 

141.  Stockholders  Resolution  for  Sale  of  Entire  Assets 

142.  Stockholders'  Resolution  Authorizing  Consolidation 

143.  Stockholders'  Resolution  to  Amend  By-laws 

144.  Directors'  Resolution  to  Open  Bank  Account 

145.  Directors'  Resolution  Designating  Depositary 

146.  Directors'  Resolution  Designating  Bank 

147.  Directors'  Resolution  Authorizing  Issue  of  Stock 

148.  Directors'  Resolution  Authorizing  Contract 

149.  Directors'  Resolution  Declaring  Dividend 

150.  Directors'  Resolution  Declaring  Dividend — Preferred 

Stock 

151.  Directors'  Resolution  Declaring  Dividend — Preferred 

and  Common  Stock 

152.  Directors'  Resolution  Appointing  Managing  Director 

153.  Directors'  Resolution  Calling  Special  Meeting  of  Stock- 

holders 

154.  Directors'  Resolution  to  Sell  Bonds 

155.  Directors'  Resolution  to  Purchase  Property 

156.  Directors'  Resolution  for  Settlement  of  Claim 

157.  Directors'  Resolution  Ratifying  Sale  of  Property 

■  1^8.  Directors'  Resolution  Removing  Officer  (New  York) 

159.  Directors'  Resolution  for  Sale  of  Entire  Assets 

XV    Forms  Used  in  Connection  With  Meetings    .     .     .1553 
Form 

160.  Secretary's  List  of  Stockholders 

161.  Outline  Minutes  for  Annual  Meeting 


CONTENTS  XVU 

Chapter  Page 

162.  Oath  of  Inspectors  of  Election — New  York 

163.  Certificate  of  Inspectors  of  Election — New  York 

164.  Acknowledgment  of  Inspectors'  Certificate 

165.  Certificate  of  Inspectors  of  Election — General 

166.  Ballot  at  Annual  Meeting 

167.  Ballot  at  Annual  Meeting — Formal 

XVI    Minutes  of  Corporate  Meetings iSSy 

Form 

168.  Minutes  of  Annual  Meeting  of  Stockholders 

169.  Minutes  of  Special  Meeting  of  Stockholders 

1 70.  Minutes  of  Adjourned  Meeting  of  Stockholders 

171.  Minutes  of  Regular  Meeting  of  Directors 

172.  Minutes  of  Adjourned  Meeting  of  Directors 

173.  Minutes  of  Special  Meeting  of  Directors 

Part  ni— Forms  Relating  to  General  Procedure 

XVII  Miscellaneous  Notices 1569 

Subscription  and  Assessment  Notices 
Form 

174.  Instalment  Notice 

175.  Notice  of  Stock  Assessment 

176.  Notice  of  Stock  Assessment — Statutory 

177.  Notice  of  Sale  of  Delinquent  Stock 

Notices  Relating  to  Dividends 

178.  Dividend  Notice — Mailing 

179.  Dividend  Notice — Publication 

180.  Notice  Accompanying  Dividend  Check 

181.  Dividend  Notice 

182.  Dividend  Notice — -Common  Stock 

183.  Dividend  Notice — Common  and  Preferred  Stock 

184.  Dividend  Notice — Mailing  Orders  Requested 

185.  Mailing  Order  for  Dividends 

Notices  of  Appointment 

186.  Notice  of  Election  as  Director 

187.  Notice  of  Election  as  Director — Acceptance  Requested 

188.  Notice  of  Appointment  as  General  Manager 

189.  Tender  of  Position  as  Sales  Manager 

XVIII  Resignations 1578 

Form 

190  Resignation  of  Director 

191.  Resignation  of  Director — Effective  on  Acceptance 

192.  Resignation  of  Director — Peremptory 

193.  Resignation  of  Director — Future  Date 

194.  Resignation  of  President — Conditional 
19.";.  Resignation  of  Treasurer 


xviii  CONTENTS 

Chapter  Page 

XIX    Corporate  and  Official  Signatures 1582 

Form 

rr)6.  Official  Signature — Informal 

197.  Official  Signature — Formal 

198.  Corporate  Signature — Informal 

199.  Corporate  Signature — Formal 

200.  Testimonium    Clauses — Corporate    Signature — Seal 

Attested 

201.  Testimonium  Clause — Two  Corporate  Signatures 

202.  Testimonium  Clause — Corporate  and  Individual .  Sig- 

natures 

203.  Testimonium  Clause — Corporate  and  Individual  Sig- 

natures 

204.  Testimonium  Clause — Signature  by  Agent 

XX  Checks,  Receipts  and  Notes 1588 

Corporate  Checks 
Form 

205.  Check — Corporate  Signature 

206.  Check — Countersigned 

207.  Check — Official  Signatures 

208.  Check — Official  Signatures — Purpose  Stated 

209.  Check — Draft  Form 

210.  Dividend  Check 

211.  Indorsement  of  Corporate  Check 

212.  Indorsement  of  Check  for  Deposit 

213.  Corporate  Draft 

Corporate  Receipts 

214.  Corporate  Receipt 

215.  Corporate  Receipt — Official  Signature 

216.  Dividend  Receipt 

Corporate  Notes 

217.  Corporate  Note — By  President 

218.  Corporate  Note — By  Treasurer 

219.  Collateral  Note — On  Demand 

220.  Corporate  Note — Collateral  Security 

XXI  Certifications 1598 

Form 

221.  Certificate  to  Service  of  Notice 

222.  Affidavit  to  Service  of  Notice 

223.  Affidavit  to  Pubhcation  of  Notice 

224.  Certified  Resolution  Designating  Bank 

225.  Certification  of  Resolution  Designating  Bank 

226.  Certification  of  Resolution 

227.  Certificate  of  Election  of  Treasurer 

228.  Certificate  of  Election  of  Officers 

229.  Certification  of  Transcript  from  By-laws 

230.  Certification  of  By-laws  as  a  Whole 

231.  Certification  of  Transcript  from  Minutes 

232.  Certification  of  Minutes — President  and  Secretary 

233.  Secretary's  Affidavit  to  Minutes 

234.  Notarial  ExempUfication  of  Minutes 


CONTENTS  jdx 

Chapter  Page 

235.  Treasurer's  Affidavit  to  Corporate  Statement 

236.  Notarial  Acknowledgment — New  York 

XXII    Powers  of  Attorney,  Contracts  and  Assignments  .     .   1606 

Powers  of  Attorney 
Form 

237.  Power  of  Attorney — To  Receive  Dividends 

238.  Power  of  Attorney — To  Collect  Money 

239.  Power  of  Attorney — To  Deliver  Deed 

240.  Power  of  Attorney — To  Manage,  Sell,  and  Deed  Land 

241.  Revocation  of  Power  of  Attorney 

Corporate  Contracts  and  Assignments 

242.  Corporate  Contract 

243.  Corporate  Bill  of  Sale 

244.  Assignment  of  Contract 

245.  Assent  to  Assignment  of  Contract 

246.  Assignment  of  Contract — By  Indorsement 

247.  Assignment  of  Patent — Individual  to  Corporation 

XXIII  Bonds  of  Indemnity 1616 

Form 

248.  Treasurer's  Bond — Personal 

249.  Indemnity  Bond  for  Lost  Stock  Certificate 

Part  rV — Forms  Relating  to  Bond  Issues 

XXIV  Bond  Issues — The  Bond 1619 

Form 

250.  Coupon  Bond 
25oa.Coupon 

251.  Trustee's  Certificate 
•    252.  Debenture  Bond 

XXV    Bond  Issues — The  Deed  of  Trust 1623 

Form 

253.  Deed  of  Trust 

Part  V — Corporate  Records,  Reports,  and  Calendar 

XXVI    Miscellaneous  Books  and  Records 1633 

Form 

254.  Subscription  Journal 

255.  Instalment  Book 

256.  Transfer  Register 

257.  Dividend  Book — Personal  Payment 

258.  Dividend  Book — Payment  by  Mail 

259.  Bond  Register 

260.  Index  of  Bondholders 

261.  Coupon  Register 


CONTENTS 


Chapter 
XXVII 


Page 
1643 


-Statement  of 


Reports 

Form 

262.  President's  Annual  Report 

263.  Report  on  Employees  and  Pay-Rolls 

264.  Treasurer's  or  Comptroller's  Report— S 

Earnings 

265.  Treasurer's  or  Comptroller's  Report — Balance  Sheet 

266.  Report  of  Committee  on  By-Laws 

XXVIII    Corporate  Calendar 1653 

Form 

267.  Corporate  Calendar  (New  York) 


Corporation 
Procedure 


BOOK  I 
CORPORATE  LAW 


.  >1 


til 


Part  I— The  Corporate  Form 


1  <. I  >■..-. 

CHAPTER  I 

ti 

INTRODUCTION 

.  ,1) 

§  I.    Business  Organization  and  the  Law 

All  business  relations  and  organizations  depend  for  their 
binding  quality  on  the  law.  For  that  reason  this  introductory- 
chapter  presents  in  outline  form  a  few  of  the  more  basic  prin- 
ciples of  the  law  of  contracts,  of  agency,  and  of  partnership, 
and  an  equally  brief  discussion  of  legal  phraseology  and  of  the 
distinction  between  common  and  statutory  law — just  those 
matters  directly  involved  in  the  consideration  of  business 
organization.  ^.^ 

§  2.    Law  of  Contracts 

All  business  relationships  are  founded  on  contracts.  A  con- 
tract is  an  agreement  of  such  a  nature  that  it  may  be  enforced 
at  law.  The  sale  of  goods,  the  appointment  of  agents,  the 
employment  of  assistants,  and  all  other  business  transactions 
are  contracts,  or  are  based  on  contracts.  Both  partnerships 
and  corporations  are  based  on  contracts. 

The  accepted  legal  definition  of  a  contract  is  "an  agreement 
between  two  or  more  parties,  for  a  sufiicient  consideration,  to 
do  or  not  to  do  some  specified  thing  or  things." 

It  is  an  agreement  and  the  minds  of  the  parties  "must 
meet." 

There  must  be  two  legally  competent  parties  to  a  contract 
and  there  may  be  more. 

3 


4  CORPORATE  LAW  [Bk.  I- 

There  must  be  a  "consideration,"  that  is,  a  legal  induce- 
ment or  recompense  in  order  to  bind  each  party.  If  there 
were  no  consideration,  it  might  be  a  matter  of  honor  for  a  man 
to  keep  his  promise,  but  the  law  would  not  compel  him  to 
keep  it  or  to  give  the  other  party  damages  if  he  failed  to  keep  it. 

There  must  be  an  obligation,  or  thing  to  be  done.  It  may 
be  to  sell  something,  or  to  do  something,  or  to  pay  money,  or 
it  may  be  not  to  do  something  the  person  would  otherwise  be 
free  to  do  or  not  to  do. 

§3.    Law  of  Principal  and  Agent  R91O  «8dfliaifa    .z  ; 

In  modern  business  life  many  things  are  necessarily  done 
by  proxy.  Consequently,  the  larger  proportion  of  men  in  busi- 
ness are  not  acting  for  themselves  but  as  agents  for  others.  In 
all  forms  of  partnership  and  corporate  activity  the  business 
that  is  done  is  done  by  agents.  Therefore  the  subject  comes 
up  again  and  again  in  this  volume. 

An  agent  is  one  who  represents  or  is  authorized  to  represent 
another  person  in  some  business  transaction  or  transactions. 
The  person  or  the  corporation  who  is  represented  by  an  agent 
is  called  the  "principal."  The  relation  between  the  principal 
and  the  agent  is  termed  "agency." 

The  agent  may  be  known  as  "agent,"  "factor,"  "broker," 
"attorney,"  "proxy,"  "delegate,"  or  "representative."  A  part- 
nership is  represented  by  its  members  who  are  agents  for  the 
firm.  A  corporation  is  represented  by  its  officers  who  are  its 
agents.  A  corporation  can  contract  in  no  other  way  than 
through  its  agents. 

§  4.    The  Law  of  Partnership 

There  are  but  two  forms  of  business  organization  in  general 
use:  the  partnership  and  the  corporation.  In  this  place  it  is 
only  desired  to  stress  those  features  of  the  law  of  partnership 
that  differentiate  it  from  the  corporation.  These  features  are 
inherent  in  the  two  forms  of  organization. 


Ch.  i]  INTRODUCTION  5 

A  partnership  is  the  result  of  a  contract  between  two  or 
more  competent  parties,  to  combine  their  money,  property, 
skill,  or  labor  for  the  transaction  of  some  lawful  business  for 
profit — it  is  nothing  more  than  a  group  of  individuals  considered 
as  individuals. 

In  a  corporation,  on  the  other  hand,  the  individuals  are 
merged  in  the  corporate  entity.  That  is,  the  law  allows  a 
corporation  to  act  as  one  person,  while  a  partnership  must  act 
as  a  group.  Hence,  in  a  partnership  each  member  is  liable  for 
the  firm  debts  as  if  they  were  his  own,  while  in  a  corporation 
a  member  is  liable  only  for  what  he  agrees  to  invest  or  has 
invested  in  its  stock. 

§  5.    The  Common  Law 

The  common  law  had  its  origin  at  a  very  early  date.  As 
soon  as  men  commenced  to  live  in  communities,  certain  rules 
of  conduct  were  evolved,  certain  uniform  methods  of  doing 
things  grew  up,  and  certain  customs  of  dealing  with  each  other 
generally  prevailed.  When  disputes  arose,  they  were  decided 
by  these  rules  and  methods  and  customs.  These,  being  made 
the  basis  of  decisions,  gradually  acquired  the  force  of  established 
law,  and  so  after  a  time,  without  any  legislative  action,  the 
early  communities  came  to  have  a  considerable  body  of  law 
which  was  called  in  England  the  "common  law." 

When  this  country  broke  away  from  England  at  the  time 
of  the  Revolution,  this  common  law  was  in  use  in  the  Thirteen 
Colonies,  was  retained  thereafter,  and  became  the  foundation 
for  our  state  and  national  systems  of  law.  When  the  common 
law  is  referred  to,  it  means  this  inherited  law  in  contradistinc- 
tion to  the  laws  passed  by  state  legislatures  and  Congress, 
which  are  referred  to  as  "statutory  law."  Many  features  of 
the  common  law  have  been  made  doubly  binding  by  being 
adopted  by  legislatures  and  enacted  as  part  of  the  statutory 
law.  On  this  account  the  common  law  and  the  statutory  law 
largely  overlap. 


6  CORPORATE  LAW  iBk   I- 

§  6.    The  statutory  Law 

The  legislatures  of  the  states  and  the  Congress  of  the  United 
States  pass  laws  or  statutes.  These  collectively  are  desig- 
nated as  statutory  law. 

The  modern  corporation  is  a  creation  of  the  law  as  passed 
by  a  legislature  or  by  Congress.  Hence,  in  dealing  with  cor- 
porate organization  or  the  technical  management  of  corpora- 
tions it  is  always  necessary  to  keep  in  close  touch  with  the 
statutes.  As  these  statutes  differ  in  the  different  states  and  are 
changed  frequently,  it  is  not  possible  to  bring  them  all  into  a 
work  such  as  this. 

It  is,  as  intimated,  necessary  for  the  corporation  lawyer  or 
official  responsible  for  the  technical  conduct  of  his  corporation 
to  keep  in  close  touch  with  the  state  laws  and  their  changes. 
In  the  more  populous  states  this  is  easily  done  as  careful  com- 
pilations may  be  secured,  giving  the  laws  relating  to  corpora- 
tions and  the  decisions  of  the  courts  on  corporate  matters. 
In  other  states  the  authorities  usually  issue  the  corporate  laws 
in  pamphlet  form,  and  they  may  be  had  by  application  to  the 
proper  state  authority — usually  the  secretary  of  state. 

The  present  book  gives  the  principles  of  corporate  law  that 
prevail  in  all  the  states  and  form  the  basis  of  the  statutory  law, 
and  in  many  cases  calls  attention  to  the  variations  of  the  basic 
law  found  in  different  states.  For  a  working  knowledge  of 
these  state  laws,  however,  with  their  numerous  variations,  refer- 
ence must  be  made  to  the  statutes  of  the  particular  state  for 
which  the  information  is  desired. 


CHAPTER  II 
BUSINESS  ORGANIZATION 

§  7.    Economic  Necessity  for  Organization^ 

In  a  primitive  society,  no  organization  other  than  the  natu- 
ral operations  of  the  family  unit  would  be  called  for;  but  so 
soon  as  any  progress  to  a  higher  social  order  was  to  be  made, 
some  form  of  organized  or  co-operative  effort  was  unavoidable. 
The  greater  effectiveness  of  team-work — of  the  united  effort 
of  two  or  more  working  together  for  a  common  purpose — gave 
those  who  could  so  co-operate  a  great  advantage  over  the  soli- 
tary individual.  The  same  thing  was  true  as  each  step  in 
advance  was  taken,  and  for  this  reason  the  earlier  forms  of 
organization  employed  in  business  have  in  the  course  of  ages 
developed  into  the  present-day  partnership  and  corporation. 

§  8.    Individual  Management 

It  is  probable  that  there  was  a  time  when  no  business 
co-operation  between  equals  was  possible,  and  all  trade  and 
industry  were  carried  on  by  individuals  of  exceptional  initia- 
tive with  the  help  of  paid  employees  and  slaves.  Some  such 
survivals  are  yet  found,  men  of  great  ability  and  will-power — 
men  who  cannot  brook  opposition  and  who  have  so  accus- 
tomed themselves  to  playing  the  game  alone  that  they  cannot 
or  will  not  co-operate  with  others  in  any  form  of  organization. 
Such  men  may  go  high  in  the  business  world  but  they  neces- 
sarily work  at  a  disadvantage  compared  with  those  who  are 
able  to  co-operate  with  their  fellows. 

It  is  possible  to  carry  on  successfully  farming  and  various 
small  businesses  in  this  manner  at  the  present  day,  and  such 


i  See  also  Book  II,  Ch.  II,  "Organization  for  Business." 

7 


8  CORPORATE  LAW  [Bk.  I- 

individual  enterprises  often  give  the  future  business  leader  a 
valuable  training  in  initiative  and  responsibility.  When,  how- 
ever, we  come  to  enterprises  of  greater  size,  it  is  practically 
always  necessary  to  take  a  partner  or  partners,  or  to  incor- 
porate. There  have  been  some  few  exceptions.  For  instance, 
John  Wanamaker  for  many  years  conducted  his  great  business 
under  his  individual  management.  He  was,  however,  finally 
driven  to  incorporation,  and  at  the  present  time  there  is  in 
this  country  no  single  instance  of  a  really  great  business  con- 
ducted as  a  sole  proprietorship. 

§  9.    Partnership 

The  first  advance  in  business  organization  was  when  two 
men  found  that  they  could  work  together  in  transactions  for 
their  joint  advantage.  It  involved  such  relations  of  trust  and 
confidence  that  in  the  early  days  it  rarely  extended  to  more 
than  two  partners. 

Partnership  has  always  involved  mutual  authority  and 
mutual  responsibility.  Each  partner  is  an  agent  for  the  firm 
with  unlimited  powers.  He  can,  in  the  scope  of  the  partner- 
ship business,  contract  for  the  firm;  and  the  firm  is  bound, 
and  each  partner  to  the  extent  of  his  entire  fortune  is  also 
bound.  Many  men  have  been  ruined  by  the  fraud  or  the 
blundering  of  their  business  partners.  This  is  the  defect  of 
copartnership  as  a  form  of  business  organization.  Each  addi- 
tional partner  increases  the  risk.  It  is  not  safe  for  anyone  to  put 
capital  into  another's  private  business — save  under  special  con- 
ditions or  with  specific  contract  reservations — because  thereby 
he  becomes  himself  a  partner  and  may  lose  not  only  his  invest- 
ment but  also  all  that  he  has  outside.  It  is  this  peculiar  fea- 
ture of  partnership  liability  that  limits  the  utility  of  the  part- 
nership as  a  form  of  business  organization  and  has  made  the 
corporation  so  generally  preferred.^ 


2 See  Ch.  Ill,  "Advantages  of  the  Corporate  Form";  also  Book  II,  Part  I,  "The  Cor- 
poration." 


Ch.  2]  BUSINESS  ORGANIZATION  9 

On  the  other  hand,  partnership  has  certain  quahties  of 
effectiveness  which  under  some  conditions  make  it  superior  to 
every  other  form  of  business  organization.  During  the  inves- 
tigation of  the  Steel  Trust,  Andrew  Carnegie,  who  for  years 
operated  the  business  later  acquired  by  the  Carnegie  Steel 
Company,  made  the  following  statement: 

I  don't  believe  that  any  corporation  can  manage  a  business 
like  a  partnership.  When  we  were  partners  I  felt  that  we  could 
run  around  corporations.  You  take  thirty-five  young  men 
interested  in  watching  even  a  leak  in  a  spigot,  and  no  corporation 
can  compete  with  such  an  organization  in  any  business. 

There  are  practically  no  large  commercial  undertakings  in 
the  country  conducted  as  partnerships.  Endicott  Johnson 
Corporation,  Arbuckle  Brothers,  and  the  Baldwin  Locomotive 
Works  were  among  the  last  to  "succumb,"  but  all  these  are 
now  corporations. 

Joint-stock  companies  are  a  form  of  partnership  in  which 
the  investments  of  the  partnership  are  represented  by  shares 
of  stock.  The  holders  of  stock  are,  however,  partners  and  are 
subject  to  the  full  liability  of  partners;  on  this  account  it  is  a 
form  of  business  association  rarely  used, 

§  10.    Business  Corporations 

The  favored  modern  type  of  business  organization  is  the 
stock  corporation.  It  owes  its  pre-eminence  to  the  fact  that 
it  allows  those  who  are  not  actively  engaged  to  invest  money 
in  a  business  safely,  that  is,  without  risk  of  greater  loss  than  the 
amount  actually  invested,  and  at  the  same  time  participate  in 
full  proportion  in  any  profits  that  may  be  made.  The  impor- 
tance of  this  feature  of  the  corporate  organization  is  found  in 
the  fact  that  modem  industry  requires  large  amounts  of  capital. 

In  our  day  practically  all  production  is  capitalistic.  There 
are  to  be  sure,  marked  differences  in  the  degree  to  which  capitalism 
is  carried  in  various  industries.     Some  industries,  from  their  very 


lO  CORPORATE  LAW  [Bk.  I- 

nature,  seem  able  to  use  more  capital  than  others  located  in  the 
same  city  or  country;  and  the  industries  in  one  city  or  country  may, 
in  general,  use  more  than  those  in  another.  But,  however  great 
these  variations,  the  fact  remains  that  most  industries  can  use 
all  the  capital  available,  and  the  more  they  use  the  higher  is  the 
productive  efficiency  to  which  they  attain.^ 

No  form  of  business  organization  affords  the  facilities  foi 
securing  capital  from  outside  investors  that  are  found  in  the 
stock  corporation.  On  this  account  it  is  the  typical  modem 
business  association,  and  with  sHght  variations  of  form  is  found 
in  use  in  every  civilized  country  in  the  world. 

§  II.    The  Charter* 

A  partnership  is  formed  by  contract  between  the  partners 
interested.  A  corporation  is  formed  by  a  contract  between  the 
state  acting  through  the  state  authorities  on  one  hand  and  the 
incorporators  (i.e.,  those  who  organize  the  corporation)  on  the 
other.  The  evidence  of  this  contract  is  the  charter,  which  is 
also  termed  a  "certificate  of  incorporation,"  or  in  some  states 
the  "articles  of  association."  The  charter  is  an  instrument  in 
writing  authorizing  the  incorporators  and  those  that  they  asso- 
ciate with  themselves  later,  to  transact  the  business  for  which 
they  have  organized  as  a  corporation. 

The  right  of  organization  to  be  a  corporation  and  to 
carry  on  its  particular  business  is  based  solely  on  its  charter, 
which  is  its  authority  for  existence. 

§  12.    The  By-Laws  5 

Because  a  corporation  requires  more  detailed  rules  of  action, 
its  charter  or  the  laws  of  the  state  give  it  the  right  to  enact 
by-laws  for  its  government.  The  charter  is  the  basic  law  of 
the  corporation,  but  these  by-laws  are  adopted  by  its  sub- 
scribers or  stockholders  to  meet  its  need  for  more  detailed 


'  Taylor  on  Principles  of  Economics,  p.  90. 

*  See  Part  V,  "The  Charter." 

•  See  Part  VI,  "The  By-Laws." 


Ch.  2]  BUSINESS  ORGANIZATION  ll 

regulation.  By-laws  prescribe  the  issues  and  the  transfers  of 
stock,  the  meetings  of  stockholders  and  directors,  and  the  power 
and  authority  of  the  directors.  They  also  prescribe  what  officers 
the  corporation  shall  have  and  their  duties.  In  addition,  they 
direct  how  the  moneys  and  property  of  the  company  shall  be 
kept  and  handled  and  how  the  by-laws  themselves  from  time 
to  time  may  be  amended  and  changed. 

§  13.    Stock  6 

For  their  varying  investments  in  a  stock  corporation,  the 
investors  receive  stock,  which  in  this  country  is  divided  into 
equal  portions  or  shares,  usually  of  the  face  or  nominal  value 
of  $100  each,  though  this  may  be  $50  or  $10  or  less.  Within  the 
last  decade,  shares  of  no  par  value  have  been  authorized.  The 
amount  of  the  shares  issued  makes  up  the  capital  of  the  cor- 
poration. The  total  amount  of  stock  that  may  be  issued  is 
limited  by  the  charter  of  the  corporation. 

§  14.     Stockholders^ 

Those  who  subscribe  for  stock  in  a  company  or  who  later 
buy  stock  from  those  who  have  subscribed,  are  termed  "stock- 
holders." They  are  entitled  to  vote  and  to  share  in  profits,  in 
proportion  to  the  number  of  shares  each  holds.  If  they  have 
subscribed  for  stock,  they  are  liable  for  whatever  the  par  value 
of  the  stock  may  be,  and  when  they  have  paid  this  they  are 
entitled  to  certificates  as  evidence  of  payment  and  as  a  matter 
of  convenience  in  making  transfers  of  their  shares. 

§  15.    Directors^ 

The  stockholders  of  a  corporation  are  usually  too  numerous 
and  too  much  occupied  to  manage  its  affairs.  Therefore,  under 
the  plan  of  corporate  organization  the  stockholders  elect  three 
or  more  directors  who  collectively  and  acting  as  a  board,  have 

•  See  Part  III,  "The  Stock  System." 
'  See  Ch.  XVII,  "Stockholders." 
"  See  Ch.  XVIII.  "Directors." 


12  CORPORATE  LAW  [Bk.  I- 

the  entire  management  and  control  of  the  corporate  property 
and  business.  The  directors  must  act  as  a  board,  in  a  duly 
assembled  meeting,  with  a  quorum  present. 

§  i6.     Officers^ 

The  board  appoints  officers  and  agents  through  whom  it 
acts.  The  usual  officers  are  a  president,  a  vice-president,  a 
treasurer,  and  a  secretary. 

The  duties  of  the  president  are  to  preside  at  meetings,  to 
exercise  general  supervision  over  the  affairs  of  the  corporation, 
and  to  sign  such  instruments  and  perform  such  other  proper 
duties  as  the  board  may  direct. 

The  usual  duties  of  the  treasurer  are  to  care  for  the  funds 
and  finances  of  the  corporation,  and  to  sign  such  instruments 
as  he  is  authorized  to  sign. 

The  secretary's  duties  are  to  keep  the  records  of  the  meet- 
ings, to  notify  the  members  of  meetings,  and  to  perform  such 
other  secretarial  duties  as  the  board  may  prescribe. 

In  some  companies  other  officers  are  appointed,  such  as 
comptrollers,  auditors,  managers,  counsel,  and  assistants  to 
officers.  Their  duties  may  be  prescribed  in  the  by-laws,  or  by 
usage,  or  by  resolution  of  the  board. 


•  See  Ch.  XIX,  "Officers." 


CHAPTER  III 
ADVANTAGES  OF  THE  CORPORATE  FORM 

§  17.    The  Purpose  of  Business  Organization 

The  object  of  all  business  organizations  is  to  combine  good 
management  with  sufficient  capital  to  conduct  some  business 
undertaking  profitably.  Because  the  corporation  accomplishes 
this  end  more  simply  and  more  efficiently  than  any  other  form 
of  organization  in  use,  it  has  become  the  usual  form  in  which  all 
of  the  larger  business  enterprises  are  conducted. 

It  is  possible  that  the  future  will  see  the  evolution  of  some 
unproved  form  of  business  organization.  Partnerships  may 
perhaps  be  allowed  to  secure  needed  capital  by  issuing  profit- 
sharing  certificates  that  will  involve  the  holder  in  no  additional 
liability.  Undoubtedly  the  corporate  form  could  be  much 
improved.  It  is,  however,  the  best  form  of  business  organization 
now  available. 

§  18.    Characteristic  Features  of  Corporate  Form 

As  already  stated,  there  are  but  two  forms  of  business 
combination  commonly  used  for  conducting  a  business  or 
an  enterprise — the  partnership  and  the  corporation.  The  one 
is  easily  entered  into,  and  as  easily  dissolved;  the  other  is  formal 
and  more  permanent.  Men  may  drift  into  partnership;  the 
law  frequently  implies  it  for  them,  or  it  may  be  made  by  a 
simple  verbal  agreement.  Incorporation,  on  the  contrary, 
may  be  had  only  by  deliberate  purpose,  carried  into  effect 
through  prescribed  forms  of  law.  A  partnership  may,  and 
frequently  does,  exist  without  the  knowledge  of  the  partners; 
an  incorporation  is  impossible  except  with  the  formally  ex- 
pressed concurrence  and  participation  of  all  the  parties. 

I? 


14  CORPORATE  LAW  [Bk.  I- 

The  general  and  steadily  increasing  preference  for  the 
corporation  over  the  partnership  as  a  form  of  business  organiza- 
tion is  due  to  the  very  material  advantages  offered  by  the 
corporation,  which  may  be  summarized  as  follows : 

1.  Its  limitation  of  stockholders'  liabilities  to  a  definite 

amount. 

2.  Its  distinct  legal  entity  for  all  business  purposes, 

3.  The  stability  and  permanence  of  its  organization. 

4.  The   representation   of    the    different   interests   in   the 

corporation  and  its  property  by  transferable  shares. 

5.  The  management  of  the  business  by  an  elected  board 
;.  ^  ;,    .(     of  directors,  acting  through  officers  and  agents. 

6.  The  greater  ease  of  securing  capital  under  the  corporate 

form  because  of  its  safeguards  and  advantages. 

These  characteristic  features  of  the  corporate  form  are 
severally  considered  in  the  following  sections  of  the  present 
chapter. 

§  19.     (i)  Limited  Liability 

The  subscriber  to  stock  and  the  holder  of  stock  not  fully 
paid  for  are  liable  to  the  corporation,  and  indirectly  to  its 
creditors,  up  to  the  par  value  of  their  stock.  In  other  words, 
if  a  corporation  becomes  insolvent,  a  subscriber  to  its  stock 
whose  subscription  is  not  fully  paid,  or  a  holder  of  stock  not 
fully  paid  for,  can  be  held  liable  for  the  corporate  debts  up  to 
the  amount  necessary  to  make  his  stock  fully  paid.  In  most 
states  a  subscription  to  stock  or  the  holding  of  stock  involves  no 
further  liability  than  this,  and  as  soon  as  the  face  value  of  stock 
is  paid  this  liability  ceases  and  the  holder  is  no  longer,  as  a  stock- 
holder, responsible  for  the  corporation  and  its  doings.  1 
'•"-'Stockholders  in  national  banks,  and  generally  stockholders 
in  banks,  trust  companies,  and  other  moneyed  corporations,  are, 


•  See  a  72,  174-176;  see  also  i  Cook  on  Corp.,  {§  212,  213,  214,  241,  242;  United  States 
V  Stonford,  i6i  U.  S.  412  (1896). 


Ch.  3]        ADVANTAGES  OF  CORPORATE  FORM  1 5 

in  addition  to  any  subscription  liability,  held  liable  for  an  amount 
equal  to  the  par  value  of  their  stock  in  case  of  the  insolvency, 
of  their  corporation.  In  some  few  states  stockholders  may  be 
held  for  any  debt  due  by  a  corporation -to  a  laborer,  servant,  or 
other  employee. 

The  liabihty  on  unpaid  stock  is  generally  understood  and 
is  not  inequitable.  The  further  statutory  liabilities,  save  those 
of  moneyed  corporations,  are  unfortunate,  because  of  lack  of 
uniformity  and  their  uncertain  action.  Not  infrequently  they 
work  serious  hardships  where  stock  is  purchased  in  ignorance 
of  their  existence.  They  are  always  productive  of  litigation 
and  the  states  in  which  they  are  found  are  to  be  avoided  for 
purposes  of  incorporation.2 

These  statutory  liabilities,  however,  are  exceptional  and 
in  the  great  majority  of  the  states  the  one  general  rule  pre- 
vails that  a  stockholder  whose  stock  has  once  been  paid  in  full 
is  liable  neither  to  assessment  by  the  corporation  nor  to  action 
by  its  creditors.  The  property  of  the  corporation  in  which  he 
is  interested  may  be  swept  away,  but  his  Hability  is  fixed  and 
limited.  His  investment  will  be  lost  but  that  is  the  worst  that 
can  happen.  The  unlimited  responsibility  of  the  partnership 
does  not  exist. 

§  20.     (2)  Legal  Entity  of  Corporation 

In  the  partnership  every  member  must  be  made  a  party 
to  all  actions  at  law  either  by  or  against  the  firm,  and  no  partner 
may  sue  or  be  sued  by  the  partnership  as  a  partnership.  He 
cannot  contract  with  his  firm,  nor  enforce  its  obligations  to  him. 
The  great  inconvenience  of  this  is  manifest.  On  occasion  it 
results  in  serious  loss  and  injustice.  It  is  a  material  defect  of 
the  system. 

The  corporation,  on  the  contrary,  is  a  distinct  legal  entity, 
entirely  apart  from  its  membership.    It  may  sue  and  be  sued 

'  See  §72. 


l6  CORPORATE  LAW  (Bk.  I- 

under  the  corporate  name.  It  may  contract  freely  with  its 
stockholders  and  even,  under  proper  conditions,  with  its  officers 
and  directors.  It  may  bring  suit  to  enforce  these  contracts, 
and  in  turn  may  be  sued  by  stockholders,  officers,  or  directors. 
In  short,  for  all  purposes  of  ordinary  business  the  corporation 
has  a  distinct,  individual  existence  of  its  own.s 

In  the  famous  Dartmouth  College  case,*  Chief  Justice  Mar- 
shall described  a  corporation  as  "an  artificial  being,  invisible, 
intangible,  and  existing  only  in  contemplation  of  law."  It 
has  been  held  that  this  definition  should  be  limited,  especially 
in  those  cases  where  it  is  sought  to  use  the  legal  fiction  of  cor- 
porate entity  to  evade  legal  obligations  or  to  work  fraud  or 
injustice. 

A  later  writer  says: 

While  a  corporation  may  from  one  point  of  view,  be  considered 
as  an  entity  without  regard  to  the  corporators  who  compKjse  it 
the  fact  remains  self-evident  that  a  corporation  is  not  in  reality  a 
person  or  a  thing  distinct  from  its  constituent  parts.  The  word 
"corporation"  is  but  a  collective  name  for  the  corporators  or 
members  who  compose  an  incorporated  association;  and  where  it  is 
said  that  a  corporation  is  itself  a  person,  or  being,  or  creature, 
this  must  be  understood  in  a  figurative  sense  only.^ 

§  21.     (3)  Permanence 

The  ordinary  partnership  depends  for  its  continued  existence 
upon  the  continued  life,  sanity,  solvency,  and  consent  of  each 
one  of  its  members.  It  is  always  readily,  and  often  unavoidably, 
terminated.  This  easy  and  at  times  undesirable  dissolution  is 
disturbing,  and,  with  its  possible  resulting  loss  of  business  and 
good- will,  is  a  serious  defect  of  the  system. 

In  the  corporation,  permanence  and  stability  are  charac- 
teristic features.     The  organization  endures  until  terminated: 


'  I  Cook  on  Corp.,  |{  i,  6,  11. 

«  Trustees  of  Dartmouth  College  v.  Woodward,  4  Wheaton  (U.  S.)  518  (1819). 
»  Morawetz  on  Private  Corporations,  {{  i,  337;  Garrigues  v.  Int.  Agricultural  Corporation, 
159  App.  Div.  (N.  Y.)  877  (1913). 


Ch.  3]  ADVANTAGES  OF  CORPORATE  FORM  1 7 

1.  By  voluntary  dissolution,  which  must  usually  though  not 

invariably  be  by  unanimous  consent  of  the  stockholders. 

2.  By  the  expiration  of  the  period  for  which  it  was  formed. 

3.  By  judicial  proceedings. 

4.  By  forfeiture  of  charter  by  the  state. 

The  foregoing  are  the  only  methods  recognized  by  law  by 
which  the  corporation  may  be  terminated.  The  lives,  the  men- 
tal or  financial  condition  of  its  stockholders,  the  antagonism  of 
an  individual  or  faction,  need  have  no  effect  on  its  existence. 
This  permanence  adds  materially  to  the  value  and  efficiency 
of  the  corporation  as  a  mechanism  for  the  transaction  of 
business. 

In  some  few  states  the  maximum  term  for  which  charters 
are  granted  is  twenty  years.  In  others  it  is  fifty.  In  others 
there  is  no  limitation,  and  the  duration  of  the  corporation  may 
be  fixed  at  any  desired  period,  or  may — at  least  in  theory — 
be  made  perpetual. « 

§  22.     (4)  Stock  System 

In  a  partnership  there  is  no  satisfactory  or  generally  recog- 
nized method  of  expressing  and  representing  the  individual 
interests  of  the  partners.  Nor  is  there  any  way,  save  by  con- 
sent of  all  the  parties  interested,  by  which  a  partner  may 
transfer  his  interest  in  whole  or  in  part  to  another  person. 
Such  a  transfer,  unless  by  general  agreement,  dissolves  the 
firm. 

In  stock  corporations  the  exact  reverse  obtains.  Under  a 
fixed  and  well-ordered  system  the  various  interests  of  the 
parties  in  whom  the  ownership  of  the  corporation  rests  are 
expressed  as  equal  parts,  or  shares,  of  the  whole.  These  shares 
are,  as  a  matter  of  convenience,  represented  by  quasi-negoti- 
able certificates  of  stock,  which  may  be  transferred  as  desired 
with  but  little  formahty  and  without  affecting  the  operations 


•  2  Cook  on  Corp.,  |  628;  Swan,  etc.,  Co.  v.  Frank,  148  U.  S.  603  (1893). 


1 8  CORPORATE  LAW  [Bk.  I- 

of  the  corporate  business.  Each  stockholder  votes  according 
to  the  number  of  shares  he  holds,  and  participates  in  dividends 
in  like  proportion.  The  convenience  and  the  obvious  business 
advantages  of  this  method  of  holding  and  transferring  interests 
in  the  corporation  are  the  most  attractive  features  of  the  cor- 
porate system. 

§  23.     (5)  Corporate  Mechanism 

The  partnership  has  no  definite  method  of  action  or  sys- 
tem of  management.  Any  partner  may  bind  the  partnership 
within  the  scope  of  its  business  and  no  one  partner  has  any 
more  legal  authority  than  another  in  partnership  affairs.  There 
is  no  legal  way  of  enforcing  the  wishes  or  decisions  of  the 
majority.  On  the  other  hand,  the  stable,  well-defined,  and 
orderly  system  of  administration  characteristic  of  the  cor- 
poration is  one  of  its  most  admirable  and  important  features. 
The  election  of  a  board  of  directors  by  the  stockholders  vot- 
ing according  to  their  stock  interests;  the  election  of  officers 
and  the  appointment  of  agents  by  this  board  for  the  direct  con- 
duct of  the  business;  the  supervision  and  control  of  these  offi- 
cers and  agents  by  the  board;  the  orderly  action  of  the  board 
as  a  body  at  meetings  palled  in  accordance  with  by-law  or 
charter  requirements — these  constitute  the  best  working 
mechanism  for  the  conduct  of  a  business  enterprise  that  has 
yet  been  devised. 

The  several  functions  of  the  stockholders,  directors,  and 
officers,  the  well-defined  laws  and  usages  governing  every  fea- 
ture of  corporate  operation,  the  records  to  be  kept,  the  reports 
to  be  made,  and  the  protection  afforded  its  members,  combine 
to  make  a  system  compared  with  which  the  workings  of  the 
ordinary  partnership  are  crude  and  inadequate. 

The  corporate  organization  may  be  and  should  be  based 
on  a  division  of  powers  and  duties  and  the  operation  of  mutual 
checks  and  balances.  If  well  arranged  and  properly  conducted 
its  operation  is  effective  and  satisfactory.    It  must  be  observed, 


(h.3]        ADVANTAGES  OF  CORPORATE  FORM  ig 

however,  that  the  ideal  corporate  organization  is  not  ordinarily 
attained,  being  lost  through  ignorance,  negligence,  or  lack  of 
experience.  Safeguards  and  checks  are  omitted  or  purposely 
set  aside  by  promoters  and  exploiters;  a  charter  and  by-laws 
well  adapted  for  one  corporation  often  are  stupidly  duplicated 
for  the  use  of  another  corporation  of  wholly  different  design 
and  purpose;  frequently  measures  of  protection  or  convenience 
are  omitted  through  ignorance  on  the  part  of  the  incorporators. 

To  avoid  such  errors  and,  with  due  regard  to  the  rights 
of  all  concerned,  to  secure  an  effective  and  smoothly  working 
corporate  mechanism,  requires  skill  and  intelligence  in  the 
organization  of  the  corporation.  To  maintain  its  proper  oper- 
ation thereafter  demands  an  honest,  capable  administration 
and  watchful  care  on  the  part  of  those  interested. 

It  may  be  stated  in  passing  that  no  system  of  conducting 
business  has  been  or  can  be  devised  that  will  protect  the  in- 
terests of  those  concerned  automatically  and  without  effort  on 
their  part.  Our  corporation  laws  are,  it  must  be  admitted,  far 
from  perfect,  but  the  best  laws  are  of  no  effect  unless  enforced, 
and  the  most  effectual  and  well-devised  system  of  business 
organization  may  be  turned  to  evil  ends  unless  efforts  in  this 
direction  are  opposed.  All  that  can  or  should  be  done  by  the 
corporate  organization  is  to  afford  the  weak  an  opportunity  to 
protect  themselves  should  the  need  arise.  If  they  will  not  avail 
themselves  of  such  opportunity  when  the  time  comes,  it  is  they 
who  are  at  fault,  not  the  system. 

§  24.     (6)  Attractiveness  to  Investors 

Speaking  generally,  any  considerable  combination  of  capi- 
tal is  impossible  under  the  partnership  system.  No  matter 
what  the  merits  of  the  enterprise  nor  how  great  the  induce- 
ments offered,  they  are  outweighed  by  the  dangerous  liabilities 
and  uncertain  operation  of  the  unincorporated  form.  For  this 
reason  any  appeal  to  the  investing  public  on  the  basis  of  a 
partnership  or  joint-stock  association  is  foredoomed  to  failure. 


20  CORPORATE  LAW  [Bk.  I- 

On  the  other  hand,  the  corporate  form  has  been  found 
most  attractive  to  investors.  It  enables  them  to  invest  or  par- 
ticipate to  a  definite  extent  without  rendering  themselves  in- 
definitely liable.  It  has  a  continued  period  of  duration,  usually 
lasting  until  insolvency  or  voluntary  liquidation.  The  busi- 
ness interest  obtained  may  be  sold,  transferred,  or  transmitted 
to  posterity  with  little  formality  and  without  material  expense. 
Its  mechanism  operates  in  well-defined  grooves  and  the  rights 
and  liabilities  of  all  concerned  are  well  known.  It  has  its  own 
personality,  and  stockholders  are  not  involved  by  its  actions, 
nor  are  they  responsible  for  its  obligations  beyond  their  liability, 
if  any,  on  stock. 

For  these  reasons,  if  it  is  desired  to  raise  capital  for  an 
enterprise  or  to  increase  the  amount  already  invested,  the  ob- 
vious method  and  the  one  almost  invariably  pursued  is  to  in- 
corporate the  undertaking  and  sell  the  securities  of  the  company 
so  formed. 

Outside  investors  may  be  allowed  to  come  in  on  the  same 
basis  as  the  originators,  but  because  those  who  have  created 
the  enterprise  generally  wish  to  control  it,  and  later  investors 
are  more  desirous  of  safe  profits,  it  is  usual  to  divide  the  stock 
into  common  or  voting  stock  and  preferred  stock  with  no  voting 
power  but  with  a  preferred  dividend,  that  is,  a  dividend  equal  to 
or  a  little  more  than  the  usual  interest  rate,  paid  before  the 
common  stock  receives  anything. ' 

In  this  connection  it  may  be  observed  that  if  the  attrac- 
tiveness of  the  corporation  as  a  field  for  investment  is  to  be  pre- 
served, it  is  essential  that  those  features  which  serve  to  protect 
the  interests  of  the  investor  shall  be  maintained  and  their 
scope  enlarged.  Under  existing  laws  it  has  happened  many 
times  that  exorbitant  and  even  fraudulent  prices  have  been 
paid  for  the  properties  taken  over  by  newly  organized  corpo- 
rations.    Undue  power  and  emoluments  have  been  given  to 


'  See  Ch.  XI,  "Preferred  Stock";  see  also  {  loi. 


Ch.3]  ADVANTAGES  OF  CORPORATE  FORM  21 

the  original  promoters.  Rights  of  minority  stockholders  have 
been  denied,  and  the  smaller  investors  have  been  debarred  from 
any  knowledge  of  the  inner  corporate  operations. 

The  immediate  result  of  such  practices  has  been  very 
prejudicial  to  promotion.  Much  money  that  would  otherwise 
have  been  available  for  the  development  of  new  enterprises 
has  gone  into  the  better  known  bonds  and  particularly  into 
the  safe  haven  of  the  savings  bank,  where  returns  are  small 
but  where  all  the  conditions  are  clearly  defined  and  both  ,{| 
principal  and  profits  are  secure. 

§  25.    Resume  '    J^    ^ 

From  the  preceding  considerations  it  seems  that  the  char- 
acteristic features  of  the  corporate  form  which  have  led  to  its     ^ 
extended  use  are:  ,.^,„  „,,  ; 

I.  Its  efficiency,  which  is  curtailed  only  by  ignorance  or  li 

lack  of  skill  in  its  organization.  t 

iJ  Its  convenience,  which  is  inherent  in  the  corporate  sys-  i 

tem  and  requires  no  special  attention.  o 

3.  Its  safety,  which  is  the  one  point  above  all  others  that  )i 

requires  attention,  not  only  because  it  is  the  one  most  apt  .  (5 
to  be  overlooked,  neglected,  or  omitted  by  intent,  but 
because  it  is  the  most  important  feature  of  any  business 
enterprise  in  which  a  number  of  people  are  concerned. 

The  corporation  is,  from  its  nature,  a  democratic  institution 
and  the  safety  of  the  investors'  interests  should  be  a  first  essen- 
tial. I^he  majority  must  rule,  but  the  rights  of  the  minority 
demand  that  this  rule  be  fair,  open,  and  honest.  Due  adj-ust- 
ment  of  all  equities  should  be  made  so  that  all  interests  are 
represented,  none  are  favored  at  the  expense  of  others,  the 
general  business  is  facilitated,  and  the  profits  are  fairly  ap- 
portioned. This  is  the  true  ideal  of  corporate  organization, 
and  that  corporation  is  the  most  ably  organized  and  conducted 
which  most  nearly  approaches  this  ideal. 


CHAPTER  IV 
DISADVANTAGES  OF  THE  CORPORATE  FORM 

§  26.     General 

It  seems  only  fair  to  give  both  sides  of  the  shield,  and  to 
point  out  to  those  proposing  to  incorporate,  certain  matters 
that  may  well  give  them  pause.  Many  times  small  businesses 
are  incorporated  when  the  expense  and  inconvenience  involved 
are  not  compensated  by  the  advantages  that  have  been  set 
forth. 

The  corporate  form  has  its  advantages  and  also  its  dis- 
advantages. Its  advantages  have  been  discussed  with  some 
detail  in  the  preceding  chapter.  Its  disadvantages — discussed 
in  the  present  chapter — lie  mainly  in  the  somewhat  invidious 
taxes  imposed  upon  corporations  and  the  somewhat  onerous 
reports  required  of  them  by  state  and  federal  legislation.  The 
objection  so  frequently  urged  against  the  corporate  form  that 
it  does  not  afford  protection  to  minority  interests  is  considered 
at  length  else  where.  1 

It  is  practically  impossible  for  a  corporation  doing  business 
over  a  wide  territory  to  have  that  assurance  of  its  rights  which  a 
sound  and  stable  business  demands.  It  must  keep  constantly 
on  the  alert  to  guard  itself  against  the  enactment  of  new  legislation 
and  must  keep  counsel  constantly  at  work  to  ascertain  what  the 
meaning  of  new  laws  is.  It  often  happens,  that  as  soon  as  a 
particular  question  has  been  decided  by  the  courts,  the  law 
construed  has  been  repealed  and  a  new  one  put  in  its  place,  of 
which  construction  must  be  had  at  the  cost  of  litigation  and 
•  uncertainty  before  its  effect  will  be  known.  The  resistance  of 
corporations  to  statutory  regulations  gives  rise  to  a  popular 
belief  that  corporations  are  not  law-abiding  bodies,  although  the 
corporation  may  be  resting  its  resistance  upon  just,  grounds. 


'  Ch.  LVIII,  "Protection  of  Minority." 


Gh.4]  DISADVANTAGES  OF  CORPORATE  FORM  23 

The  corporation  must,  in  opposing  what  appears  to  be  destructive 
legislation,  pay  the  price  of  an  unpopularity  which  reacts  in 
further  legislation  or  in  unfavorable  verdicts  by  juries.  In  the 
true  sense  of  the  words,  therefore,  it  cannot  be  said  that  corpora- 
tions stand  before  the  law  with  the  same  rights  as  individuals.^ 

§  27.     Onerous  Legislative  Requirements 

Within  the  last  few  years  the  costs  and  burdens  imposed 
on  corporations  by  the  legislatures  of  the  various  states  and 
finally  by  federal  legislation  have  materially  increased — so 
much  so  that  before  deciding  in  any  specific  case  to  incorporate 
a  business  it  is  advisable  to  investigate  carefully  and  deter- 
mine just  w^hat  obligations  the  proposed  incorporation  will 
entail. 

Where  it  is  desired  to  secure  the  investments  of  a  number 
of  people  in  a  business  enterprise,  incorporation  offers  such 
,.,  advantages  that  it  is  practically  the  only  possible  form,  and  in 
such  cases  the  only  recourse  is  to  minimize  the  disadvantages 
as  far  as  may  be  done.  Not  infrequently,  however,  when  the 
incorporation  of  an  existing  partnership  or  individual  business 
is  under  consideration,  the  conscientious  lawyer  is  compelled  to 
counsel  against  such  a  step  and  advise  his  clients  to  bear  the 
ills  they  have  rather  than  to  incur  the  taxes,  annual  reports, 
and  other  onerous  burdens  imposed  on  corporations. 

According  to  a  famous  French  minister,  the  whole  prob- 
lem of  taxation  is,  as  in  plucking  geese,  to  secure  the  most 
■feathers  with  the  least  squawking.  Proceeding  upon  this  primi- 
tive principle,  both  state  and  national  legislators  have  found 
the  line  of  least  resistance  in  the  corporation  and  have  taxed 
it  unreasonably. 

As  a  matter  of  fact  and  fairness,  private  corporations  should 
not  pay  higher  taxes  or  be  called  upon  for  more  onerous  reports 
than  individuals  or  partnerships  engaged  in  like  enterprises, 
save  as  to  the  small  fees  for  filing  and  recording  where  cor- 


2  Sears  on  Trust  Estates  as  Business  Companies  (192 1),  i  4, 


24  CORPORATE  LAW  IBk.  I- 

porate  instruments  are  required  to  be  filed  in  public  offices. 
The  business  corporation,  as  such,  enjoys  no  franchise  or 
monopoly;  it  merely  employs  a  convenient  form  of  business 
organization.  If  this  form  facilitates  the  transaction  of  busi- 
ness and  is  superior  to  the  partnership  form  of  business  organi- 
zation, its  use  should  be  encouraged,  not  hindered. 

So  far  as  holding  corporations  and  trust  combinations  are 
harmful  they  should  be  prohibited,  for  taxes  levied  on  them 
are  no  compensation  for  the  harm  they  do,  and  do  not  benefit 
those  who  suffer  from  their  abuse  of  power;  public  utility 
corporations  may  well  pay  some  compensation  to  the  public  for 
the  monopolies  they  enjoy,  either  in  increased  taxes  or  in  the 
form  of  regulated  rates;  but  ordinary  private  corporations 
should  not  be  hampered  unnecessarily  in  any  way,  and  should 
be  taxed  only  for  the  property  they  hold  and  at  no  higher  rate 
than  individuals  and  partnerships. 

In  those  localities  where  it  is  customary  to  discourage 
enterprise  and  punish  industry  by  levying  occupation  taxes, 
corporations  should  pay  the  same  as  individuals  and  partner- 
ships, but  no  more.  In  other  words,  the  corporate  form  should 
bear  its  part  of  the  burden  of  taxation  but  should  not  be  handi- 
capped with  more. 

§  28.     Summary  of  Taxes  and  Reports 

The  taxes  and  reports  required  of  corporations  may  be 
generally  summarized  as  follows: 

Taxes : 

1.  Organization   taxes  payable   to   the   state   of  incor- 

poration. 

2.  Annual  franchise  taxes  paid  to  the  state  of  incor- 

poration. 

3.  Annual  taxes  on  property. 

4.  State  income  taxes  (in  some  states). 

5.  State  inheritance  taxes  (in  most  states). 


Ch.  4]  DISADVANTAGES  OF  CORPORATE  FORM  25' 

6.  Stock  transfer  taxes  (in  New  York,   Massachusetts, 

and  Pennsylvania). 

7.  Taxes  and  license  fees  in  each  state  outside  the  home 

state  in  which  the  corporation  does  business. 

8.  Federal  taxes. 

Reports : 

1.  Local  tax  reports. 

2.  State  tax  reports. 

3.  Federal  tax  reports. 

4.  Annual  reports  of  officers,  etc. 

5.  Reports  in  each  state  outside  the  home  state  in  which 

the  corporation  does  business. 

These  corporate  taxes  and  reports  will  be  severally  con- 
sidered in  the  following  sections. 

Taxes 

§  29.     (i)  Organization  Taxes 

These  are  taxes  imposed  by  the  state  as  a  preliminary  to 
incorporation.  They  range  from  a  nominal  fee,  as  in  Arizona, 
to  a  tax  of  3^  of  1%  on  the  entire  authorized  capital  stock, 
as  in  Pennsylvania.  In  connection  with  the  tax  there  are 
included  sundry  filing  fees  that  increase  the  total.  In  them- 
selves the  organization  tax  and  fees  are  not  serious  as  they  have 
to  be  paid  but  once.s 

§  30.     (2)  Annual  Franchise  Taxes 

The  corporate  franchise  is  the  primary  franchise,  that  is  the 
right  or  privilege,  granted  by  the  state,  of  being  a  corporation, 
and  of  doing  such  things,  and  such  things  only,  as  are  authorized 
by  the  Charter.* 

The  amount  of  the  annual  franchise  tax,  as  in  the  case  of 
the  organization  tax,  varies  widely.     In  Louisiana,  Nevada, 


•  See  Ch.  VIII,  "Cost  of  Incorporation." 
«  14  Corpus  Juris,  }  160;  see  also  {  199. 


26  CORPORATE  LAW  [Bk.  I- 

and  some  few  other  states,  there  is  no  franchise  tax,  and  from 
this  it  ranges  up  to  ^  of  i%  on  actual  values  in  Penn- 
sylvania. The  tax  is  a  distinct  special  imposition  upon  the 
corporate  form — a  payment  for  the  privilege  of  transacting 
business  as  a  corporation.  It  is  in  addition  to,  and  entirely 
separate  from,  the  annual  property  taxes  mentioned  in  the  next 
section.  The  franchise  tax,  while  not  entirely  equitable,  is  a 
source  of  much  revenue  to  the  more  important  incorporating 
states.  5 

§  31.     (3)  Annual  Property  Taxes 

These  are  the  same  in  character  and  amount  as  the  prop- 
erty taxes  paid  by  individuals,  and  are  therefore  justly  imposed 
on  corporations.  The  corporation,  however,  is  at  some  dis- 
advantage in  this  matter,  as  it  cannot  evade  the  taxes  in  the 
very  facile  way  that  individuals  do.  This  being  true,  it  fre- 
quently happens  that  an  incorporated  business  pays  a  much 
larger  property  tax  than  it  did  before  incorporation,  even 
though  its  property  holdings  have  not  increased.  The  property 
tax  is,  however,  the  one  corporation  tax  to  which  no  just  ex- 
ception can  be  taken.  It  is  theoretically  at  least  uniform,  equi- 
table, and  proper. 

§  32.     (4)  State  Income  Taxes 

Several  states — notably  Massachusetts,  Wisconsin,  Con- 
necticut, and  West  Virginia — impose  a  tax  upon  the  net  incomes 
of  corporations  from  business  transacted  and  capital  invested 
in  the  state.  In  each  of  these  states  the  tax  is  upon  the  income 
of  all  corporations  doing  business  in  the  state,  foreign  as  well 
as  domestic.  In  West  Virginia  the  tax  is  an  excise  tax  imposed 
for  the  privilege  of  doing  business  within  the  state.  Neither 
Wisconsin  nor  Connecticut  imposes  any  annual  franchise  tax 
upon  corporations,  but  in  West  Virginia  the  excise  tax  is  in 

'  See  {  76. 


Ch.  4]  DISADVANTAGES  OF  CORPORATE   FORM  27 

addition  to  the  other  usual  taxes,  making  the  corporate  burden 
a  heavy  one. 

New  York  has  recently  imposed  a  4^%  tax  upon  the  net 
income  of  two  classes  of  corporations,  "manufacturing"  and 
"mercantile"  corporations.  The  tax  is  denominated  a  franchise 
tax  but  a  new  feature  is  that  it  exempts  the  corporations  subject 
to  the  act  from  all  personal  property  taxes.  As  in  other  states, 
the  tax  applies  to  foreign  as  well  as  domestic  corporations  and 
when  only  a  portion  of  the  company's  business  is  transacted 
within  the  state  the  tax  is  proportionately  reduced. 

^10  bleq  aoed  ?.Rt[  xsi 
§  33.     (5)  State  Inheritance  Taxes     .  ^^,j..^  ^^,  ^,j„.  ^^„,,^^ 

An  inheritance  tax  is  now  imposed  in  all  of  the  more  im- 
portant states,  and  when  incorporation  is  contemplated  the  in- 
heritance tax  laws  of  the  state  of  incorporation  are  an  element 
to  be  considered,  especially  in  the  case  where  the  incorporation 
is  to  take  place  in  a  state  other  than  the  state  where  the  new 
company  is  to  do  most  of  its  business.  Under  such  circumstances 
there  may  in  some  cases  be  double  and  even  triple  taxation  by 
the  states.  /  j*     ► 

If  the  state  in  which  the  decedent  resided  has  an  inheritance 
tax,  the  transfer  will  be  taxable  in  that  state  irrespective  of 
whether  the  stock  held  by  the  decedent  is  stock  of  a  foreign 
or  a  domestic  corporation.  If  the  corporation  is  a  foreign 
corporation  a  second  tax  may  be  imposed  in  the  state  of  in- 
corporation, depending  upon  whether  that  state  imposes  a  tax 
upon  the  devolution  of  stock  in  a  domestic  corporation  held 
by  a  non-resident. 

In  most  of  the  states,  stock  in  a  domestic  corporation  held 
by  a  non-resident  decedent  is  subject  to  the  inheritance  tax. 
In  New  York,  stock  held  by  a  non-resident  decedent  is  not 
subject  to  the  inheritance  tax  unless  the  corporation  holds 
real  property  in  New  York,  in  which  case  the  stock  is  subject 
to  a  tax  for  such  proportion  of  its  value  as  the  real  property 


28  CORPORATE  LAW  [Bk.  I- 

held  by  the  corporation  in  New  York  State  bears  to  the  entire 
property  of  the  corporation.  The  law  apphes  to  stock  in  both 
foreign  and  domestic  corporations,  but  excepts  from  its  pro- 
visions certain  classes  of  corporations,  including  transporta- 
tion, moneyed,*  and  manufacturing  companies.  At  the  present 
time  stock  in  a  New  Jersey  corporation  which  owns  real  estate 
in  New  York,  that  is  held  by  a  decedent  residing  in  Delaware, 
might  be  subject  to  taxation  under  the  inheritance  laws  of 
Delaware,  New  Jersey,  and  New  York. 

Usually  the  corporation  is  required  either  to  collect  the 
taxes  or  to  refuse  transfer  of  the  stock  on  its  books  until  the 
tax  has  been  paid  or  a  waiver  is  obtained  from  the  state  officer 
charged  with  the  collection  of  the  tax. 

§  34.     (6)  Stock  Transfer  Taxes 

In  New  York,  Massachusetts,  and  Pennsylvania  a  stamp 
tax  of  2  cents  on  each  $100  of  face  value  is  imposed  on 
every  sale  or  transfer  of  stock  in  the  state,  whether  the  cor- 
poration is  domestic  or  foreign.  The  statutes  of  the  various 
states  and  the  rulings  thereunder  are  very  similar.  In  addition 
to  the  money  fines  imposed  for  failure  to  comply  with  the  law, 
the  statutes  of  each  state  provide  that  a  transfer  of  stock 
made  without  paying  the  tax  cannot  be  made  the  basis  of  any 
action  or  proceeding  in  the  state  courts.  A  share  of  stock 
sold  in  one  of  the  three  states  named  and  transferred  in  another 
is  taxable  in  both  jurisdictions. 

§  35*     (7)  Taxes  on  Foreign  Corporations 

All  corporations  having  a  place  of  business  in  states  other 
than  that  in  which  they  are  incorporated,  are  required  to  con- 
form to  the  local  laws  regulating  foreign  corporations.  These 
laws  usually  require  a  license  to  do  business — for  which  pay- 
ment must  be  made — and  the  payment  thereafter  of  an  annual 


•  A  "moneyed"  corporation  is  a  bank,  trust  company,  or  other  financial  institution. 


Ch.  4]  DISADVANTAGES  OF  CORPORATE  FORM  29 

tax.  In  some  states  the  tax  imposed  on  foreign  corporations 
is  so  onerous  that  it  is  economy  to  organize  a  small  local  sub- 
company  to  conduct  the  operations  necessary  in  such  states. 

The  taxes  imposed  on  foreign  corporations  are  usually  on 
the  same  basis  as  those  imposed  on  domestic  corporations,  but 
in  most  states  the  franchise  or  equivalent  tax  is  imposed  only 
on  the  proportion  of  capital  stock  actually  employed  in  state. 

§36.     (8)  Federal  Taxes  ^ 

The  federal  taxes  which  affect  corporations  are  as  follows: 

(a)  The  income  tax 

(b)  Excess  profits  tax 

(c)  Capital  stock  tax 

(d)  The  stamp  transfer  tax 

(e)  The  inheritance  tax 

These  are  referred  to  but  briefly  in  this  work.    To  treat  the  > 
subject   adequately   would   require   more   space   than   is   here 
given   to    the   entire   subject   of   corporate   organization   and 
management. 

§  37.    Corporation  Income  Tax  ^ 

The  federal  tax  on  net  corporate  income  is  from  January  i, 
1922,  12^%.  The  net  income  is  found  by  deducting  from 
gross  income  the  allowable  deductions. 

§38.    Excess  Profits  Tax  ^  '^n  I'A  vfnmn. 

The  tax  on  excess  profits  will  happily  cease  from  January  i, 
1922.  It  will  have  to  be  paid  on  the  net  income  for  1921  if 
this  is  above  $3,ocx).  It  is  computed  on  the  basis  of  the  income 
as  shown  by  the  returns  made  for  the  normal  tax.  Its  complexi- 
ties frequently  require  the  aid  of  a  skilled  accountant. 


'  See  Ch.  XLI,  "Stock  Transfer  Taxes — Corporate  Taxes." 

•  See  I  389;  see  also  Montgomery  on  Income  Tax  Procedure  (1933). 

•  See  i  390. 


30  CORPORATE  LAW  [Bk.  I- 

§  39.    Capital  Stock  Tax'" 

The  capital  stock  tax  is  imposed  only  upon  corporations 
having  a  capital  stock  of  the  fair  average  value  for  the  pre- 
ceding year  in  excess  of  $5,000,  and  is  a  tax  of  i/io  of  1%  upon 
such  excess.     Reports  are  due  and  tax  payable  in  July. 

§  40.    Federal  Stock  Transfer  Tax  " 

The  Federal  Revenue  Law  of  19 18  prescribes  a  stamp  tax 
of  5  cents  on  each  original  certificate  for  $100  of  face  value  or 
fraction  thereof,  and  on  all  later  transfers  of  stock  a  stamp 
tax  of  2  cents  on  each  $100  or  fraction  thereof. 

§  41.    Federal  Estate  Tax 

The  federal  estate  tax  is  an  inheritance  tax  on  all  estates 
amounting  to  $50,000  or  more.  Corporate  stock,  like  all  other 
forms  of  property,  is  subject  to  the  tax,  and  the  law  imposes 
the  duty  upon  the  corporation  or  transfer  agent  to  collect 
the  tax  or  see  that  the  same  is  paid  or  that  no  tax  is  due  before 
transferring  stock  upon  the  corporate  books. 

Reports 

§  42.     (i)  Local  Tax  Reports;  (2)  State  Tax  Reports 

Local  tax  reports,  made  in  connection  with  the  usual  prop- 
erty taxes,  are  similar  to  those  of  individuals. 

A  state  tax  report  or  reports  are  required  of  corporations, 
primarily  for  purposes  of  taxation,  but  beyond  this  they  are 
required  to  supply  a  record  of  the  officers  and  directors  of  the 
corporation  and  such  other  data  as  may  be  deemed  necessary. 

§  43-     (3)  Federal  Tax  Reports 

The  income  tax  report  is  simple  to  prepare  under  a  well- 
arranged,  modem  accountiAg  system,  but  otherwise  it  is  diffi- 


i»  See  {  388. 
"See  J  386. 


Ch.  4]  DISADVANTAGES  OF  CORPORATE  FORM  31 

cult  and  troublesome.  The  report  must  be  filed  on  or  before 
March  15,  and  covers  the  calendar  year  ending  December  31, 
preceding,  unless  the  corporation  designates  the  last  day  of 
some  other  month  as  the  closing  of  its  fiscal  year  and  gives 
proper  notice  to  the  collector.  In  such  case  the  report  will 
cover  the  fiscal  year  so  designated,  and  the  dates  for  filing 
the  report  and  for  payment  of  the  tax  will  be  adjusted  ac- 
cordingly. 

The  government  regulations  require  that  reports  for  the 
capital  stock  tax  be  filed  by  every  corporation  doing  business 
in  the  United  States.  The  report  must  be  filed  in  July  of  each 
year  and  covers  the  preceding  twelve  months. 

Failure  or  refusal  to  file  either  of  these  reports  within  the 
time  required  by  law,  or  the  filing  of  a  false  or  fraudulent 
return,  renders  the  corporation  liable  to  a  severe  penalty  and 
an  additional  tax  to  be  added  to  the  assessment. 

§  44.     (4)  Annual  Reports 

In  addition  to  the  tax  report,  many  states  require  the  filing 
of  another  report,  usually  in  January  of  each  year  or  other- 
wise at  some  specified  time  after  the  annual  meeting,  giving 
the  names  and  addresses  of  the  corporate  officers  and  directors, 
and  the  location  of  the  principal  ofiice  in  the  state.  The  report 
is  usually  simple  and  is  a  reasonable  requirement,  as  parties 
having  claims  against  the  corporation  or  desiring  to  institute 
actions  against  it  should  have  reliable  information  as  to  who 
the  officers  are  and  where  they  can  be  found. 

§  45.     (5)  Reports  of  Foreign  Corporations 

The  corporation  is  usually  required  to  make  reports  in 
each  state  in  which  it  does  business.  These  reports  are  in 
most  states  similar  to  those  required  to  be  filed  by  domestic 
corporations. 


Part  II — Pre -Incorporation  Considerations 


CHAPTER  V 
SUBSCRIPTION  LISTS   AND   CONTRACTS 

§  46.    General 

3  In  former  days  the  subscription  list  was  regarded  as  a 
necessary  preliminary  to  incorporation.  It  was  circulated  to 
determine  whether  sufficient  support  could  be  obtained  to 
justify  the  proposed  incorporation  or,  if  this  were  already 
known  to  be  the  case,  to  commit  the  subscribers  definitely  and  to 
fixed  amounts  before  the  organization  was  actually  under- 
taken. 

Now  the  corporation  is  usually  organized  first,  property  of 
some  kind  is  taken  over,  and  stock  is  then  sold  or  subscriptions 
solicited  to  raise  any  needed  capital.  Under  this  plan  the  sub- 
scription list  is  of  much  less  prominence  and  importance  than 
formerly. 

There  are,  hbwever,  still  many  cases  of  incorporation  in 
which  the  preliminary  subscription  is  employed  and  is,  at 
times,  essential.  The  farmers  of  a  neighborhood  may  wish  to 
establish  a  creamery  or  a  co-operative  store;  in  some  growing 
town  the  citizens  may  wish  to  combine  their  efforts  for  the 
construction  of  an  electric  plant,  the  organization  of  a  bank, 
the  opening  of  a  library,  or  the  establishment  of  some  local 
industry.  In  such  event  the  subscription  list  is  circulated 
as  the  first  step  toward  the  formation  of  the  contemplated 
corporation.  Also  in  other  cases,  memoranda  or  agreements, 
which  are  the  equivalent  of  the  subscription  list,  are  entered 
into  between  the  parties  interested,  and  these  are  the  prelimi- 

33 


b-jh 


34  CORPORATE  LAW  [Bk.  I- 

nary   and   definite  steps  towards   the  intended  corporate  or- 
ganization, i 

§  47.    Nature  of  the  Subscription  Contract 

Prior  to  the  organization  of  the  corporation,  the  ordinary 
subscription  is  merely  a  continuing  proposition  from  the  sub- 
scriber to  the  proposed  corporation  for  the  purchase  of  a  speci- 
fied amount  of  stock.  At  this  stage  the  subscription  is  not 
a  complete  and  enforceable  contract,  because  the  other  party 
thereto — the  proposed  corporation — has  no  legal  existence, 
and,  until  the  corporation  is  formed,  the  death,  insanity,  or 
voluntary  withdrawal  of  the  subscriber  would  cancel  the  pro- 
position and  thereby  terminate  the  proposed  contract.^ 

After  the  corporation  is  organized  and,  by  either  expressed 
or  implied  acceptance  of  the  subscriptions  to  its  stock,  has 
completed  its  part  of  the  contract,  the  subscription  list  becomes  a 
binding  agreement  between  the  parties  thereto,  and  the  corpora- 
tion may,  if  necessary,  bring  suit  for  specific  enforcement.' 

To  avoid  the  possibility  of  revocation  which  is  characteristic 
of  the  ordinary  subscription  list  before  its  acceptance  by  the 
corporation,  subscriptions  are  frequently  made  payable  to 
trustees,  who  act  for  the  corporation  in  the  matter,  undertaking 
its  organization,  and  where  desirable  the  collection  of  the 
subscriptions  in  whole  or  in  part.  Under  such  a  contract 
properly  drawn,  the  subscriptions,  if  unconditional,  are  binding 
as  soon  as  made;  if  conditional,  as  soon  as  the  conditions  are 
fulfilled.* 

§  48.    Effect  of  Acceptance  of  Subscription 

The  acceptance  of  a  vaUd  subscription  by  the  corporation 

not  only  renders  the  contract  a  binding  one  but  also,  of  itself, 

t. 


«  See  also  Book  III,  Ch.  VII,  "Stock  Subscription  System";  and  Book  IV,  Ch.  IV,  "Sub- 
scription Lists." 

'  Hudson  R.  E.  Co.  v.  Tower,  156  Mass.  82  (1892);  s.  c,  161  Mass.  10  (1894). 
'  10  Cyc.  pp.  388,  389,  394.  n.  57",  i  Cook  on  Corp.,  55  71.  72,  75. 
*  Horseshoe  Pier,  etc.,  Co.  v.  Sibley,  157  Cal.  442  (1910). 


Ch.  si  SUBSCRIPTION  LISTS  AND  CONTRACTS  35 

constitutes  the  subscriber  a  stockholder  of  the  corporation.  If 
his  subscription  is  made  to  a  trustee  for  the  corporation,  he 
becomes  a  stockholder  as  soon  as  the  corporation  is  organized 
and  his  subscription  turned  in  by  the  trustee.  In  either  case 
nothing  further  is  necessary  to  establish  him  legally  in  this 
position  nor  in  the  enjoyment  of  his  rights  as  a  stockholder. 
The  delivery  of  the  stock  certificates,  while  a  formal  recognition 
of  this  status,  confers  nothing  that  he  did  not  have  before,  being 
simply  a  convenient  evidence  of  his  stock  interest. 

These  cases  in  one  court  in  which  the  subscriber  to  capital 
stock  has  been  treated  as  a  stockholder  are  cases  in  which  the 
contract  between  him  and  the  corporation  showed  that  he  was 
a  stockholder  having  complied  with  the  terms  of  his  subscription 
and  all  that  was  required  upon  his  behalf  was  a  certificate 
evidencing  the  same,  s 

Even  though  the  subscriber  never  pays  his  subscription,  he 
is  a  stockholder  from  the  time  of  the  acceptance  of  his  subscrip- 
tion until  such  time  as  by  proper  procedure  his  subscription  is  / 
canceled  or  forfeited  for  non-compliance  with  its  conditions.*  \ 

On  the  other  hand,  it  is  to  be  noted  that  the  corporation 
when  organized  is  under  no  compulsion  to  accept  or  recognize 
the  ordinary  subscription  to  its  stock.  The  subscriber  is  not 
bound,  neither  is  the  corporation,  until  the  contractus  completed 
as  to  both  parties  by  the  acceptance  of  the  subscription  by  the 
corporation.''  If  the  subscription  is  made  to  a  trustee  for  the 
corporation  and  is  accepted  by  him,  this  would  make  a  binding 
contract  between  the  subscriber  and  the  trustee,  but  would 
not  bind  the  corporation  until  its  acceptance  of  the  subscription, 
expressed  or  implied.  If  the  corporation  accepted  the  benefit 
of  the  trustee's  act,  it  would  thereby  also  accept  the  trustee's 
contracts,  from  which  such  benefits  accrued.  The  very  fact 
of  the  organization  of  the  corporation  by  the  trustee,  or  trustees, 


'  Kruse  v.  Brewing  Co.,  79  N.  J.  Eq.  392  (1911). 

'  Clark  &  Marshall,  {{  366,  378b,  and  cases  cited. 

'  Hudson  R.R.  Co.  v.  Tower, "161  Mass.  10  (1894);  s.  c,  156  Mass.  82  (1893). 


36  CORPORATE  LAW  [Bk.  I- 

might  be  held  to  be  an  acceptance  of  the  subscription  contracts 
which  rendered  such  incorporation  possible. 

Usually,  however,  the  acceptance  of  subscriptions  by  the 
corporation  does  not  enter  into  consideration,  such  acceptance 
following  its  organization  as  a  matter  of  course.  Litigation 
may  be  necessary  to  compel  payment  of  subscriptions,  but  not 
usually  to  compel  their  acceptance  by  the  corporation, 

§  49.    Exception  to  Rule  in  New  York 

In  New  York,  contrary  to  the  weight  of  authority  else- 
where, the  courts  do  not  treat  an  original  subscription  to  stock 
in  a  corporation  thereafter  to  be  formed  as  a  continuing  offer, 
but  hold  that,  to  be  enforceable,  it  must  contain  all  of  the 
elements  of  a  valid  contract  at  the  time  it  is  made.  Consequently 
they  will  not  enforce  a  simple  subscription  for  stock  in  a  corpora- 
tion thereafter  to  be  formed,  but  lay  down  the  rule  that,  to  be 
enforceable,  such  subscription  must  amount  to  an  agreement 
between  two  or  more  parties  to  form  the  corporation  and  to 
take  stock  therein,  and  that  only  after  its  formation  by  such 
parties,  or  by  someone  authorized  to  act  for  them  in  this  regard, 
can  the  subscription  to  stock  be  enforced  by  the  corporation 
when  formed. 8 

§  50.    Subscriptions  Made  as  Part  of  Incorporation 

Subscriptions  made  as  part  of  a  prescribed  statutory  form 
of  incorporation  are  irrevocable  as  soon  as  made. 9  This  applies 
to  a  certificate  of  incorporation  wherein  the  parties  executing 
it  appear  as  subscribers  to  designated  shares  of  stock.  It  also 
applies  to  subscriptions  made  on  books  or  lists  opened  by  com- 
missioners where  this  is  part  of  a  prescribed  statutory  form  of 
incorporation. 


'Avon  Springs  Sanatarium  v.  Weed,  189  N.  Y.  557  (1907);  Sanders  v.  Bumaby,  166 
App.  Div.  (N.  Y.)  274  (191S). 

»2  Clark  &  Marshall  on  Corp.,  J  4Sie;  Dupee  v.  Horse  Shoe  Co.,  117  Fed.  40  (1903); 
Stevens  v.  Episcopal  Church  History  Co.,  140  App.  Div.  (N.  Y.)  570  (1910). 


Ch.  5)  SUBSCRIPTION  LISTS  AND  CONTRACTS  37 

It  has  been  held  in  some  cases  that  where  a  statutory  form 
has  been  prescribed  for  taking  subscriptions,  those  taken  in 
any  other  form  are  not  binding.^  0  This  does  not  seem  reasonable, 
and  there  is  good  authority  for  the  contrary  view.ii 

After  the  completion  of  any  subscription  agreement  by  the 
proper  action  of  both  parties  thereto,  it  becomes  a  simple  con- 
tract and  subject  to  the  usual  laws  of  contracts. 

§  51.    Subscription  Distinguished  from  Agreement  to  Buy  Stock 

The  subscription  to  stock  must  be  distinguished  from  an 
agreement  to  purchase  stock.12  In  the  first  instance  the  sub- 
scriber becomes  a  stockholder  immediately  upon  the  acceptance 
of  his  subscription  by  the  corporation.  In  the  latter  case  he 
does  not  become  a  stockholder  until  the  consummation  of  his 
agreement  and  the  delivery  to  him  of  his  certificates  of  stock. 
A  subscription  list  might  be  so  worded  as  to  be  merely  an 
agreement  to  purchase  stock,  in  which  case  the  subscribers 
would  not  be  stockholders  until  they  received  their  certificates 
of  stock." 

As  a  general  rule  the  courts  construe  subscription  agreements 
very  liberally  in  accordance  with  what  appears  to  be  the  intent 
of  the  parties,  but  a  direct  statement  that  "We,  the  undersigned, 
hereby  agree  to  subscribe,  etc.,"  instead  of  the  proper  form,  "We, 
the  undersigned,  hereby  subscribe,  etc.,"  might  have  a  very  dif- 
ferent legal  effect  from  that  intended. '*  An  agreement  beginning 
"We,  the  undersigned,  severally  promise  and  agree  to  and  with 
each  other  that  we  will  associate  ourselves  into  a  corporation, 
etc.,"  was  held  good  in  Massachusetts.is 


"  Poughkeepsie,  etc.,  Co.  v.  Griffin,  24  N.  Y.  150  (1861);  Shelby  Co.  Ry.  Co.  v.  Crow, 
137  Mo.  App.  461  (1909). 

"  10  Cyc.  p.  392,  n.  42;  Planters,  etc.,  Co.  v.  Webb,  144  Ala.  666  (1905). 

"  Morawetz  on  Corp.,  {  61:  2  Clark  &  Marshall,  {  382;  Wood  Harvester  Co.  v.  Jefiferson, 
71  Minn.  367  (1898);  Palais  du  Costume  Co.  v.  Beach,  143  S.  W.  852  (1912). 

"  See  Book  IV,  Ch.  IV,  "Subscription  Lists." 

"  General  Electric  Co.  v.  Wightman,  3  App.  Div,  (N.  Y.)  118  (1896);  Palais  du  Costume 
Co.  V.  Beach,  143  S.  W.  852  (1912). 

"  Athol  Music  Hall  Co.  v.  Carey,  116  Mass.  471  (l87S). 


38  CORPORATE  LAW  [Bk.  I- 

§  52.    Form  of  Subscription  Contract 

Generally  the  form  of  the  subscription  list  is  of  small  im- 
portance if  the  intent  of  the  parties  is  clearly  expressed.  Ex- 
cept for  the  difficulty  of  proof,  a  verbal  subscription,  if  within 
the  statute  of  frauds,  would  be  binding.i^ 

As  a  matter  of  ordinary  precaution,  however,  the  subscrip- 
tion list  should  be  prepared  with  due  regard  to  form  and  with 
a  clear  presentation  of  all  important  details.  The  name  of 
the  proposed  corporation,  its  general  purpose,  its  capitalization, 
the  par  value  of  shares,  the  state  in  which  it  is  to  be  incorporated, 
and  the  conditions  under  which  the  subscription  is  made — 
all  should  be  set  forth  with  precision.  Enough  should  be 
included  to  prevent  any  question  as  to  the  nature  of  the  sub- 
scription and  the  conditions  under  which  it  was  made. 

§  53.    Cautions  as  to  Forms  of  Subscriptions 

It  is  entirely  possible  to  draw  a  subscription  paper  so  loosely 
that  the  subscribers  cannot  be  bound  when  the  corporation 
is  formed  and  attempts  to  accept  their  subscriptions.  This  is 
so,  for  instance,  when  there  is  nothing  in  the  subscription 
agreement  to  connect  the  corporation  formed  with  the  corpora- 
tion contemplated  by  the  subscription  agreement.  A  subscrip- 
tion agreement  should  identify  the  proposed  corporation  with 
reasonable  clearness,  and  should  either  name  the  person  or 
persons  who  are  to  form  the  corporation,  or  be  in  its  terms  an 
agreement  between  the  persons  signing  it  to  organize  such  a 
corporation.  In  this  case  the  corporation  should  be  organized 
by  the  persons  named.  If  A,  B,  and  C  sign  a  mere  subscription 
to  a  corporation  to  be  formed,  and  afterward  E,  F,  and  G,  who 
are  not  mentioned  in  the  subscription  paper,  organize  such  a 
corporation,  there  is  no  necessary  connection  between  the 
parties,  and  the  newly  organized  corporation  cannot,  by  merely 
accepting  the  subscriptions  of  A,  B,  and  C,  bind  them.i^ 


'•  I  Cook  on  Corp.,  {  52;  Peninsula  Leasing  Co.  v.  Cody,  161  Mich.  604  (1910). 
"Woods  Motor  Vehicle  Co.  v.  Brady,  181  N.  Y.  145  (1905);  Sanders  v.  Bumaby,  166 
App.  Div.  (N.  Y.)  274  (1915). 


Ch,  si  SUBSCRIPTION  LISTS  AND  CONTRACTS  39 

In  Massachusetts,  Maine,  and  New  Hampshire  the  sub- 
scription contract  must  contain  an  express  agreement  to  pay. 
If  such  a  promise  is  not  contained  in  the  agreement,  the  only 
remedy  is  forfeiture  of  the  subscriber's  stock  for  non-payment.^s 

Where  it  is  inconvenient  to  go  into  full  details  of  the  cor- 
poration and  the  terms  of  subscription  in  the  subscription 
Ust  proper,  a  general  statement  or  prospectus  is  frequently 
prepared  and  accompanies  the  list.  Where  this  is  done  the 
statements  of  this  prospectus  become  a  part  of  the  represen- 
tations upon  which  the  subscriptions  are  secured,  and  must  be 
lived  up  to  in  all  essential  details  if  the  subscription  is  to  be  held.^^ 

§  54.    Effect  of  Material  Variation 

Any  material  variation  from  the  statements  of  the  sub- 
scription list,  such  as  a  change  of  capital,  or  purposes,  or  location, 
will  release  the  subscribers.20  For  this  reason,  only  those 
details  should  be  stated  explicitly  in  the  subscription  list  that 
have  been  fully  decided  upon,  any  undecided  points  being 
either  omitted,  or  stated  as  undecided,  or  otherwise  so  covered 
that  no  matter  how  they  are  finally  settled  the  subscriptions 
previously  secured  will  not  be  aflfected.  For  instance,  if  the 
name  of  the  proposed  corporation  has  not  been  finally  deter- 
mined, the  list  may  be  headed  with  any  suggested  name,  as 
"The  Arnold  Separator  Company,"  while  the  body  of  the 
document  states  that  the  subscriptions  are  made  to  the  stock 
"of  a  corporation  to  be  organized  under  the  name  of  'The 
Arnold  Separator  Company,'  or  such  other  name  as  may  be 
later  determined."  Or  if  the  capitalization  were  not  definitely 
settled  the  subscription  list  might  fix  sufficiently  elastic  limits 
by  the  use  of  such  phrases  as  "not  less"  or  "not  to  exceed," 
according  to  the  conditions.  Subscribers  to  such  a  list  could 
not  plead  any  voidance  of  their  subscriptions  no  matter  what 


18  N.ew  Haven  Horse  Nail  Co.  v.  Linden  Spring  Co.,  142  Mass.  349.  354  (1886). 

'•Southern  Insurance  Co.  v.  Milligan,  154  Ky.  216  (1913);  Lehman-Charley  v.  Bartlett, 
I3S  App.  Div.  (N.  Y.)  674  (1909);  aflfd.,  202  N.  Y.  524  (1911). 

"  I  Cook  on  Corp.,  {  54;  2  Cook  on  Corp.,  {  502;  Woods  Motor  Vehicle  Co.  v.  Brady, 
181  N.  Y.  14s  (1905);  Clarksburg  Board  of  Trade  v.  Davis.  86  S.  E.  (W.  Va.)  929  (i9iS). 


40  CORPORATE  LAW  [Bk.  I- 

name  or  what  capitalization,  within  the  limits,  was  eventually 
selected. 

At  times  individual  subscription  blanks  are  sent  out  instead 
of  a  single  list.  At  other  times  several  similar  lists  are  circulated 
as  a  matter  of  convenience.  If  properly  worded  to  show  their 
common  purpose,  these  separate  lists  will  for  all  legal  purposes 
be  held  as  a  single  list. 

§  55.    The  Common  Law  Rule 

It  is  to  be  noted  that  under  the  common  law,  unless  other- 
wise specified  in  the  agreement  of  subscription,  the  entire  capital 
stock  of  the  proposed  corporation  must  be  subscribed  before 
any  of  the  subscriptions  are  binding  and  enforceable.21  In  some 
of  the  states  this  has  been  modified  by  statute,  but  unless 
this  has  been  done  the  rule  prevails,  and  where  it  is  desirable 
that  subscriptions  for  a  less  amount  than  the  entire  capital  stock 
shall  hold,  the  subscription  list  should  so  specify.  It  is  com- 
petent for  the  subscription  list  to  fix  this  amount  at  any  desired 
figure  and  the  subscriptions  will  be  binding,  provided  the  other 
requisite  conditions  are  fulfilled,  so  soon  as  the  specified  amount 
is  secured. 

Any  person  competent  to  contract  may  make  a  binding 
subscription  for  stock.  A  subscriber  for  stock  need  not  neces- 
sarily be  an  incorporator  of  the  company,  though  usually,  as 
a  matter  of  statutory  requirement,  an  incorporator  must  be  a 
subscriber  to  the  company's  stock.  One  corporation  cannot 
usually  subscribe  for  the  stock  of  another  corporation,  though 
it  may  be  permissible  in  the  case  of  a  corporation  authorized 
to  hold  the  stock  of  other  corporations. 

§  56.    Underwriting  Agreements 

In  the  organization  of  the  larger  corporations,  and  more 
especially  those  designed  to  effect  industrial  combinations,  it 


"  I  Cook  on  Corp.,  {{  176-181;  Converse  v.  Gardner  Governor  Co.,  174  Fed.  30  (1909); 
Myers  v.  Sturgis,  123  App.  Div.  (N.  Y.)  470  (1908). 


Ch.  si  SUBSCRIPTION  LISTS  AND  CONTRACTS  41 

is  usually  very  important  and  at  times  absolutely  essential 
that  funds  be  raised  in  advance  of  the  time  when  the  corporate 
securities  can  be  offered  for  sale,  or  that  there  be  some  positive 
assurance  that  the  necessary  funds  will  be  derived  from  the  sale 
of  these  securities  when  they  are  ready  to  be  offered.  Under 
such  conditions  the  use  of  the  ordinary  subscription  agreement 
would,  at  the  best,  be  ineffective  and  in  most  cases  absolutely 
impracticable.  Recourse  is  then  had  to  the  modified  form  of 
subscription  agreement  known  as  the  underwriting  agreement.22 


w  See  Book  II,  Ch.  XXVII.  "Underwriting." 


CHAPTER  VI 
CONTRACTS  PRIOR  TO  INCORPORATION 

§  57.    Status  of  Corporation  upon  Organization 

When  a  corporation  has  been  created  by  the  state,  it  comes 
into  being  free,  unencumbered,  with  no  existing  business  relations, 
and  with  no  debts,  contracts,  or  obligations  of  any  kind,  save 
those  expressed  in  its  charter  and  in  the  statute  law  of  the  state 
of  domicile.  It  is  not  bound  by  anything  done  or  said  before 
its  incorporation  unless  embodied  in  its  charter.  A  corporation 
cannot  be  bound  before  it  exists,  as  no  one  could  then  act  with 
authority  as  its  agent  or  representative.^ 

After  its  organization,  the  corporation  may  recognize  or 
accept  any  proffered  contracts  it  sees  fit,  and  this  applies  to 
contracts  made  on  its  account  before  its  incorporation.  Its 
acceptance  of  such  a  contract  may  be  expressed  or  implied.  If 
the  corporation  takes  the  benefit  of  the  contract,  it  is  liable 
thereon  without  any  express  recognition  or  formal  acceptance. 2 
For  example,  if  offices  had  been  leased  for  the  corporation  before 
its  incorporation,  and  the  corporation  when  organized  occupied 
the  offices,  it  would  be  liable  on  the  contract  without  further 
acceptance.  If  the  corporation  did  not  occupy  the  offices  but 
by  a  proper  resolution  recognized  the  contract  and  assumed  the 
rent,  it  would  be  liable.  If  it  neither  occupied  the  offices  nor 
assumed  the  lease,  there  would  be  no  acceptance  either  expressed 
or  implied  and  the  corporation  could  not  be  held.  The  whole 
matter  rests  in  its  discretion.^ 


1  See  {  63|  see  also  3  Cook  on  Corp.,  {  707;  Oakes  v.  Water  Co.,  143  N.  Y.  430  (1894); 
Federal,  etc.,  Co.  v.  Loeb,  147  App.  Div.  (N.  Y.)  737  (1911). 

*  Robins  v.  Ry.  Co.,  100  Me.  496  (1905);  In  re  Ballou,  215  Fed.  810  (1914). 

'Bond  V.  Atlantic  Terra  Gotta  Co.,  137  A.  D.  (N.  Y.)  671  (1910);  Sheator  Tel.  Co.  v. 
Tel.  Co.,  217  111.  577  (190s);  Whitney  v.  Wyman,  loi  U.  S.  392  (1879);  Martin  v.  Remington- 
Martin  Co.,  95  A.  D.  (N.  Y.)  18  (1904). 

42 


Ch.  6]  CONTRACTS  PRIOR  TO  INCORPORATION  43 

In  Massachusetts  and  in  Missouri  the  courts  hold  that  a 
corporation  cannot,  by  adoption  or  otherwise,  ratify  a  contract 
made  when  it  was  not  in  existence  by  one  who  assumed  to  act 
as  its  agent.  It  may,  if  its  directors  see  fit,  make  a  new  contract 
on  the  same  terms,  but  this  is  a  new  contract  and  must  be 
complete  as  a  contract  in  itself/  A  contract  made  prior  to  the 
incorporation  might  amount  to  an  offer  to  the  corporation  which 
it  could  accept.  5 

§  58.     Status  of  Contracting  Parties 

Contracts  are  continually  entered  into  by  incorporators, 
promoters,  or  trustees  for  and  on  account  of  unorganized  cor- 
porations. These  contracts  are  entered  into  on  behalf  of  the 
corporation  and  in  its  interests,  but  the  party  who  enters  into 
any  such  contract  is  himself  liable  in  the  absence  of  an  express 
agreement  to  the  contrary  until  the  assumption  of  the  contract 
by  the  corporation. ^  Then,  if  it  was  understood  that  he  was 
acting  in  the  interests  of  the  corporation,  the  party  directly 
contracting  is  relieved  of  liability,  the  corporation  taking  over 
the  liability  in  his  stead.  If,  however,  there  were  no  such 
understanding  the  party  who  originally  made  the  contract 
would  be  responsible,  even  after  the  contract  was  taken  over  by 
the  corporation.  T 

For  example,  if  offices  are  leased  for  the  use  of  a  corporation 
about  to  be  formed,  with  the  clear  understanding  that  the 
party  making  the  lease  is  acting  for  the  unorganized  corporation, 
such  party  is  personally  liable  and",  if  the  corporation  fails  to 
assume  the  lease,  can  be  held  for  the  full  amount,  but  so  soon 
as  the  contract  is  assumed  by  the  new  corporation  he  is  released. 
If,  however,  the  lease  were  taken  without  a  clear  understanding 
that  the  party  was  acting  for  .the  corporation,  he  would  not  be 
_ iiu]   SP 

*  Pennell  v.  Lothrop,  191  Mass.  3S7  (1906);  Whiting  &  Sons  Co.  v.  Barton,  204  Mass. 
169  (1910). 

*  Holyoke  Env.  Co.  v.  U.  S.  Envelope  Co.,  182  Mass.  171  (1902). 

*  I  Machen  on  Corp.,  {  358  et  seq. 

'  Case  Mfg.  Co.  v.  Soxman,  138  U.  S.  431-437  (1891);  Strause  v.  Richmond  Woodworking 
Co.,  109  Va.  724  (1909). 


44  CORPORATE  LAW  [Bk.  I- 

relieved  by  the  mere  fact  that  the  corporation  took  over  the 
lease,  but  would  still  be  liable  and,  should  the  corporation  fail 
to  pay  its  rent,  might  be  called  upon  to  make  good  the  deficiency. 
For  this  reason,  in  making  contracts  for  the  benefit  of  an 
unorganized  corporation,  the  fact  that  they  are  being  made  for 
such  proposed  corporation  shouM  be  clearly  recognized  and 
expressed.  The  parties  making  such  contracts  should  also 
recognize  their  own  liability  in  the  matter  and,  if  there  is  any 
uncertainty  as  to  the  ultimate  organization  of  the  corporation 
or  its  acceptance  of  the  contracts,  should  make  them  dependent 
upon  the  organization  of  the  corporation  and  its  acceptance  of 
the  contracts,  or  otherwise  be  prepared  to  assume  the  respon- 
sibility themselves.  8 

§  59.    Agreements  among  Incorporators 

There  is  another  class  of  agreements  relating  to  the  un- 
organized corporation  of  a  very  different  nature.  These  are 
the  understandings  or  agreements  among  the  incorporators  or 
other  interested  parties  which  define  the  nature  of  the  proposed 
corporation,  its  purposes,  and  often  the  details  of  its  organization 
and  management.  Among  the  parties  these  agreements  are 
perfectly  proper  and  legitimate,  but  they  affect  the  corporation 
only  so  far  as  they  are  incorporated  in  its  charter  or  by-laws 
when  these  are  drawn. 

It  is  to  be  borne  in  mind  that  provisions  may  be  incorporated 
in  the  charter  or  made  part  of  the  by-laws  in  pursuance  of  a 
contract  or  as  a  consideration  for  a  contract,  in  such  wise  that 
their  subsequent  alteration  or  repeal  can  be  effected  only  by 
consent  of  the  interested  parties.  One  partner  may  agree  to  the 
incorporation  of  the  partnership  business  on  condition  that 
certain  provisions  be  embodied  in  the  by-laws,  the  maintenance 
and  observance  of  such  provisions  constituting  part  of  the 
consideration  for  the  transfer  of  the  partnership  property.  Such 
by-law  provisions,   properly  incorporated   and  duly   adopted, 


'  I  Machen  on  Corp.,  t  361 


Ch.  6]  CONTRACTS  PRIOR  TO  INCORPORATION  45 

cannot  be  revoked  without  the  consent  of  all  parties  concerned.' 
No  by-law  can  be  repealed  so  as  to  violate  or  impair  a  vested 
right.  10 

Often  agreements  in  regard  to  incorporation  are  mere  verbal 
understandings.  Usually,  if  not  carried  out,  these  only  result 
in  the  refusal  of  the  aggrieved  party  to  move  further  in  the 
matter,  such  agreements  not  ordinarily  furnishing  sufficient 
basis  for  litigation. 

Even  formal  agreements  between  promoters  as  to  the 
subject  matter  of  a  charter  can  rarely  be  specifically  enforced, 
and  the  only  recourse  of  the  aggrieved  party  is  a  refusal  to 
participate  in  the  subsequent  organization  of  the  corporation 
or,  if  damages  can  be  shown,  to  bring  a  suit  against  the  offending 
parties  for  their  breach  of  contract.ii 

§  60.    The  Promoter's  Function 

A  generally  approved  definition  of  a  promoter  is  as  follows: 

A  promoter  is  a  person  who  brings  about  the  incorporation 
and  organization  of  a  corporation.  He  brings  together  the 
persons  who  become  interested  in  the  enterprise,  aids  in  procuring 
subscriptions,  and  sets  in  motion  the  machinery  which  leads  to 
the  formation  of  the  corporation  itself.  .  .  . 

A  person  who  procures  subscriptions  and  aids  in  organizing  the 
company  and  frames  the  papers  and  manages  the  procuring  of 
options  and  the  vesting  of  title,  is  a  promoter,  even  though  he 
is  also  a  subscriber.^* 

A  late  work  says  of  promotion: 

All  business  enterprises  owe  their  existence  in  the  beginning, 
to  the  imagination  of  some  one  man.  Very  frequently  he  co- 
operates with  others,  so  that  the  original  plans  appear  to  be  the 
results  of  the  joint  efforts  of  a  group  of  men.     The  American 


•  Kent  V.  Quicksilver,  etc.,  Co.,  78  N.  Y.  iS9;  Lowenthal  v.  Rubber,  etc.,  Co.,  sa  N.  J. 
Eq.  440. 

"  Wright  V.  Knights  of  the  Maccabees,  196  N.  Y.  391  (1909). 

»  I  Machen  on  Corp.,  {  410;  Rudiger  v.  Coleman,  112  A.  D.  (N.  Y.)  279  (1906). 

"  2  Cook  on  Corp.,  J  651.  See  Book  II,  Ch.  XXI,  "Promoters."  Ch.  XXII,  "The 
Promoter's  Leeral  Status." 


46  CORPORATE  LAW  [Bk.  I- 

Telephone  and  Telegraph  Company  owes  its  existence  to  the 
imagination  of  Alexander  Graham  Bell  and  his  enthusiastic 
confidence  in  the  commercial  adaptability  of  the  telephone,  but 
the  success  of  the  company  in  its  earliest  years  was  due  quite  as 
much  to  the  financial  skill  of  another  man,  the  advertising  ability 
.';■  of  still  another,  and  the  power  of  organization  of  yet  another.  In 
•  1  one  sense.  Bell  was  the  promoter  of  the  telephone  company  because 
he  conceived  the  instfument  and  foresaw  its  economic  significance. 
But  in  another  sense,  his  associates  are  all  to  be  looked  upon  as 
promoters  because  their  united  efforts  were  required  to  launch 
the  new  undertaking."   "    ''" 

§  6i.    Promoters'  Contracts 

"'The  general  doctrine  that  no  one  is  authorized  to  contract 
for  a  corporation  before  it  is  formed  applies  to  all  contracts 
with  and  by  promoters.  The  promoter  is  himself  liable  on 
these  precorporate  contracts,  unless  otherwise  expressly  pro- 
vided, but  the  corporation  is  not.i^      ,  „ 

For  example,  as  is  frequently  the  case,'  the  promoters  of 
an  enterprise  may  agree  with  an  attorney  for  its  incorporation, 
authorizing  him  to  attend  to  the  whole  matter,  including  dis- 
bursements, preparation  of  seal,  printing,  etc.;  the  amount  of 
his  professional  fee  being  agreed  upon  in  advance.  On  the 
organization  of  the  corporation,  its  directors  might,  if  they 
saw  fit,  disclaim  the  whole  matter  and  the  attorney  would 
have  neither  recourse  nor  claim  against  the  corporation  on 
account  of  his  contract  with  the  promoters.  The  corporation 
having  utilized  his  legal  services  in  its  incorporation,  would 
probably  be  held  for  a  fair  fee  and  for  the  necessary  disburse- 
ments, such  as  the  state  fee,  notarial  charges,  filing  fees,  etc. 
But  such  claims  would  have  to  be  based  on  their  own  merits, 
•not  on  the  terms  of  the  agreement  made  with  the  promoters. 
That  agreement  would  have  no  standing  as  against  the  cor- 
poration, and  should  this  latter  reject  the  seal,  printing,  etc., 


"  2  Dewing  on  Finan.  Policy  of  Corp.,  p.  4. 

'*  Bank  v.  Church  Federation,!  29  Iowa  268  (1906);  Munson  v.  Syracuse,  etc.,  R.  R.  Co., 
103  N.  Y.  59  (1886);  Bond  v.  Atlantic  Terra  Gotta  Co.,  137  App.  Div.  (N.  Y.)  671  (1910). 


Ch.  61  CONTRACTS  PRIOR  TO  INCORPORATION  47 

the  attorney  would  have  no  ground  to  proceed  against  the 
corporation  therefor,  but  must  look  to  the  promoters.is 

The  most  difficult  question  arising  under  contracts  with 
promoters  relates  to  the  sale  of  property  to  the  corporation. 
It  is  a  matter  of  almost  daily  occurrence  for  promoters  to  dis- 
pose of  property  to  corporations  organized  by  them  for  the 
express  purpose  of  taking  over  such  property.  This  some- 
what complicated  subject  is  discussed  in  detail  in  a  later 
chapter.16 

§  62.    Option  Contracts 

In  the  formation  of  corporations,  and  especially  in  the 
formation  of  combinations,  it  is  frequently  necessary  that  op- 
tions be  secured  in  advance  of  the  actual  incorporation.  As 
these  options  may  be,  and  often  are,  absolutely  essential  to 
the  enterprise,  they  must  be  secured  before  the  corporation  is 
formed  and  frequently  involve  very  considerable  expen,ditures 
of  money. 

Notwithstanding  the  importance  of  these  contracts  and 
their  peculiar  nature,  they  fall  under  the  general  rules  gov- 
erning precorporate  contracts.  If  accepted,  they  become  the 
contract  of  the  corporation;  if  rejected,  the  corporation  cannot 
be  held.  If  the  corporation  refuses  to  take  over  any  such 
option  contracts,  the  party  obtaining  or  holding  them  would 
have  no  claim  for  compensation  or  for  damages  on  account  of 
any  payments  made  by  him  thereon  or  in  connection  therewith. 
He  might  have  some  claim  against  his  associates  if  they  made 
any  promises  to  him  in  regard  to  the  options  or  authorized 
him  to  procure  them,  for  the  joint  account,  but  the  corporation 
itself  could  not  be  compelled  to  accept  them,  nor  could  it  be 

held  in  any  way  except  by  its  voluntary  consent." 

to  io:VfiA  '  .  .nO  ? 


'^  Re  Empress  Engineering  Co.,  L.  R.  16,  Ch.  D.  125  {1881);  Weatherford  Ry.  Co.  v. 
Granger,  86  Texas  350  (1894);  Taussig  v.  St.  Louis,  etc.,  Ry.,  166  Mo.  28  (1901);  Bank  v. 
Eckels,  191  Pa.  372  (1899). 

'•  See  Book  II,  Ch.  XXII.  "The  Promoter's  Legal  Status." 

"  See  Book  IV,  Ch.  X,  "Options  and  Voting  Trust  Agreements." 


4$  CORPORATE  LAW  [Bk.  I- 

§  63.    Trustees'  Contracts 

When  the  organization  of  a  corporation  is  contemplated, 
not  infrequently  a  trustee,  or  trustees,  will  be  selected  to  act 
for  the  inchoate  corporation.  Some  arrangement  of  the  kind 
is  necessary  where  subscriptions  to  the  stock  of  the  corporation 
are  to  be  made  binding  before  its  organization.  Also  it  is 
usually  advisable  to  have  definite  parties  in  charge  of  the 
matter  who  have  power  to  act  for  the  subscribers. 

Such  trustees  frequently  collect  payments  on  subscrip- 
tions, make  disbursements  in  the  interest  of  the  new  enter- 
prise, and  in  some  cases  actually  carry  on  the  undertaking 
until  such  time  as  the  corporation  may  be  advantageously 
organized  and  put  in  control  of  the  going  concern. 

No  matter  how  far  such  trustees  may  have  carried  the 
corporate  affairs  nor  to  what  extent  they  may  have  contracted 
in  the  interests  of  the  corporation,  they  have  the  same  in- 
dividual liability  on  these  contracts  and  the  same  inability  to 
force  them  on  the  corporation,  as  in  the  case  of  any  other 
precorporate  contracts. 

The  coign  of  vantage  occupied  by  the  trustees  is  found 
in  the  fact  that  they  are  in  control  of  the  organization,  and 
where,  on  behalf  of  the  corporation,  contracts  of  any  impor- 
tance have  been  entered  into,  or  disbursements  have  been 
made,  or  obligations  have  been  incurred  by  them,  they  will 
see  that  these  are  properly  assumed  by  the  corporation  before 
its  control  passes  from  their  hands.  Then,  if  these  contracts 
have  been  entered  into  in  proper  form  so  that  the  assumption 
by  the  corporation  releases  the  trustees,  these  latter,  barring 
fraud,  are  thereafter  absolutely  free  from  any  liability  on 
account  of  their  precorporate  undertakings.^* 

§  64.    Effect  of  Failure  to  Incorporate 

When  contracts  are  entered  into  in  expectation  of  the 
formation  of  a  corporation  and  on  its  behalf,   the   trustees' 

"  See  {  s8. 


Ch.  6]  CONTRACTS  PRIOR  TO  INCORPORATION  49 

status,  if  the  corporation  fails  of  incorporation,  depends  upon 
the  nature  and  condition  of  the  contract.  A  subscription  to  its 
stock,  no  matter  how  irrevocable,  would  be  terminated;  if 
payments  had  been  made  thereon  to  a  trustee,  any  unexpended 
amount  might  be  reclaimed;  and  if  the  trustee  were  to  blame 
for  the  failure  to  incorporate,  he  might  be  responsible  for  the 
portion  expended  as  well.  Other  contracts,  if  clearly  made 
on  behalf  of  the  proposed  corporation,  would  in  most  cases 
be  terminated.  If  not  clearly  so  made,  the  parties  acting  for 
the  corporation  might  be  held  to  specific  performance  or  for 
damages  for  non-performance.  If  the  contracts  were  made 
with  the  distinct  understanding  that  they  were  for  the  benefit 
of  the  proposed  corporation,  the  parties  acting  for  the  unor- 
ganized corporation  could  not  insist  on  performance  for  their 
own  benefit. 

Subscribers  may  under  some  circumstances  be  held  liable 
as  partners  for  expenses  incurred  if  the  attempted  incorpora- 
tion is  not  effected.  Thus  where  a  projected  incorporation 
failed  the  court  said:  "Under  the  facts  disclosed  in  this  case, 
the  corporation  had  no  existence;  there  was  simply  an  im- 
matured  intention  of  the  parties  to  form  a  corporation  .  .  . 
there  being  no  responsible  principal,  the  associated  parties 
must  be  held  liable  as  partners."i9  In  Illinois,  Mississippi, 
and  some  other  states  the  statutes  provide  that  the  incorporator 
shall  be  held  personally  liable  where  the  incorporation  is 
incomplete.2' 


"Furniture,  etc.,  Co.  v.  Crawford,  127  Mo.  356  (1894);  Meyer  v.  Brunson,  88  S.  E. 
(S.  C.)  350  (1916);  Bank  v.  Sheldon,  86  Kan.  460  (1912). 

'0  Ragland  v.  Doolittle,  100  Miss.  498  (191 1);  Richardson  Fueling  Co.  v.  Seymour,  235 
111.  319  (1908). 


Jill 


0^ 


CHAPTER  VII 
.  ,j  .  WHERE  TO  INCORPORATE 

§  65.    General 

In  the  United  States,  business^ is  hampered  by  the  fact 
that  the  laws  regulating  the  conduct  of  business  vary  as  we 
cross  the  imaginary  lines  that  separate  state  from  state.  If 
the  corporation  laws  and  taxes  were  uniform  in  every  state 
of  the  Union,  or  if  the  whole  matter  were  regulated  by  gen- 
eral federal  laws,  the  best  location  for  any  particular  cor- 
poration could  easily  be  determined.  It  would  then,  as  a  matter 
of  course,  be  organized  in  that  state  in  which  the  principal 
operations  were  to  be  carried  on  or  in  which  its  headquarters 
might  most  conveniently  be  located. 

There  is,  however,  great  variation  in  the  cost  of  incorpora- 
tion in  different  states,  also  in  the  rates  and  methods  of  taxa- 
tion after  incorporation.  The  general  requirements  and  regu- 
lations imposed  on  corporate  operations  also  differ  widely. 

Owing  to  the  material  differences  in  the  costs,  regulations, 
and  requirements  of  the  several  state  laws,  taken  in  connection 
with  the  fact  that  a  corporation  organized  in  one  state  may, 
under  the  restrictions  imposed  on  foreign  corporations  by 
other  states,  do  business  in  these  states,  the  selection  of  the 
place  of  incorporation  frequently  becomes  a  balancing  of  the 
comparative  advantages  and  disadvantages  of  the  available 
states.  The  low  taxes  of  one  state  will  be  weighed  against 
the  better  corporation  laws  of  another;  the  liabilities  incurred 
in  a  convenient  state  with  the  freedom  therefrom  in  another 
less  convenient  state;  the  benefit  of  incorporation  under  desir- 
able laws  in  an  "outside"  state  and  consequent  burdens  in 
the  "operating"  state,  as  against  direct  incorporation  in  this 

5° 


Ch.  7]  WHERE  TO  INCORPORATE  5 1 

latter;    or  the  privileges  allowed  by  one  state  as  against  the 
immunities  enjoyed  under  the  laws  of  another. 

imi-not  idif  '  li  ^lon 

§  66.    Domestic  Incorporation 

Within  the  boundaries  of  the  state  by  which  it  is  chartered 
a  corporation  is  a  domestic  corporation;  outside  these  bound- 
aries it  is  a  foreign  corporation.  Within  its  own  state  a  cor- 
poration has  certain  recognized  powers  and  privileges  as  a, 
matter  of  right;  outside  it  has  only  such  powers  and  rights  as 
may  be  accorded  foreign  corporations  by  the  laws  or  customs 
of  the  particular  state.  These  regulations  as  to  foreign  cor- 
porations vary  greatly  in  the  different  states.  In  some,  foreign 
corporations  are  discriminated  against,  while  in  others,  upon 
compliance  with  the  prescribed  formalities,  foreign  corpora- 
tions have  the  same  status  as  domestic  corporations. 

As  a  rule  a  corporation  should  be  organized  in  that  state 
in  which  its  principal  operations  are  to  be  carried  on,  and  this 
rule  should  not  be  departed  from  unless  to  gain  some  distinct 
advantage.  At  times,  however,  there  may  be  weighty  reasons 
for  incorporating  in  an  outside  state.  Also  it  often  happens 
that  the  business  of  a  corporation  must  be  conducted  in  a 
number  of  different  states,  in  which  case  it  is  domiciled  in 
one  state  and  thereafter  transacts  its  business  in  the  others  as 
a  foreign  corporation.  The  selection  of  the  home  state  then 
becomes  purely  a  question  of  expediency.i 

§  67.    Foreign  Incorporation 

A  corporation  is  not'  a  citizen  of  the  United  States  and 
has  no  claims  to  the  privileges  and  immunities  of  citizenship 
under  the  Constitution.2  It  is  an  artificial  creation  of  the 
state  in  which  it  is  incorporated,  and  in  that  state  is  endowed 
by  common  and  statute  law  with  certain  rights,  powers,  and 
immunities.     It  is  also  usually  allowed  to  carry  on  its  oper- 


'  See  H  224,  225. 

»  Paul  V.  Virginia.  8  Wall.  168  (1868). 


52  CORPORATE  LAW  [Bk.  I- 

ations  in  other  states,  with  all  the  powers  and  privileges  it  en- 
joys in  its  home  state.^  These  other  states  may,  however,  if 
they  so  desire,  ignore  the  fictitious  personality  of  the  foreign 
corporation,  refuse  it  recognition,  debar  it  from  initiating  liti- 
gation in  the  state  courts,  consider  it  a  partnership  if  htigation 
be  brought  against  it,  or  even  entirely  prohibit  its  corporate 
operations  within  the  state  except  in  so  far  as  they  may  be 
permitted  by  the  constitutional  provisions  regulating  interstate 
commerce.  * 

Article  I  of  the  United  States  Constitution  gives  the  federal 
government  the  sole  authority  "to  regulate  commerce  with 
foreign  nations,  and  among  the  several  states  and  with  the 
Indian  tribes."  Consequently,  attempts  of  the  state  authori- 
ties to  prevent  or  impose  restrictions  on  corporations  taking 
orders  in  or  shipping  goods  into  a  state  have  been  held  un- 
constitutional. 

Generally,  however,  no  discrimination  is  exercised  against 
the  foreign  corporation.  In  most,  if  not  all  the  states,  laws 
will  be  found  providing  for  certain  fees  and  other  require- 
ments as  a  prerequisite  to  the  exercise  of  the  corporate  rights 
by  foreign  corporations  within  the  state,  but  upon  compUance 
with  these  demands  they  are  admitted  freely  and  are  usually 
accorded  aU  the  rights  and  privileges  of  domestic  corporations. 
Some  states  have  even  favored  "the  stranger  within  the 
gates,"  as  in  New  York,  where  for  many  years  domestic  cor- 
porations were  subjected  to  high  fees,  burdensome  reports, 
and  possible  liabilities,  which  were  not  imposed  upon  foreign 
corporations  doing  business  within  the  state.  As  a  conse- 
quence the  citizens  of  New  York  when  desirous  of  incor- 
porating a  local  business  or  enterprise  would  resort  to  other 
states  for  the  purpose,  and  the  corporation  so  organized  would 
thereafter  do  business  in  New  York  as  a  foreign  corporation, 


'  Tootle  V.  Singer,  ii8  Iowa  S33.  536  (1902);  Lancaster  v.  Amsterdam  Improvement  Co., 
140  N.  Y.  576  (1894)- 

*  2  Morawetz  on  Corp.,  {  96sa;  Ducat  v.  Chicago,  10  Wall.  410  (1870);  Pembina  Mining 
Co.  V.  Pa.,  125  U.  S.  181  (1888);  Pensacola  Tel.  Co.  v.  W.  U.  Tel.  Co.,  96  U.  S.  i  (1877). 


Ch.  7]  WHERE  TO  INCORPORATE  _         53 

and  this  though  all  the  parties  interested  resided  in  the  state 
and  all  the  corporate  business  was  transacted  there. 

This  practice  gave  rise  to  litigation  to  determine  the  right 
of  citizens  to  incorporate  elsewhere  when  the  corporate  busi- 
ness was  to  be  conducted  in  the  state,  but  the  decisions  were 
uniformly  and  unreservedly  in  favor  of  such  right,  s  In  other 
states  the  same  question  has  arisen  and  has  been  so  uniformly 
decided  in  the  same  way  that  the  principle  may  be  regarded 
as  firmly  established. « 

In  some  states  conditions  of  so  onerous  a  nature  exist  as 
to  render  foreign  incorporations  most  desirable,  as  for  instance 
the  double  liability  of  Minnesota,  which  is  imposed  upon  the 
stockholders  of  certain  corporations  when  organized  under  the 
laws  of  the  state.  Under  ordinary  conditions  the  stockholders 
of  a  foreign  corporation  doing  business  in  the  state  escape 
this  double  liability  altogether,  being  subject  only  to  such 
liabilities  as  are  imposed  by  the  corporation  laws  of  the  state 
of  organization.' 

§  68.    The  Liability  in  California 

In  this  connection  it  is  to  be  noted  that  the  state  of  Cali- 
fornia, in  which  a  special  liability  is  imposed  upon  stockholders 
of  domestic  corporations,  has  sought  to  extend  this  same 
liabiUty  by  statute  provision  to  the  stockholders  of  foreign 
corporations  doing  business  within  the  state.  This  liability 
has  been  sustained  in  two  decrees  of  the  Supreme  Court  of  the 
United  States,  in  one  instance  as  against  the  California  stock- 
holders of  a  Colorado  corporation  doing  business  in  Cali- 
fornia, and  in  the  second  case  as  against  a  New  York  stock- 
holder of  an  Arizona  corporation  doing  business  in  California. 
In  the  first  case,  however,  the  corporation  was  organized  in 


'  Merrick  v.  Van  Santvoord,  34  N.  Y.  207  (1866);  Demarest  v.  Flack,  128  N.  Y.  20s 
(1891),  Lancaster  v.  A.  I.  Co.,  140  N.  Y.  576  (1894). 

•People  V.  Fidelity  Co.,  iS3  HI.  25  (1894);  Haskins  v.  Kelly,  77  Kans.  ISS  (1908); 
Saltmarsh  v.  Spaulding,  147  Mass.  224  (1888). 

'Bank  v.  Hall.  35  O.  St.  158  (1878);  Canada  Southern  R.  Co.  v.  Gebhard,  109  U.  S. 
527  (1883);  Risdon  I.  &  L.  Works  v.  Furness,  i  K.  B.  49  (1906). 


54         .  CORPORATE  LAW  [Bk.  I- 

Colorado,  mainly  by  citizens  of  California,  for  the  express 
purpose  of  doing  business  in  California,  and  this  purpose, 
with  unusual  and  perhaps  unnecessary  frankness,  was  specifi- 
cally set  forth  in  the  charter. « 

In  the  second  case  the  charter  recited  that  the  corporation 
was  formed  to  carry  on  business  in  Arizona  and  California, 
and  the  defendant  prior  to  the  incorporation  had  signed  a 
writing  reciting  the  intent  of  the  subscribers  to  form  a  cor- 
poration in  Arizona  for  the  purpose  of  acquiring  land  in  Cali- 
fornia and  locating  a  hotel  thereon.  While  not  questioning 
the  principle  that  the  corporation  could  not  without  authority 
from  the  stockholder  make  him  answerable  in  a  way  not  con- 
templated by  the  charter,  the  court  in  the  latter  case  held  that, 
on  the  facts,  the  stockholder  had  assented  to  the  doing  of 
business  in  California  and  was  therefore  bound. » 

§  69.     Risks    of    Doing    Business    in    Foreign    State    Without 
Authorization 

It  may  be  stated  as  a  general  rule  that  if  corporate  busi- 
ness of  any  importance  is  to  be  carried  on  in  a  foreign  state, 
all  the  requirements  of  that  state  in  regard  to  foreign  cor- 
porations should  be  complied  with  as  a  matter  of  business 
policy  and  expediency.  In  some  states  severe  fines  are  im- 
posed on  corporations  doing  business  without  a  license,  though 
the  usual  penalty  is  the  refusal  of  corporate  recognition  by 
the  foreign  state.  The  corporation  may,  however,  still  carry 
on  business  within  such  foreign  state,  its  property  is  safe  from 
confiscation,  and  it  cannot  be  prevented  from  bringing  suit  in 
all  proper  cases  in  the  United  States  courts  in  that  state. 
Beyond  this,  however,  it  has  no  status.  It  carmot  enforce  a 
contract  or  collect  a  debt  in  the  state  courts.  Where,  however, 
as  in  Michigan,  Missouri,  and  several  other  states,  the  statutes 
declare  all  contracts  made  by  unauthorized  foreign  corpora- 


•Pinney  v.  Nelson,  183  U.  S.  144  (igoi).* 
•Thomas  v.  Matthiessen,  232  U.  S.  221  (1914). 


Ch.  7]  WHERE  TO  INCORPORATE  55 

tions  to  be  void,  no  action  is  maintainable  upon  such  contracts 
even  in  the  federal  courts. i"  In  Florida  it  has  been  held  that, 
if  sued,  an  unauthorized  foreign  corporation  may  be  treated 
as  a  partnership  and  its  stockholders  be  considered  as  part- 
ners.ii 

In  addition  to  the  restrictions  and  penalties  imposed  upon 
unauthorized  corporations,  as  corporations,  many  states  make 
the  officers  and  agents  acting  for  the  corporation  within  the 
state  liable  to  heavy  penalities,  and  five  of  the  western  states 
make  the  ofiicers  and  agents  of  the  corporation  jointly  and 
severally  liable  in  any  and  all  contracts  of  such  corporation 
made  within  the  state  during  the  time  that  the  corporation  was 
in  default. 

§  70.    Cheap  Incorporation 

Resort  to  outside  incorporation  on  account  of  its  cheapness 
is  legitimate  but  not  always  wise.  The  cheap  states  have 
their  advantages,  but  the  excellence  of  their  corporate  regu- 
lations does  not  figure  among  these.  Nor  is  the  status  of 
their  incorporations  as  a  class  entirely  desirable  for  reputable 
organizations. 

Occasions  will  occur  when  temporary  or  experimental  in- 
corporations are  desirable,  or  where  the  conditions  are  such 
that  the  cheapest  incorporation  must  be  made  to  serve,  or 
where  the  laxity  of  corporate  regulation  is  regarded  as  advan- 
tageous.   Then  the  cheap  location  will  be  sought. 

Speaking  generally,  however,  the  ease  and  cheapness  with 
which  incorporation  may  be  secured  in  these  localities  draw 
to  them  the  unsubstantial  enterprises,  illusive  undertakings, 
and  fraudulent  schemes  that  so  frequently  adopt  the  cor- 
porate guise  for  their  dubious  careers.  These,  flocking  to 
the  cheaper  states,  give  bad  repute  to  their  incorporations,  and 

10  Despres,  Bridges  &  Noel  v.  Zierleyn,  163  Mich.  399  (1910);  Parke  Davis  &  Co.  v. 
Muller,  24s  Mo.  168  (1912);  Haynes  Wheel  Co.  v.  Am.  Distributing  Co.,  257  Fed.  Rep.  881 
(1919). 

"  Taylor  v.  Branham,  35  Fla.  297  (1895). 


56  CORPORATE  LAW  [Bk.  I- 

the  very  fact  of  organizatioA  in  one  of  these  states  is  a  cir- 
cumstance requiring  explanation  and  tending  to  prejudice  the 
experienced  investor.  In  other  words,  the  corporation  is  in 
bad  company  and  is  likely  to  suffer  the  usual  results  of  such 
association. 

An  even  more  material  objection  to  the  states  of  cheap 
incorporation  is  found  in  the  fact  that  their  corporation  laws 
are  crude,  incomplete,  and  for  the  most  part  unadjudicated. 
Nor  is  there  any  reasonable  assurance  of  the  permanency  of 
the  existing  laws.  Obviously  they  have  been  compiled  hastily 
and  without  requisite  care  and  consideration,  and  they  are 
liable  to  be  amended  or  altered  at  any  time  with  equal  haste 
and  lack  of  judgment.  The  possibilities  in  this  direction  are 
illustrated  by  the  corporate  career  of  West  Virginia.  Prior  to 
1 901,  West  Virginia  had  a  virtual  monopoly  of  the  cheap  in- 
corporation business.  Its  rates  were  low  and  its  requirements 
simple.  Incorporations  flowed  to  it  in  a  steady  stream  and 
its  revenue  therefrom  was  large  and  very  profitable.  In  1901, 
however,  without  previous  warning  and  without  obvious  rea- 
sons beyond  an  ill-judged  avarice,  the  state  legislature  raised 
the  corporate  fees  and  taxes  materially  and  made  them  com- 
plicated as  well  as  burdensome.  The  result  was  the  practical 
destruction  of  the  incorporating  business  in  West  Virginia. 
Most  of  the  outside  corporations  already  in  the  state  rein- 
corporated elsewhere,  new  incorporations  ceased  to  come,  and 
West  Virginia  is  no  longer  considered  an  available  resort  for 
incorporators  from  other  states. 

§  71.    Reputation  of  Different  States 

Each  of  the  incorporating  states  has  a  general  reputation 
in  corporate  matters.  This  primarily  arises  from  the  character 
and  operation  of  its  corporate  legislation  and  from  the  security 
afforded  thereby  to  corporate  investors  and  creditors,  but  is 
directly  derived  from  the  character  of  the  corporations  or- 
ganized under  its  laws. 


Ch.  7]  WHERE  TO  INCORPORATE  57 

This  reputation  is  of  much  importance  to  corporations  in- 
tending to  offer  their  securities  to  intelligent  investors.  In  the 
cheaper  localities,  on  account  of  this  cheapness  and  the  accom- 
panying laxity  of  the  corporate  laws,  such  reputation  is  dis- 
tinctly bad.  The  mere  fact  that  a  corporation  is  organized  in 
Arizona  or  Nevada  is  sufficient  to  put  experienced  investors  on 
their  guard  and  renders  the  sale  of  corporate  securities  difficult. 

Among  the  more  moderately  priced  incorporating  states, 
Maine  stands  well  and  is  resorted  to  by  many  eastern  corpo- 
rations. Delaware  has  a  fair  reputation  and,  with  its  moderate 
organization  fees  and  annual  taxes,  is  a  popular  state  for  out- 
side incorporations. 

New  Jersey  was  at  one  time  the  most  popular  state  in  the 
Union  for  outside  incorporations  of  large  capitalization,  but 
in  1 913  the  legislature  passed  certain  laws  affecting  corpora- 
tions known  as  the  "Seven  Sisters  Acts,"  which  prohibited 
holding  corporations,  and  otherwise  made  restrictions  which 
greatly  hampered  New  Jersey's  business  of  incorporation. 
New  Jersey  felt  the  change  severely  and  has  recently  restored 
to  good  standing  the  holding  corporation  and  the  subsidiary 
company.  These  are  now  lawful,  provided  their  effect  is  not 
to  "substantially  lessen  competition,"  or  to  "restrain  trade," 
or  to  "create  a  monopoly." 

Massachusetts  stands  high,  on  account  of  the  conservatism 
of  her  laws.  Pennsylvania  is  greatly  handicapped  by  the  com- 
plications of  her  corporation  laws,  and  the  high  fees,  but  stands 
well,  as  do  also  Illinois  and  other  important  states  lying  between. 
New  York  under  its  present  corporation  laws  ranks  high. 

§  72.    Liabilities  Imposed  in  Different  States 

When  the  selection  of  a  state  for  incorporation  is  under 
consideration  the  special  liabilities  attaching  to  directors  and 
stockholders  of  a  corporation  are  matters  for  careful  investiga- 
tion. The  unusual  stock  liabilities  found  in  Minnesota  and 
California  are  very  serious,  if  not  insuperable,  objections  to 


$8  CORPORATE  LAW  [Bk.  I- 

incorporation  in  these  states.  In  the  cheap  localities  the  usual 
liability  on  unpaid  stock  exists,  but  there  are  no  special  liabili- 
ties of  either  directors  or  stockholders. 

In  the  more  important  incorporating  states  stockholders 
generally  have  no  liabilities  save  on  unpaid  stock,  though  in 
Massachusetts,  New  York,  and  a  few  other  states  there  is  a 
stockholders'  liability  to  laborers  employed  by  the  corporation. 
Also  in  Idaho,  Minnesota,  and  some  other  states  failure  to 
observe  certain  requirements  as  to  corporate  organization  and 
procedure  may  involve  stockholders  in  liability;  and  in  a  num- 
ber of  states  the  legislatures  have  re-enacted  the  common  law 
liability  of  stockholders — which  exists  in  all  states — for  divi- 
dends or  other  disbursements  to  the  stockholders  which  im- 
pair the  capital  stock. 

In  most  of  the  states  directors  are  held  liable  only  for 
negligence  or  direct  fraud. 

§  73.    Protection  of  Minority  in  Different  States 

The  protection  of  minority  interests  is  at  times  of  very 
great  importance.  It  could  hardly  be  satisfactorily  secured  in 
any  state  where  special  charter  provisions  are  not  permitted, 
though  in  some  states  where  such  provisions  are  not  allowed, 
the  right  to  cumulative  voting  is  effectually  secured  by  the 
constitution  or  the  statutes  of  the  state,  and  the  minority  is 
to  that  extent  protected.  In  Delaware,  New  Jersey,  and  New 
York  protection  may  be  secured  by  charter  provisions.  In 
Maine  it  may  be  had  only  by  by-law  enactment,  which,  as 
the  by-laws  are  subject  to.  repeal  by  the  majority,  is  practically 
no  protection.i2 

§  74.    General  Rules  for  Selection  of  State 

Usually  the  selection  of  the  place  of  incorporation  will  be 
determined  by  the  particular  conditions.  The  more  important 
of  the  few  general  rules  that  can  be  given  are  as  follows : 

w  See  Oh.  LVIII,  "Protection  of  Minority." 


Ch.  7]  •  WHERE  TO  INCORPORATE  59 

1.  A  corporation  having  but  one  plant  or  place  of  busi- 
ness, in  which  all  or  the  greater  part  of  its  capital  is  involved, 
should  be  incorporated  in  the  state  where  that  plant  or  place 
of  business  is  located. 

2.  Any  large  corporation,  or  industrial  combination,  formed 
to  transact  business  or  operate  plants  in  a  number  of  states 
will,  for  the  reasons  already  given,  find  incorporation  in  Dela- 
ware advantageous,  while  Maine  also  is  favored  for  incorpora- 
tions of  this  kind. 

3.  Temporary  incorporations,  some  few  close  corporations, 
purely  speculative  corporations,  incorporations  of  doubtful 
stability,  and  all  other  corporations  desiring  the  maximum  of 
capitalization  with  the  minimum  of  expense  and  restriction, 
will  naturally  gravitate  to  the  bargain-counter  localities  where 
the  cost  of  incorporation  is  nominal. 


tjmiA  ba»  Z9dl,  ( 


CHAPTER  VIII 

COST  OF  INCORPORATION 

§  75.    General 

The  direct  expenses  of  incorporation  are  the  initial  organ- 
ization taxes  paid  the  state  authorities,  the  incidental  fees 
for  filing  and  acknowledgments,  fees  paid  to  counsel,  and  the 
cost  of  the  corporate  equipment.  Thereafter  the  expenses 
are  presumably  the  same  as  for  an  unincorporated  concern, 
save  for  the  annual  franchise  tax  and  possibly  an  increased 
property  taxation  that  may  result  from  the  greater  difficulty 
of  evasion  under  the  corporate  form. 

The  incidental  fees  are  usually  trifling.  The  initial  state 
fees  and  the  subsequent  annual  taxation  are  more  serious. 
As  these  differ  greatly  in  the  various  states,  however,  only  a 
general  consideration  of  the  subject  can  be  undertaken  here. 

§  76.    Organization  Fees  and  Annual  Taxes 

In  deciding  upon  a  locality  for  incorporation  the  matter 
of  fees  and  taxes  should  not  be  given  undue  importance.  In 
many  cases  really  important  advantages  are  sacrificed  for  the 
sake  of  immaterial  savings  in  fees.  Unless  the  saving  is  con- 
siderable, it  is  rarely  expedient  to  incorporate  in  a  foreign 
state  for  this  reason  alone.  The  following  tables  give  the 
states  most  utilized  for  general  incorporation  purposes. 

It  is  to  be  noted  that  all  such  tables  of  comparative  expenses 
are  misleading  without  some  explanation.  For  instance,  the 
annual  taxes  of  the  following  table  are  based  on  the  supposi- 
tion that  in  each  case  the  entire  •  stock  of  the  corporation 
is  issued  and  outstanding.  Also  the  annual  taxes  as  given 
are  exclusive  of  the  usual  tax  imposed  on  any  real  or  personal 

60 


Ch.  8] 


COST  OF  INCORPORATION 


61 


Comparative  Table  of  Organization  Expenses 
Including  Taxes  and  All  Filing  and  Incidental  Fees 


Capital  Stock 
of  Company 

New  Jersey 

New  York 

Delaware 

Maine 

South 
Dakota 

$          1,000 

«     35 

$     45 

$     25 

$      27 

$  IS 

5,000 

35 

45 

25 

27 

IS 

10,000 

35 

45 

25 

27 

IS 

25,000 

35 

47-50 

25 

67 

IS 

50,000 

35 

60 

25 

67 

20 

100,000 

35 

85 

25 

67 

20 

500,000 

no 

285 

65 

67 

25 

1,000,000 

210 

535 

115 

117 

2S 

5,000,000 

1,010 

2,535 

265 

517 

"S 

10,000,000 

2,010 

5.035 

1,015 

1,017 

iSS 

Comparative  Table  of  Annual  Franchise  Taxes 

$        1,000 

$       I 

$    5 

$    5 

None 

5,000 

5 

5 

5 

10,000 

10 

5 

5 

Annual 

25,000 

25 

Income 

5 

5 

50,000 

50 

Tax 

10 

5 

100,000 

100 

of 

4^% 

10 

10 

500,000 

500 

25 

50 

1,000,000 

1,000 

50 

75 

5,000,000 

4f>oo 

150 

275 

10,000,000 

4,250 

275 

525 

property  held  in  the  state,  which  is  taxed  in  all  respects  as  if 
owned  by  an  individual.  In  New  York  the  annual  tax  has 
been  superseded  by  an  annual  income  tax  of  4^%  on 
the  net  income  as  reported  in  the  federal  income  tax  report. 

In  the  table  as  given  the  usual  incidental  expenses  of  each 
state  have  been  included  as  part  of  the  organization  tax.  These 
incidental  fees  vary.  In  New  York  they  amount  approximately 
to  $35;  in  New  Jersey  $10;  in  Delaware  $15;  in  Maine  $17; 
in  South  Dakota  $3.  In  Arizona  these  fees  would  amount  to 
from  $20  to  $30.     . 


62  CORPORATE  LAW  [Bk.  I- 

The  comparative  cost  of  incorporation  comes  up  for  con- 
sideration only  when  foreign  incorporation  is  contemplated. 
In  all  such  cases  the  cost  of  keeping  up  a  state  office  and  agent 
in  the  selected  state  is  to  be  added  to  the  usual  expenses.  This 
would  vary  from  $25  to  $50  annually  for  corporations  of 
moderate  capitalization,  and  usually  includes  assistance  in 
holding  annual  meetings  in  the  state  and  such  attention  to 
state  reports  as  is  demanded  by  the  local  law. 

§  77.    Annual  Franchise  Taxes 

It  is  to  be  noted  that  the  annual  franchise  tax  in  New  Jersey 
amounts  to  a  very  considerable  sum.  The  annual  franchise 
tax  in  Maine  and  in  Delaware  is  moderate.  In  the  District  of 
Columbia,  Illinois,  North  and  South  Dakota,  and  some  other 
of  the  western  states,  there  is  no  aimual  franchise  taxation. 
Connecticut  and  Wisconsin  have  no  franchise  tax  but  have  an 
income  tax  which  applies  to  the  income  of  corporations.  In 
considering  the  question  of  cost,  it  is  to  be  remembered  that 
foreign  corporations  are  usually  required  to  pay  license  fees  and 
taxes  in  the  states  in  which  they  do  business,  and  often  foreign 
incorporation  merely  adds  the  cost  of  the  outside  incorporation 
to  the  taxes  that  cannot  be  avoided  in  the  state  in  which  the 
corporation  conducts  its  operations.  In  some  cases,  however, 
a  foreign  incorporation  may  save  onerous  local  taxation,  as  in 
the  New  York  case  of  People,  etc.  v.  Feitner,i  where  debts  due 
the  company  from  parties  outside  the  state  were  held  taxable 
in  the  state,  as  was  also  personal  property  generally  regardless 
of  its  situs.  At  that  .time  foreign  incorporation  would  have 
saved  the  corporation  over  $30,000  per  annum.  At  present, 
however,  the  New  York  income  tax  on  corporations  has  super- 
seded the  taxation  then  in  force,  and  personal  property  and 
accounts  receivable,  as  such,  are  not  taxed. 


'  54  App.  Div.  (N.  Y.)  217  (1906). 


Ch.  8]  COST  OF  INCORPORATION  63 

§  78.    Effect  of  Bond  Issue 

Where  a  corporation  is  organized  to  take  over  a  business  or 
property,  it  is  often  possible  and  frequently  distinctly  advan- 
tageous to  issue  bonds  in  part  payment  for  the  property  taken 
over.  The  necessary  capital  stock  of  the  company  is  thereby 
reduced  by  just  the  amount  of  this  bond  issue,  and  the  state 
fees  and  the  state  taxation  thereafter  are  also  proportionately 
less.  Also  in  many  states,  the  corporation  in  rendering  its 
statement  of  taxable  property  is  allowed  to  deduct  any  out- 
standing indebtedness.  The  bond  issue  is  an  entirely  legitimate 
indebtedness  and  in  these  states  may  be  deducted  from  the 
taxable  property  of  the  corporation  in  ascertaining  the  basis 
of  taxation.  This  law  was  sustained  by  the  decision  in  an 
extreme  case,2  where  the  corporation  under  consideration  had 
an  outstanding  bond  issue  of  $2,250,000,  an  amount  far  in 
excess  of  its  total  capital  stock,  and  at  least  twice  the  amount 
of  its  actual  assets.     In  this  decision  the  court  said: 

Tbis  indebtedness  must  in  the  nature  of  things  be  taken  into 
consideration  in  arriving  at  the  value  of  the  capital  of  the  relator. 
And  when  it  is  seen  that  the  indebtedness  of  a  corporation  is 
double  the  amount  of  aU  its  assets,  it  follows,  upon  the  system 
adopted  by  the  state  for  the  assessment  of  corporations  that 
the  actual  value  of  the  capital  of  such  a  corporation  is  zero. 

In  New  York  the  tax  on  the  corporate  income  has  taken  the 
place  of  the  tax  on  the  personal  property  of  corporations,  but 
in  other  states  the  reduction  of  taxable  assets  by  issuing  bonds 
instead  of  stock  can  still  be  effected. 

In  reckoning  the  federal  income  tax,  the  interest  paid  on 
outstanding  bonds  would  be  a  legitimate  deduction  and  would 
cut  down  the  income  subject  to  taxation.  It  would  have  the 
like  effect  in  those  states  where  corporate  income  is  taxed.s 


*  People,  etc.  v.  Barker,  139  N.  Y.  55,  63  (1894). 
'  See  also  {  93. 


64  CORIORATE  LAW  [Bk.  I- 

§  79.    Effect  of  Location  of  Place  of  Business 

In  some  states  a  corporation  is  taxed  on  personal  property 
in  the  place  where  its  principal  place  of  business  is  located,  and 
this  place  of  business  is  fixed  by  its  charter.  This  formerly 
obtained  in  the  state  of  New  York.*  It  is  possible  that  in  other 
states  this  plan  of  evading  taxation  may  still  be  effective,  as  it 
was  in  New  York  for  many  years.  5 

§  80.    Avoiding  Fees  and  Taxation 

As  stated  elsewhere,  it  is  usually  advisable  for  an  incorpora- 
tion to  be  taken  out  in  that  state  where  the  principal  business 
is  to  be  conducted.  At  times,  however,  the  incorporating  fees 
are  so  excessive  that  the  corporation  is  forced  to  resort  to  another 
state  where  the  fees  are  less  onerous,  doing  business  in  its  own 
state  thereafter  as  a  foreign  corporation.  For  instance,  had 
the  Steel  Trust  incorporated  in  Pennsylvania,  which  would 
naturally  have  been  its  home  state,  its  initial  fees  would  have 
amounted  to  over  $3,500,000.  In  the  state  selected,  New 
Jersey,  these  fees  amounted  to  but  $220,000. 

Incorporation  in  a  less  expensive  state  is  the  most  obvious 
method  of  avoiding  excessive  state  fees,  where  practicable. 
Conditions  may  exist,  however,  which  fix  the  state  of  incorpora- 
tion despite  the  question  of  fees;  and  where  the  fees  are  high, 
the  details  of  incorporation  should  then  be  so  adjusted  as  to 
reduce  these  fees  and  the  annual  taxation  thereafter  to  the 
lowest  possible  figure. 

One  ill  effect  of  income  taxes,  both  state  and  federal,  is  to 
penalize  careful  management,  and  as  a  consequence  among  those 
corporations  having  large  incomes,  advertising,  salaries,  and 
other  outlays  have  been  largely  increased  as  a  means  of  reducing 
the  net  income  subject  to  taxation. 

There  is  a  limit  to  this,  but  salaries  have  undoubtedly  been 


*  Union  Steamboat  Co.  v.  City  of  Buffalo.  82  N.  Y.  351  (1880). 

'  At  present,  with  most  New  York  corporations  the  new  4  }^  %  income  tax,  uniform  in  all 
patts  of  the  state,  makes  this  form  of  evasion  impracticable. 


Ch.  8]  COST  OF  INCORPORATION  65 

awarded  with  greater  liberality  since  the  income  law  was  adopted. 
Where  the  corporation  is  not  a  close  corporation,  but  persons 
outside  the  corporation  own  part  of  its  stock,  such  increase  of 
salaries  may  defraud  them  of  their  rightful  dividends. «  In 
some  states  taxes  are  arranged  upon  a  sliding  scale,  depending 
upon  the  rate  of  dividends  paid.  Where  this  is  true,  close 
corporations  not  infrequently  reduce  their  dividends  by  the 
disposal  of  profits  as  salaries,  instead  of  allowing  these  profits 
to  accumulate  and  be  distributed  as  dividends. 

In  many  states  manufacturing  corporations  are  either 
entirely  released  from  the  payment  of  state  franchise  taxes 
or  are  granted  a  more  liberal  basis  or  rate.  Such  exemption 
would  naturally  be  claimed  as  far  as  possible. 

§  81.    Double  Incorporation  to  Avoid  Fees  and  Taxation 

A  more  intricate  method  of  avoiding  taxation  sometimes 
followed  is  the  organization  of  a  company  with  the  desired 
name,  purposes,  and  capitalization  in  some  state  where  taxa- 
tion is  moderate,  as  Delaware,  Maine,  South  Dakota,  or  Arizona. 
Stock  is  issued  for  property  in  apportionment  of  interests  and 
for  other  purposes  as  necessary.  This  is  the  actual  corporation. 
A  small  operating  company  is  then  incorporated  in  the  state  in 
which  the  business  is  really  to  be  conducted,  with  the  same 
name  and  purposes,  but  with  a  nominal  capitalization,  possibly 
only  1%  of  that  of  the  larger  corporation.  The  smaller  cor- 
poration then  acts  as  the  local  agent  of  the  larger  corporation, 
under  such  arrangement  as  the  particular  conditions  indicate, 
the  larger  corporation  not  appearing  actively  in  the  conduct  of 
the  business. 

If  the  small  corporation  is  to  have  an  entirely  independent 
existence,  with  officers  and  stockholders  distinct  from  those  of  the 
larger  company,  it  is  usually  arranged  that  it  shall  make  no 
profits,  all  these  being  diverted  to  the  larger  corporation.  If 
this  separate  existence  is  not  necessary,  the  stock  of  the  smaller 


» See  Ch.  LX,  "The  Management  of  Close  Corporations." 


66  CORPORATE  LAW  [Bk.  Ir 

corporation  is  held  either  by  the  larger  corporation  or  by  the 
stockholders  of  the  larger  corporation  in  due  proportion.  The 
officers  of  the  smaller  corporation  are  then  usually  the  same  as 
for  the  larger  corporation,  and  the  relations  between  the  two 
are  very  close. 

It  is  obvious  that  organization  fees  and  taxes  are  by  this 
device  largely  avoided,  and  that  both  state  and  local  taxation 
thereafter  are  materially  lessened  if  not  almost  entirely  evaded. 
The  general  plan  is,  however,  difficult  and  complicated  and 
requires  the  assistance  of  able  counsel  for  its  proper  execution. 

§  82.    Legal  and  Illegal  Methods  of  Avoiding  Taxation 

The  whole  system  of  taxation  is  unsatisfactory  and  in- 
equitable. Many  corporations  make  false  returns,  shift  cash 
accounts,  manufacture  fictitious  indebtedness,  and  resort  to 
other  expedients  of  doubtful  legaUty  or  morality  in  order  to 
relieve  the  burden  of  taxation.  Such  methods  are,  of  course, 
impossible  where  even  ordinary  ethics  of  honor  and  honesty 
prevail.  Indeed,  the  methods  of  avoiding  taxation  heretofore 
outlined  and  such  others  along  the  same  lines  as  the  statutes 
of  the  various  states  may  allow,  are  not  free  from  criticism. 
They  are  legal,  but  are  evasions  of  the  spirit  of  the  law.  If, 
however,  a  legislature  in  its  wisdom  has  decreed  that  a  corpora- 
tion organized  with  both  stocks  and  bonds  shall  have  these 
latter  deducted  from  the  former  in  order  to  establish  its  taxable 
status,  or  that  an  obscure  village  where  taxes  are  light  may  be 
selected  by  a  wealthy  city  corporation  as  its  principal  office  for 
taxation,  there  would  seem  no  vaHd  business  reason  why  corpora- 
tions should  not  take  advantage  of  the  situation  while  it  lasts 
and  avoid  all  taxation  that  may  be  escaped  without  fraud  and 
subornation  of  perjury.  The  same  thing  may  also  be  said  of 
incorporating  in  an  outside  state  where  taxation  is  less,  and 
doing  business  at  home  as  a  foreign  corporation.  It  is  not  a 
manifestation  of  the  highest  spirit  of  civic  patriotism,  but  other- 
wise it  is  not  to  be  condemned. 


Ch.  8]  COST  OF  INCORPORATION  67 

§  83.    Counsel  Fees  rnoiJB  tn-jriim-j 

The  corporation  is  a  creature  of  the  law  and  in  its  forma- 
tion every  requirement  of  the  law  must  be  observed.  It  is 
not  sufficient  that  the  corporation  be  merely  brought  into  exist- 
ence. With  the  aid  of  a  printed  charter  form,  and  a  ready- 
made  set  of.  by-laws,  even  the  inexperienced  may  do  this.  It 
must  be  incorporated  under  the  proper  forms,  with  proper 
adjustment  of  detail,  and  with  such  knowledge  of  the  condi- 
tions and  possibilities  that  it  secures  every  legitimate  advantage 
allowed  or  permissible  under  the  laws  which  authorize  its  crea- 
tion. For  this  reason  lawyers,  and  the  inevitable  concomitant, 
lawyers'  fees,  are  important  features  of  any  incorporation  in 
which  actual  values  are  involved. 

Where  cheap  incorporations  are  imperative,  or  where  the 
character  of  the  incorporation  does  not  justify  the  employment 
of  an  attorney,  the  incorporating  agencies  are  usually  employed 
at  a  cost  of  from  $25  to  $50,  and  the  incorporation  is  secured 
in  one  of  the  cheaper  incorporating  states.  Usually  it  is  not 
worth  more  than  it  costs. 

For  the  better  class  of  incorporations,  where  a  really  sound 
and  effective  organization  is  desired,  the  fees  of  any  qualified 
attorney  would  hardly  be  less  than  $50,  even  where  city  prices 
do  not  prevail;  and  from  this  the  fees  would  range  far  upward 
according  to  the  complexity  of  the  arrangements,  the  standing 
and  experience  of  the  counsel,  and  the  increase  of  responsibility 
as  property  values  increase. 

It  is  to  be  noted  that  an  incorporation  differs  from  the 
conduct  of  litigation  in  the  fact  that  the  amount  of  work  and 
responsibility  involved  may  be  estimated  in  advance  with 
reasonable  accuracy.  For  this  reason  the  proper  counsel  fees 
may  be  determined  with  precision  and  are  usually  agreed  upon 
before  incorporation  is  undertaken. 

In  determining  the  fees  the  reputation  of  the  counsel  em- 
ployed frequently  plays  an  important  part.  The  known 
skill,  experience,  and  standing  which  make  up  the  reputation 


68  CORPORATE  LAW  [Bk.  I- 

of  an  eminent  attorney  not  only  insure  the  validity  and  the 
working  value  of  the  incorporation,  but  may,  and  frequently 
do,  assist  materially  in  the  subsequent  sale  of  corporate  securities 
and  in  the  general  welfare  of  the  corporation.  It  is  obvious 
that  if  the  incorporating  counsel  ranks  high,  his  name  in  con- 
nection with  the  corporation  is  not  only  a  guaranty  of  its 
technical  correctness,  but  of  the  propriety  of  its  purposes,  the 
solidity  of  its  undertaking,  and  generally  of  the  status  and 
character  of  the  whole  enterprise. 

§  84.    Corporate  Equipment 

The  cost  of  the  stock  books,  certificates,  seal,  etc.,  necessary 
or  usually  employed  in  connection  with  a  corporation,  varies 
widely  according  to  the  nature  of  the  outfit.  The  ordinary 
corporation  of  moderate  capitalization  and  pretensions,  desirous 
of  restricting  its  expenditures,  might  secure  everything  necessary 
in  neat  and  attractive  shape  for  the  modest  sum  of  $10.  This 
includes  stock  certificates,  printed  on  lithographed  blanks,  the 
corporate  seal,  minute  book,  stock  book,  and  transfer  book. 

If  a  handsomer  outfit  is  required,  with  special  lithographed 
designs  for  certificates,  and  more  costly  bindings  for  books, 
the  price  of  the  outfit  will  easily  run  up  to  $40  or  $50  and  more. 
If  specially  engraved  certificates  are  requisite  or  desired,  this 
price  will  be  increased  to  anywhere  from  $100  to  $500,  according 
to  designs,  character,  etc.  If  bonds  are  to  be  included  in  any 
of  these  outfits,  the  cost  will  be  doubled  or  trebled,  according  to 
the  quality  of  the  work  and  material.  Loose-leaf  minute  books 
range  in  price  from  $3  to  $15,  according  to  style  and  size. 

The  corporate  books  of  account  need  be  no  different  either 
in  kind  or  cost  from  those  used  by  an  unincorporated  concern. 


Part  III— The  Stock  System 


CHAPTER  IX 
THE  CAPITALIZATION 

§  85.    Capital 

It  is  necessary  to  discriminate  between  (i)  capital,  (2)  capital 
stock,  and  (3)  capitalization. 

1.  The  "capital"  of  a  corporation  is  the  total  amount  of  its 
assets  of  all  kinds  in  excess  of  liabilities,  up  to  the  amount  of  the 
outstanding  capital  stock;  assets  over  and  above  that  amount 
constitute  "surplus."i 

2.  The  "capital  stock"  of  a  corporation  is  the  amount  of 
stock  it  is  authorized  by  its  charter  to  issue.  This  is  the  usual 
significance  of  the  term,  though  when  used  in  the  statutory 
law  its  meaning  has  been  restricted  to  the  amount  actually  paid 
in  by  the  stockholders.2 

3.  The  "capitalization"  of  a  corporation  includes  not  only 
its  shares  of  capital  stock  issued,  but  any  bond  issues  or  deben- 
tures that  may  be  outstanding.  These  are  termed  generally 
"corporate  securities." 

A  late  work  on  financing  says: 

From  a  practical  standpoint  the  authorized  capital  stock  of  a 
corporation  is  nothing  more  than  a  formal  permission  or  authoriza- 
tion from  the  state  to  issue  stock  up  to  a  specified  amount.  This 
amount,  expressed  in  dollars — or  as  a  certain  number  of  shares, 


'Williams  v.  Western  Union  Tel.  Co.,  93  N.  Y.  162  (1883);  Equitable  Life  Assurance 
Society  V.  Union  Pacific  R.  R.  Co..  162  App.  Div.  (N.  Y.)  81  {1914). 

^SUte  V.  Fire  Association,  23  N.  J.  L.  19s  (1851);  Burrall  v.  Railroad  Co.,  75  N.  Y.  211 
(1878);  People  V.  Morgan,  178  N.  Y.  433  (1904)- 

69 


7©  CORPORATE  LAW  [Bk.  I- 

when  shares  of  no  par  value  are  employed — is  decided  upon  in  the 
first  place  by  the  incorporators,  is  stated  in  their  application  for 
charter,  and  on  allowance  of  the  application  becomes  the  authorized 
capital  stock  of  the  new  corporation.  It  is  supposed  to  be  the 
amount  of  stock  necessary  or  convenient  for  the  purposes  of  the 
company.' 

Another  writer  defines  the  varying  terms,  as  follows : 

By  capital  is  meant — in  ordinary  usage — the  actual  property 
devoted  to  some  productive  end.  It  is  the  substance  of  the 
business.  .  .  . 

.  .  .  "capital"  refers  to  the  actual  wealth  employed  in  an 
undertaking,  and  "capitalization"  to  the  representation  of  this  '"  i 
wealth  in  terms  of  purely  artificial  and,  in  the  end,  fictitious  values. 
A  part  of  these  representative  values,  namely  those  contributed 
by  the  proprietors,  is  designated  "capital  stock";  and  the  other 
part,  that  contributed  by  outsiders,  is  spoken  of  as  "debt."  .  .  . 

The  term  "capitalization"  or  the  valuation  of  the  capital, 
includes  the  capital  stock  and  the  debt.* 

§  86.    Basis  of  Capitalization 

In  the  earlier  history  of  business  corporations,  the  capital 
stock  of  any  particular  company  was  usually  determined  by 
the  amount  of  actual  cash  and  property  deemed  necessary 
for  the  corporate  purposes,  or  was  restricted  to  an  amount  equal 
to  the  cash  subscriptions  which  could  be  secured  for  the  proposed 
exploitation.  In  either  case  the  capitalization  was  intended 
to  represent  the  actual  cash  or  property  values  originally  put 
into  the  corporate  enterprise. 

At  the  present  time  the  theory  of  capitalization  has  been 
somewhat  modified  and  extended,  and  even  in  conservative 
operations,  at  least  a  portion  of  the  earning  value  is  usually 
included  in  the  original  capitalization. 

The  modem  theory  is  simple.  Any  enterprise  may  be  con- 
sidered as  worth  the  amount  upon  which,  with  due  regard  to 


'  2  Financing  an  Enterprise,  by  H.  R.  Conyngton,  p.  286.     See  Book  II,  Chs.  XII,  XIII, 
"Capitalization . ' ' 

*  I  Dewing  on  Finan.  Policy  of  Corp.,  p.  4. 


Ch.9i  THE  CAPITALIZATION  71 

sinking  fund  and  maintenance  requirements,  it  can  pay  fair 
dividends,  and  it  may  therefore  justly  be  capitalized  at  that 
figure.  In  other  words,  the  earning  capacity  of  the  enterprise 
rather  than  the  cash  value  of  the  property  involved  forms  the 
usual  basis  of  capitalization. 

As  stated  by  a  writer  of  eminence  in  financial  matters: 
"The  ultimate  basis  of  all  economic  values,  as  will  be  observed 
frequently  hereafter  in  this  study,  is  the  social  service  evidenced 
by  earning  power,  "s 

If  fairly  done  and  kept  within  reasonable  bounds,  this  general 
basis  of  capitalization  is  hardly  open  to  serious  objection.  On 
the  contrary,  in  many  cases  there  are  substantial  business  reasons 
for  its  adoption.  If  the  enterprise  be  capitalized  on  the  basis  of 
its  immediate  cash  or  cost  value,  it  may,  and  should  if 
meritorious,  pay  dividends  far  above  the  regular  rates  of  interest 
or  the  usual  returns  on  invested  funds,  and  this  fact  inevitably 
attracts  attention,  provokes  opposition,  and  invites  competition. 

§  87.    Effect  of  Capitalization  on  Sale  of  Shares 

Also  stock  in  a  dividend-paying  concern  may  usually  be 
sold  at  a  better  price  on  a  large  capitalization,  if  this  latter  be 
justified  by  the  dividend  paid,  than  it  possibly  could  on  a  more 
conservative  valuation. 

For  instance,  if  an  enterprise  were  capitalized  at,  say, 
$200,000,  on  which  it  could  earn  and  pay  a  regular  annual 
dividend  of  6%,  its  stock  should  sell  readily  at  par,  or  100. 
If  its  capitalization  were  reduced  one-half,  to  $100,000,  so  that 
its  regular  annual  dividend  became  12%,  the  stock,  having 
twice  the  earning  power  and  representing  the  same  corporate 
property,  should  theoretically  sell  at  twice  par,  or  200.  As  a 
matter  of  fact  it  would  do  nothing  of  the  kind,  ordinarily  bring- 
ing from  175  to  180  according  to  circumstances  and  showing  the 
"cashing"  value  of  the  smaller  capitalization  to  be  from  10  to 
12^%  less  than   that  of   the  larger.     That  is,  the  smaller 

*  I  Dewing  on  Pinan.  Policy  of  Corp.,  p.  43. 


72  CORPORATE  LAW  [Bk.  I- 

capitalization  would  involve  a  loss  on  the  sale  of  the  entire  capital 
stock  of  from  $20,000  to  $25,000.  As  long  as  this  is  true,  enter- 
prises will  be  capitalized  on  their  earning  capacity  rather  than 
on  their  actual  immediate  property  value.  This  is  treated  more 
fully  later  in  the  chapter. 

Also,  if  capital  is  to  be  raised  for  a  newly  organized  cor- 
poration, the  larger  capitalization,  if  within  reasonable  limits, 
gives  much  the  better  basis  for  the  "bargain-counter"  offerings 
so  frequently  necessary  in  the  sale  of  stock.  Greater  induce- 
ments, at  least  in  appearance,  may  be  offered  the  buyer,  and, 
as  suggested  in  the  preceding  paragraph,  from  the  standpoint 
of  future  transactions  the  position  of  the  buyer  himself  is  better. 

For  these  and  other  reasons  the  general  practice  at  the 
present  time,  even  in  conservative  circles,  is  to  capitalize  at 
that  amount  upon  which  the  enterprise  or  undertaking  may  be 
reasonably  expected  to  pay  fair  dividends — that  is,  the  earning 
capacity  is  made  the  basis  of  capitalization.  The  practice  is 
often  deprecated  and  may  be  easily  carried  so  far  under 
exaggerated  estimates  of  earning  as  to  become  dangerous  and 
at  times  dishonest.  Kept  within  reasonable  bounds,  however, 
it  would  not  seem  to  be  objectionable  from  the  standpoint  of 
either  morals  or  sound  finance  and  it  does  give  certain  legitimate 
advantages. 

§  88.    Capitalization  at  Less  Than  Real  Values 

In  many  cases  the  owners  of  small  businesses  in  which 
but  a  few  people  are  interested  and  to  which  others  are  not 
to  be  admitted,  find  it  advantageous  to  incorporate  at  a  capitali- 
zation much  below  the  real  value  of  the  concern.  Other  con- 
ditions also  arise  in  which  the  corporation  with  capitalization 
below  its  real  value  is  a  convenient  business  mechanism.  The 
arrangement  is  advisable  in  all  those  cases  where  merely  an 
apportionment  of  interest  is  desired  under  the  corporate  form. 
The  fees  and  taxes  are  thereby  kept  at  the  minimum,  the 
attention  of  competitors  is  not  attracted,  the  organization  itself 


Ch.g]  THE  CAPITALIZATION  1^3 

may  be  made  very  simple,  and  every  purpose  of  the  incorporation 
is  effectively  fulfilled.  ''^'•^'  '•'-'"' 

In  those  small  and  close  corporations  where  profits  threaten 
to  become  excessive  as  compared  with  the  capitalization,  the 
dividend  rate  is  sometimes  kept  down  by  the  distribution  of 
surplus  profits  under  the  guise  of  salaries.  It  need  hardly  be 
said  that  the  plan  can  only  be  adopted  with  justice  and  safety 
when  all  the  stockholders  participate  in  due  proportion  in  these 
salary  distributions .   If  fairly  carried  out  the  practice  is  legitimate . « 

§  89.    Capitalization  at  Real  Values 

In  banks  and  other  financial  institutions  the  capital  stock 
is  fixed  at  the  amount  deemed  necessary  for  the  purposes  of 
the  business,  and  this  capital  stock  is  sold  at  par.  In  those 
states  where  a  double  liability  attaches  to  the  stock  of  financial 
institutions,  the  more  solid  of  these  require  their  subscribers 
to  pay  into  surplus  an  amount  equal  to  their  subscriptions,  or, 
in  other  words,  the  subscription  price  is  placed  at  double  the 
par  value  of  the  stock  in  order  to  cover  this  statutory  liability 
in  advance.  ; 

In  most  mercantile  businesses  it  is  usual  to  approximate 
the  real  value  of  the  enterprise-  in  the  capitalization.  Such 
valuation  may,  it  is  true,  include  good-will,  trade-names,  and 
the  other  more  or  less  intangible  assets  of  the  business  that 
differentiate  the  going  concern  from  a  mere  stock  of  goods. 
In  any  estabhshed  business  it  is  obvious  that  these  values  are 
quite  as  actual  as  any  of  the  more  material  properties  and 
are  quite  as  properly  included  in  the  capitalization.  Their 
inclusion,  however,  does  amount  for  all  practical  purposes  to 
a  capitalization  on  earning  power. 

§  90.     Capitalization  on  Earning  Capacity 

This  is  the  rule  in  capitalizing  corporate  combinations 
and   public   utilities.     Usually   bonds   or  preferred   stock,   or 

» See  {  549. 


74  CORPORATE  LAW  [Bk.  I- 

both,  are  issued  to  the  extent  of  the  real  values;  then  com- 
mon stock  is  issued  to  such  amount  as  the  estimated  earning 
capacity  will  carry  after  payment  of  the  dividends  and  interest 
on  preferred  stock  and  bonds. 

The  overwhelming  volume  of  watered  stock  that  formerly 
emanated  from  public  utility  and  industrial  organizations  and 
combinations  was  attributable  to  the  excessively  optimistic  and 
misleading  estimates  of  earning  capacity  made  by  promoters. 
If  the  earning  capacity  of  these  incorporations  had  been  actually 
equal  to  the  burdens  imposed  upon  them,  the  large  issues  of 
stock  would  from  some  points  of  view  have  been  fully  justified, 
but  in  too  many  cases  of  this  kind  the  dividends,  where  they 
came  at  all,  were  uncertain,  irregular,  or  entirely  inadequate. 

In  determining  the  capitalization  of  speculative  corporations 
organized  to  exploit  mines,  inventions,  and  other  uncertain 
undertakings,  an  even  more  liberal  spirit  may  prevail,  the 
promoters  estimating  future  earning  powers  on  the  basis  of 
expectations.  In  some  few  cases  such  enterprises  succeed,  the 
capitalized  anticipations  are  realized,  and  dividends  are  paid  up 
to  the  promoter's  brightest  hopes.  These  few  and  exceptional 
instances  then  become  an  alleged  justification  for  the  over- 
capitalization of  all  similar  undertakings. 

No  safe  rules  can  be  formulated  for  the  capitalization  of  these 
uncertain  enterprises.  Usually  their  stock  must  be  sold  at  a 
tremendous  discount  from  face  value.  This  caUs  for  a  propor- 
tionately large  overcapitalization  to  which  it  is  not  usual  to 
apply  the  ordinary  principles  of  business.  Caveat  emptor — let 
the  buyer  beware. 

§  91.    Capitalization  of  Good- Will 

The  following  definition  of  "good-will"  is  not  the  legal 
definition,  but  for  our  purpose  it  is  possibly  more  useful : 

Money  invested  in  bonds  and  other  safely  secured  investments 
should,  at  the  present  high  rates,  bring  annual  returns  of  from  6 
to  8  per  cent.    When  invested  in  business  it  should  bring  cpn- 


Ch.  9l  THE  CAPITALIZATION  75 

nO'    siderably  more  to  justify  the  greater  risks  involved,  the  percentage 

of  annual  returns  then  ranging  from  10  per  cent  to  50  per  cent 

or  more,  depending  upon  the  character  and  conditions  of  the 

particular   business.     This   difference    between    the   returns   on 

security  investments  and  the  returns  on  business  operations  may 

"2.fi   be  designated  as  "good-will"  returns,  and  good-will  may  be  defined 

:l'j     as  the  profit-producing  power  of  an  established  business  beyond 

J-,     mere  interest  and  replacement  returns;  or,  from  another  point  of 

view,  as  the  value  of  an  established  business  over  and  above  the 

,    value  of  its  material  assets.' 

•  In  the  incorporation  of  any  going  concern  or  of  any  combina- 
tion or  reorganization  of  going  concerns,  good-will  is  an  asset  of 
much  importance  and  is  as  a  matter  of  course  included  among 
the  other  assets  to  be  capitalized.  This  practice  is  entirely 
legitimate,  as  the  good- will  stands  for  the  diffeience  between 
the  real  value  of  a  live  business  and  the  property  value  of  the 
stock,  equipment,  and  other  items  which  make  up  its  implements 
of  trade  As  a  matter  of  fact,  the  good-will  is  not  infrequently 
the  most  valuable  asset  of  the  concern,  even  where  other  assets 
are  of  considerable  worth. 

On  account  of  the  intangible  nature  of  good-will,  its  correct 
appraisement  is  often  a  matter  of  very  considerable  difficulty. 
Its  value  varies  with  local  conditions  and  is  at  best  almost 
entirely  a  matter  of  business  judgment.  Because  of  this  diffi- 
culty of  accurate  valuation,  good-will  is  a  favorite  device  for 
inflating  purposes  and  frequently  affords  a  basis  for  unjustifi- 
able stock-watering.  '" 

In  the  ordinary  mercantile  incorporation,  good-will  is  often 
included  without  specific  recognition.  A  lump  sum  is  put  upon 
the  business  as  a  whole  and  the  corporation  is  capitahzed  at  the 
figure  so  obtained.  At  other  times  a  separation  is  effected 
between  the  property  assets  and  good-will.  Where  this  is  done 
common  stock  is  frequently  issued  to  the  appraised  value  of  the 
good-will,  while  the  cash  and  accounts,  stock,  machinery,  realty, 
and  other  property  assets  are  provided  for  by  an  issue  of  pre- 

'  2  Financing  an  Enterprise,  by  H.  R.  Conyngton,  p.  340.  See  Book  II,  Ch.  XIII, 
"Capitalization — Good- Will,  Surplus  and  Initial  Expense." 


76  CORPORATE  LAW  [Bk.  I- 

f erred  stock,  the  two  issues  making  up  the  total  capitalization 
of  the  corporation. 

In  this  case  the  preferred  stock  represents  the  tangible  assets, 
and  its  preference  dividend  is  in  the  nature  of  a  high  interest 
on  the  actual  value  of  this  property.  In  the  event  of  the  dis- 
solution or  liquidation  of  the  corporation,  this  preferred  stock 
is  frequently  paid  out  or  redeemed  before  the  common  stock 
receives  anything,  s 

The  common  stock,  on  the  other  hand,  representing  the 
intangible  assets — the  good-will  and  earning  capacity  of  the 
business — receives  no  dividend  of  any  kind  until  all  other  obli- 
gations have  been  paid,  and  then  only  out  of  surplus  profits. 

§  92.    Form  of  Capitalization  iraJhioi 

After  deciding  upon  the  capitalization  of  an  enterprise,  a 
further  question  arises  as  to  the  form  of  this  capitalization. 
The  simplest  plan  is  to  have  only  common  stock,  but  at  times 
there  are  material  advantages  in  the  use  of  preferred  stock. 

Preferred  stock  occupies  a  position  between  common  stock 
and  the  bond.  It  is  a  safer  form  of  investment  than  common 
stock,  but  it  carries  no  rights  of  foreclosure.  It  takes  prece- 
dence of  common  stock  as  to  payment  of  dividends  and  fre- 
quently as  to  its  ultimate  redemption,  but  its  dividend  is  not 
payable  unless  earned.  Its  dividend  is  fixed  and  it  does  not  as 
a  rule  participate  in  excess  profits,  but  its  rate  is  usually  much 
higher  than  the  interest  rate  of  a  bond.  Where  preferred  stock 
can  be  used  to  raise  money,  it  is  regarded  as  a  much  more  satis- 
factory means  than  an  issue  of  bonds.  1  joi 

§  93.    Bond  Issues 

Where  a  corporation  has  real  property  or  invests  in  prop- 
erty having  a  tangible  value,  it  is  often  of  advantage  to  issue 
bonds  in  place  of  some  portion  of  the  stock  capitalization.  An 
enterprise  requiring  $150,000  in  actual  value  might,  instead  of 


•See  Ch.  XI,  "Preferred  Stock." 


Ch.  9l  THE  CAPITALIZATION  77 

capitalizing  for  that  amount,  incorporate  for  but  $100,000  and 
then  issue  bonds  for  the  additional  $50,000. 

The  interest  to  be  paid  on  these  bonds  would  be  less  than 
the  dividends  a  prosperous  business  would  pay  Upon  the  same 
amount  of  stock,  and  the  difference  represents  a  profit  for  the 
stock  actually  issued.  Against  this  is  the  fact  that  the  interest 
must  be  paid  whether  profits  justify  it  or  not,  as  also  the  further 
fact  that  if  interest  is  not  paid  foreclosure  proceedings  will 
probably  bring  the  corporation  to  an  untimely  termination  or 
to  a  reorganization.  In  this  latter  case  the  proceedings  are 
usually  disastrous  and  most  of  the  assets  are  likely  to  be  ab- 
sorbed in  settling  the  claims  of  the  bondholders.  Because  of 
this  the  issuing  of  bonds  is  not  safe  unless  the  corporation  is 
sound  and  of  reasonably  quick  earning  powers.  If  there  is  any 
doubt  on  these  points,  preferred  stock,  the  security  next  to  bonds 
in  safety  and  desirability,  is  the  more  prudent  method  of  raising 
money.  9 

In  arranging  for  a  bond  issue  it  is  necessary  to  consider  care- 
fully its  possible  effect  on  the  local  and  federal  taxation  of  the 
corporation. 

While  the  excess  profits  tax  prevailed  there  was  the  objec- 
tion to  a  bond  issue,  that  its  amount  could  not  be  included  with 
invested  capital  in  computing  exemption  from  the  tax;  hence 
preferred  stock  was  usually  issued  instead. 

§  94.    Capitalization  as  Affected  by  Financial  Exigencies 

If  an  enterprise  is  speculative  in  its  character  and  the  owners 
expect  direct  profits  from  its  financing,  or  if  promotion  pay- 
ments are  added  to  the  load  under  which  the  new  corporation 
is  expected  to  stagger  to  success,  the  conditions  do  not  tend  to 
conservative  capitalization.  In  such  cases  the  immediate  finan- 
cial necessities  take  precedence  of  almost  everything  else  and 
the  capitalization  is  shaped  to  that  end.  Profits  for  owners  and 
promoters,  bonus  stock,  commissions,  advertising,  and  the  gen- 

•See  Chs.  LIV.  LV,  "Bonds";  see  also  »  78. 


78  CORPORATE  LAW  {Bk.  I- 

eral  expenses  of  financing  are  included,  until  finally  the  actual 
business  necessities  of  the  corporation  represent  but  a  fraction 
of  the  total  capitalization,  and  the  final  arrangement  at  times 
becomes  a  fraud  upon  the  investing  public. 

It  is  unfortunate  that  the  capitalization  of  a  corporation 
should  be  influenced  by  considerations  such  as  these.  At  times, 
however,  an  enterprise  will  be  of  such  a  purely  speculative 
nature  that,  with  all  honesty  of  purpose,  it  would  be  impossible 
to  finance  it  on  any  conservative  basis.  Concessions  to  the 
necessities  of  the  situation  are  then  imperative,  divergencies 
from  the  ideal  corporate  arrangements  cannot  be  avoided,  and 
the  best  that  can  be  done  is  to  reduce  them  to  the  minimum. 
In  such  cases  the  real  interests  of  the  corporation — which  are 
the  successful  inauguration  and  prosecution  of  its  business  and 
the  production  of  profits  for  its  stockholders — should  be  kept 
closely  in  view  and  only  such  concessions  made  as  are  abso- 
lutely essential  to  successful  financing, 


CHAPTER  X 

STOCK 

§  95.    Capital  Stock  1 

The  capital  stock  of  a  corporation  is  the  maximum  amount 
of  stock  it  may  issue  under  the  provisions  of  its  charter.  This 
may  bear  some  direct  relation  to  the  actual  property  values 
or  "capital"  possessed  by  the  corporation— from  which  it  is  to 
be  absolutely  distinguished — or  may  be  far  above  or  below  this 
real  capital. 

The  stock  capitalization  may  be  based : 

1.  On  the  actual  cash  value  of  the  corporate  property. 

2.  On  the  amount  required  for  the  development  of  the  under- 

taking. 

3.  On  the  earning  power  of  the  corporate  business. 

4.  On  the  speculative  basis  of  what  these  earning  powers 

may  be  when  the  business  is  developed. 

5.  On  some  combination  of  these  factors. 

The  capital  stock  of  a  corporation  is  fixed  by  its  charter 
and  can  usually  be  increased  or  diminished  only  by  amendment 
of  that  instrument. 

The  capital  stock  of  a  corporation  may  be  issued  in  part  or 
in  whole,  and  its  total  authorized  amount  bears  no  necessary 
relation  to  the  amount  of  stock  sold,  subscribed,  or  outstand- 
ing. For  instance,  a  corporation  with  a  capital  stock  of  $100,- 
000  might  have  issued  one-half  of  this  amount,  the  remainder 
being  reserved  for  subsequent  use.  The  outstanding  stock  is 
then  $50,000,  but  its  capital  stock  is  $100,000  and  remains  at 


» See  also  Book  II,  Ch.  V,  "Common  Stock,"  and  Ch.  VI,  "Preferred  Stock." 

79 


8o  CORPORATE  LAW  [Bk.  I- 

this  amount  until  changed  by  amendment  of  the  charter  or 
other  statutory  method. 

In  this  connection  it  should  be  noted  that  formerly,  when 
the  common  law  controlled,  a  corporation  was  required  to 
have  its  entire  capital  stock  subscribed  before  beginning  busi- 
ness. Until  this  was  done  it  could  not  enforce  the  subscrip- 
tions to  its  stock.2  Now,  however,  in  most  states  the  strin- 
gency of  this  rule  has  by  statutory  enactments  been  greatly 
relaxed.  Some  minimum  amount,  fixed  by  statute  and  usually 
much  smaller  than  the  total  stock  capitalization,  may  be  desig- 
nated by  the  charter  as  the  amount  with  which  the  corporation 
will  begin  business,  and  as  soon  as  this  amount  has  been  sub- 
scribed the  corporation  can  enforce  subscriptions  to  its  stock 
and  may  begin  its  operations.  In  a  few  states  a  further  pro- 
portion of  the  capital  stock  must  be  paid  in  within  a  specified 
time,  as  in  New  York,  where  a  corporation  must  have  at  least 
one-half  its  total  capital  stock  paid  up  within  one  year  from 
the  date  of  incorporation.^ 

§  96.    Shares 

For  the  sake  of  accuracy  and  convenience  in  representing 
the  interests  of  the  various  stockholders  in  the  capitalization 
and  in  the  corporate  enterprise  and  property  behind  it,  capital 
stock  is  divided  into  shares  which  are  almost  invariably  of 
equal  face  value,  and  together  make  up  the  whole  stock  capi- 
tahzation.  In  the  absence  of  statutory  restriction  there  seems 
no  reason  why  a  corporation  may  not  issue  common  and  pre- 
ferred stock  of  different  par  values.  In  New  York  a  provision 
in  the  corporate  charter  for  such  an  arrangement  would  prob- 
ably be  upheld. <  In  California,  however,  such  a  provision  has 
been  held  invalid  on  the  ground  that  it  is  in  contravention  of 


•See  I  Cook  on  Corp.,  {}  176-181. 

'  This  law  is  largely  a  dead  letter,  as  no  one  is  charged  with  its  enforcement  and  no  penalty 
is  imposed  for  failure  to  comply  with  its  provisions. 
«See  White  on  Corp.  (8th  Ed.),  p.  442. 


Ch.  lo]  STOCK  81 

the  statute  declaring  that  no  distinction  shall  be  made  between 
classes  of  stock  as  to  voting  power,  s 

Unless  restricted  by  statute,  shares  may  be  of  any  desired 
face  value,  though  the  greater  portion  of  the  issued  stock  of 
this  country  is  in  the  form  of  $100  shares.  Mining  stocks  are 
often  issued  in  shares  of  the  face  value  of  $1,  this  being  done 
with  a  view  to  more  impressive  offerings  and  to  the  reception 
of  smaller  subscriptions  than  could  well  be  taken  with  larger 
shares.  In  any  enterprise  to  be  financed  by  popular  subscrip- 
tion, a  small  share  value  is  considered  good  policy,  $10  being 
a  figure  frequently  selected.  Where  the  holders  of  stock  are 
few  in  number  and  it  is  desired  to  render  the  sale  or  other  dis- 
position of  the  stock  difficult,  or  other  reasons  make  such 
course  advisable,  the  face  value  of  the  shares — where  not  pro- 
hibited by  statute — is  sometimes  placed  at  $500  or  more. 
The  shares  of  the  original  Carnegie  Company  were  $1,000  each, 
but  the  United  States  Steel  Corporation  placed  its  shares  at 
$100  in  order  to  facilitate  their  sale  to  the  investing  public. 
Unless  there  is  some  valid  reason  to  the  contrary,  the  generally 
recognized  share  value  of  $100  is  to  be  preferred  and  selected. 

An  interesting  innovation  in  share  values  is  the  share  of 
unspecified  value,  that  is,  a  share  without  any  named  par  value, 
such  share  merely  representing  a  fractional  interest  in  the 
profits  and  assets  of  the  corporate  enterprise.  It  is  argued 
that  such  shares,  lacking  the  "price  ticket"  of  a  nominal  value, 
will  force  the  investing  public  to  investigate  the  real  value  of 
the  enterprise  and  the  real  probability  of  profits,  and  thus 
determine  the  real  value  of  the  shares  much  more  surely  and 
quickly  than  under  the  present  system  of  valued  shares. e 

§  97.    Certificates  of  Stock 

A  certificate  of  stock  is  merely  a  convenient  evidence  of 
the  ownership  of  corporate  shares,   and  its  loss  or  destruc- 


>  Film  Producers  Inc.  v.  Jordan,  iS4  Pac.  (Cal.)  60s  (i9i6). 

•  See  Chs.  XIV,  XV,  ancf  XVI,  discussing  shares  without  par  value. 


8a  CORPORATE  LAW  [Bk.  I- 

tion  does  not  affect  such  ownership  in  any  way.  The  loss  of 
the  certificate  may  embarrass  the  stockholder  on  occasion,  just 
as  the  loss  of  a  deed  to  real  estate  or  bill  of  sale  to  other  prop- 
erty might  be  embarrassing,  but  he  can  still  collect  his  divi- 
dends, attend  and  vote  at  stockholders'  meetings,  and  generally 
perform  his  functions  as  a  stockholder,  just  as  he  did  before 
the  loss  of  his  certificate.  If  he  wishes  to  sell  or  otherwise 
transfer  his  interest  in  the  corporation,  his  certificate  would 
probably  have  to  be  replaced  before  the  purchaser  or  trans- 
feree would  consent  to  take  over  the  stock.  Usually  the  cor- 
porate by-laws  provide  for  the  issue  of  a  new  cert  ficate  in 
case  of  loss  or  destruction  of  one  already  issued.  The  matter 
is,  however,  troublesome  at  the  best,  generally  necessitating 
the  giving  of  a  bond  or  other  guaranty  to  the  corporation, 
and  the  loss  of  certificates  is  to  be  avoided  if  possible. '^ 

It  is  to  be  noted  that  the  certificate  of  stock  is  purely  a 
matter  of  form  and  convenience,  that  the  ownership  of  stock 
may  and  frequently  does  exist  before  any  certificates  are 
issued,  and  that  it  would  be  entirely  possible  to  conduct  a  cor- 
poration— with  the  consent  of  its  stockholders — without  the 
ssue  of  certificates  at  all,  the  stock  books  of  the  corporation 
*then  being  the  sole  evidence  of  stock  ownership.  While  this  is 
true,  stockholders  are  entitled  to  certificates  evidencing  the 
stock  owned  by  them  and  can  force  the  issue  of  such  certificates 
if  withheld. 

At  common  law,  certificates  of  stock  are  not  negotiable, 
and  if  the  owner  of  a  certificate  of  stock  loses  it  or  it  is  stolen 
from  him  when  indorsed  in  blank,  a  subsequent  bona  fide  pur- 
chaser of  such  stock  is  not  protected  against  the  true  owner, 
unless  the  owner  was  guilty  of  negligence. «  By  mercantile 
custom,  however,  stock  certificates  have  been  largely  treated  as 
negotiable  instruments,  and  in  a  number  of  states  certificates 


'See  SI  26s,  359. 

'  I  Cook  on  Corp.,  {  358;  Knox  v.  Eden  Musee  Co.,  148  N.  Y.  441  (1896). 


Ch.  lo]  STOCK  83 

of  stock  have  been  made  negotiable  instruments  under  a  statute 
generally  known  as  the  "Uniform  Stock  Transfer  Act."» 

§  98.    Unissued  Capital  Stock 

A  corporation  is  empowered  by  its  charter  to  issue  stock 
up  to  the  full  amount  of  its  authorized  capital  stock.  At  the 
time  the  charter  is  allowed  all  this  stock  is  unissued.  There- 
after it  may  be  issued,  in  whole  or  in  part,  at  the  discretion  of 
the  corporation  or  as  required  by  its  operations.  The  unissued 
stock,  no  matter  whether  it  be  the  whole  capital  stock  or  only 
a  reserved  portion  thereof,  represents  nothing  whatever  beyond 
the  potential  right  of  issue.  It  has  no  intrinsic  value.  It  is 
merely  the  right,  granted  by  the  state,  to  issue  stock  up  to 
the  prescribed  amount. 

This  being  so,  the  unissued  stock  cannot  in  any  way  be 
regarded  as  an  asset  of  the  corporation.  If  sold  it  brings  in 
cash,  property,  or  other  values  that  have  a  greater  or  less  intrin- 
sic worth,  but  the  outgoing  stock  carries  with  it  an  interest  in 
the  corporate  property  that  should  equal  the  value  received  for 
such  stock.  The  general  corporate  property  has  been  increased, 
but  the  ownership  thereof  has  likewise  been  increased  in  the 
same  proportion.  In  bookkeeping  parlance  the  increase  of 
assets  and  liabilities  is  exactly  equal.  The  unissued  stock 
therefore  represents  nothing  more  than  the  right  to  admit  new 
members,  or  stockholders,  into  the  corporation,  upon  payment 
of  the  proper  quid  pro  quo.  To  regard  it  as  an  asset  would 
be  as  illogical  as  to  consider  the  right  to  admit  new  partners 
in  a  firm  an  asset  of  the  partnership.!  <> 

§  99.    Issued  Stock 

Stock  is  always  supposed  to  be  issued  at  its  face  or  par 
value  for  cash  or  other  actual  values.    At  the  time  of  organiza- 


»  These  states  are  New  York,  Ohio,  Pennsylvania,  Rhode  Island,  Wisconsin,  Louisiana, 
Maryland,  Massachusetts,  Michigan,  New  Jersey,  Connecticut,  Illinois,  Tennessee,  and  also 
in  Alaska. 

i»  See  {  123. 


84  CORPORATE  LAW  [Bk.  I- 

tion,  therefore,  the  face  value  of  the  stock  issued — if  full-paid — 
would,  theoretically,  equal  the  actual  value  of  the  corporate 
assets.  Even  if  this  be  true  in  fact,  these  values  may,  and 
generally  do,  vary  widely  thereafter.  If  the  corporation  is 
successful,  its  assets  may  increase  far  beyond  the  nominal 
value  of  its  issued  stock,  while  if  unsuccessful  these  assets  will 
probably  fall  far  below  the  total  face  value  of  the  issued  stock. 
That  is,  the  value  of  such  stocks  as  shown  by  the  books  of  the 
corporation  will  be  far  above  or  below  the  par  value.  The  sell- 
ing price  may,  and,  depending  largely  upon  the  rate  of  divi- 
dends maintained  and  the  general  desirability  of  the  stock, 
probably  will  be  at  a  still  different  figure. 

Frequently  a  corporation,  by  purchase,  gift,  or  otherwise, 
regains  its  issued  stock.  Such  stock  coming  back  into  the 
possession  of  the  corporation  is  not  retired  thereby  or  brought 
back  into  the  condition  of  unissued  stock,  but  is  designated 
as  treasury  stock,  may  be  sold  when  desirable,  and  is  usually 
regarded  as  an  asset." 

§  100.    Full-Paid  Stock 

In  the  absence  of  statutory  laws  to  the  contrary,  stock  may 
be  issued  on  any  basis  that  the  directors,  with  the  assent  of 
the  stockholders,  deem  best.  That  is,  it  may  be  issued  for 
its  full  face  value  in  money  or  property,  or  for  only  a  portion 
of  its  face  value,  or  on  a  promise  to  pay,  or  on  partial  pay- 
ments, or  on  no  payment  at  all  as  a  free  gift.12  If,  however, 
it  is  not  paid  for  at  its  full  face  value  in  money,  property,  or 
services — where  payment  is  allowed  by  services — it  is  not  full- 
paid  stock,  and  therefore  carries  a  Uability  to  non-assenting 
stockholders  and  to  creditors  of  the  corporation  for  the  amount 
still  unpaid.!' 


"  See  Ch.  XIII,  "Treasury  Stock." 

"  2  Clark  &  Marshall  on  Corp-.  8  39oa  and  cases  cited;  i  Cook  on  Corp.,  {{  30,  46;  Scovill 
V.  Thayer,  105  U.  S.  143  (1881);  In  re  Caledonia  Coal  Co.,  254  Fed.  Rep.  742  (1918). 

|»  See  Ch.  XII,  "Full- Paid  Stock";  also  2  Clark  &  Marshall  on  Corp.,  }§  397,  401;  Camden 
V.  Siuart,  144 U.S.  104  (1892);  Merchants',  etc..  Agency  v.  Davidson,  23  Cal.  App.  274  (1913). 


Ch.  lo]  STOCK  85 

^  The  courts  have  shown  a  tendency  of  late  years  to  con- 
strue the  law  more  strictly  against  any  dubious,  unfair,  or  in- 
equitable payment  of  stock  when  the  rights  of  creditors  or 
stockholders  are  concerned.  1* 

The  term  "watered  stock"  is  merely  a  convenient  desig- 

.  nation  for  stock  issued  in  excess  of  the  values  behind  it.is 

^'§  loi.    Common  and  Preferred  Stock'*- '    ,^ 

f   **  )   -'^r\i   n 

Preferred  stock  is  that  to  which  some  preference  has  been 
given  over  other  stock  of  the  same  corporation  as  to  partici- 
pation in  profits,  and  often  in  assets  in  case  of  liquidation.  If 
'  there  is  no  distinction  in  regard  to  these  two  features  the  stock 
of  a  corporation  is  all  common  stock. 

Different  preferred  stocks  may  be  issued  by  the  same  cor- 
poration in  any  desired  variety  of  preference  as  to  dividends 
and  redemption  or  liquidation  rights.  These  are  distinguished 
from  each  other  as  first,  second,  and  third  preferred  stock,  or 
by  other  designations  descriptive  of  the  peculiar  status  of  each 
stock. 

§  102.    Other  Classifications 

As  stated,  the  capital  stock  of  a  corporation  may  be  divided 
into  common  and  preferred  stock  on  the  basis  of  its  relation 
to  the  corporate  profits  or  property.  Stock  may  also  be  classified 
in  other  ways.  Most  of  these  other  classifications  relate  to  the 
voting  right.  The  simplest  is  a  division  of  the  stock  into  two 
classes,  one  class  voting,  the  other  not  exercising  this  right. 
(This  classification,  however,  would  not  be  permitted  under 
the  California  statute.)  For  instance,  in  the  incorporation  of 
a  partnership  where  one  or  more  take  the  active  management, 


"  See  V.  Heppenheimer,  6g  N.  J.  Eq.  36  (190s);  Arnold  v.  Searing,  73  N.  J.  Eq.  262  (1907); 
s.  c.  78  Atl.  Rep.  762  (1910);  Mason  v.  Carrothers,  ids  Me.  392  (1909);  Old  Dominion  Copper 
Co.  V.  Bigelow,  188  Mass.  31s  (1905);  s.  c,  203  Mass.  159  (1909);  Bigelow  v.  Old  Dominion 
Copper  Co.,  74  N.  J.  Eq.  457  (1908);  same  facts  in  Old  Dominion  Copper  Co.  v.  Lewisohn, 
210  U.  S.  206  (1908). 

"  See  SS  119,  120. 

"See  Ch.  XI,  "Preferred  Stock";  also  Book  II,  Ch.  V,  "Common  Stock."  and  Ch.  VI. 
"Preferred  Stock." 


86  CORPORATE  LAW  [Bk.  I- 

others  merely  supplying  the  capital,  the  active  partners  might 
have  their  interests  represented  by  voting  stock  and  the  interest 
of  the  silent  partners  represented  by  non- voting  stock. i^ 

Other  classifications  are  possible  in  considerable  variety, 
and  generally  it  may  be  said  that  any  desired  classification 
is  allowable  that  is  not  repugnant  to  equity,  to  the  common 
law,  or  to  the  statute  law  of  the  state  under  which  the  corporation 
is  organized.  On  the  other  hand,  it  may  be  said  that  unusual 
classifications,  unless  clearly  demanded  by  the  conditions,  are 
not  to  be  recommended.  They  may  work  unexpected  hard- 
ships, are  at  times  very  uncertain  in  their  actions,  and  introduce 
undesirable  complexities  into  the  corporate  mechanism. 

Classifications  of  stock  may  be  authorized  either  by  charter 
or  by-law  provisions.  As  a  matter  of  prudence  th6y  should 
be  incorporated  in  the  charter  where  possible.  The  specifica- 
tions relating  to  any  class  of  stock,  except  unmodified  common 
stock,  should  be  printed  in  full  on  the  face  of  each  certificate 
by  which  such  stock  is  represented.^^ 


"  See  Ch.  LIX,  "Incorporating  a  Partnership." 
18  See  SS  481,  534. 


CHAPTER  XI 

PREFERRED  STOCK  ^ 

§  103.    Nature  and  Use 

Preferred  stock  is  that  which  has  some  preference  as  to 
dividends  or  assets  over  other  stock  of  the  same  corporation. 
This  preference  is  usually  given  to  make  such  stock  safer  or 
more  attractive,  though  at  times  its  purpose  is  to  limit  divi- 
dends or  gain  some  other  desired  end. 

Preferred  stock  is  perhaps  most  commonly  employed  where 
money  is  to  be  raised  for  the  development  or  operation  of  a 
corporate  enterprise.  For  this  purpose  it  may  be  made  to  offer 
greater  safety  both  as  to  principal  and  dividends  than  common 
stock,  while  it  does  not  carry  the  dangerous  foreclosure  privi- 
lege of  the  bond. 

When  a  business  is  incorporated,  preferred  stock  is  fre- 
quently issued  to  represent  or  pay  for  the  actual  property 
assets;  the  good- will  and  other  intangible  assets  being  repre- 
sented by  an  issue  of  common  stock.  When  a  partnership  is 
incorporated,  the  excess  investment  of  one  partner  is  very  often 
represented  or  satisfied  by  an  issue  of  non-voting  preferred 
stock,  while  the  interests  of  a  silent  partner  may  be  conven- 
iently cared  for  by  the  same  means.  Where  an  invention  or 
other  property  is  taken  over  and  payment  made  in  stock,  the 
transferrer,  on  account  of  its  greater  safety,  will  frequently 
demand  a  portion  or  the  whole  of  his  price  in  preferred  stock, 
and  generally  the  device  will  be  found  most  useful  in  effecting 
the  adjustments  and  allowances  so  frequently  necessary  in 
incorporating. 


» See  Book  II.  Ch.  VI,  "Preferred  Stock," 

87 


88  CORPORATE  LAW  [Bk.  I- 

Usually  preferred  stock  is  created  by  charter  provision,  the 
preferences  and  restrictions  being  set  forth  at  length.  In  many 
states  it  may  be  authorized  by  proper  by-law  provisions,  but  it 
is  always  better  and  safer  to  provide  for  it  in  the  charter.2 

After  incorporation,  unless  otherwise  provided  by  statute, 
the  assent  of  every  stockholder  is  required  for  the  issue  of  pre- 
ferred stock.  This  is  reasonable,  as  the  value  of  the  common 
stock  may  be  depreciated  by  such  an  issue.  In  many  states  the 
statutes  allow  preferred  stock  to  be  issued  after  incorporation 
when  authorized  by  a  prescribed  majority  of  the  outstanding 
stock.' 

§  104.    Certificates  for  Preferred  Stock 

Preferred  stock  is  issued  in  many  different  forms  and  with 
many  different  classifications,  privileges,  and  restrictions.  The 
possible  range  is  wide  and  includes  almost  any  desired  attribute 
not  contrary  to  law  or  public  policy.  All  the  conditions  of  any 
particular  issue  should  appear  upon  the  face  of  the  certificate 
by  which  such  preferred  stock  is  represented.  If  the  specifica- 
tions are  too  voluminous  for  this,  the  fact  that  the  certificate 
represents  preferred  stock  should  appear  plainly  on  its  face, 
together  with  a  reference  to  the  provisions  of  the  charter  by 
which  such  stock  is  authorized.  Such  notice  is  sufficient  to  put 
any  intending  purchaser  on  his  guard,  and  if  he  purchases  the 
stock  he  cannot  afterward  assert  ignorance  of  its  conditions  as 
a  basis  for  litigation  or  claims  against  the  corporation. 

§  105.    Rights  Carried  by  Preferred  Stock  /ji^ooi, 

Unless  specifically  prohibited  therefrom  by  proper  provision 
in  the  charter,  by-laws,  or  other  authorization  under  which  such 
stock  is  issued,  preferred  stock  carries  the  right  to  vote  and  the 
right  to  participate  in  dividends  beyond  the  preferential  divi- 
dend after  the  common  stock  has  received  a  dividend  equal 


2  I  Cook  on  Corp.,'}  268;  Toledo,  etc.,  R.  R.  v.  Tnist  Co.,  95  Fed.  497  (1899);  Kent  v. 
Quicksilver  Mining  Co.,  78  N.  Y.  IS9  (1879). 

3  Hinckley  v.  S.  &  S.  Co.,  107  App.  Div.  (N.  Y.)  470  (190S);  s.  c,  193  N.  Y.  S09  (1908). 


Ch.  ii]  PREFERRED  STOCK  89 

thereto.  That  is,  in  any  year,  if  the  preferred  dividend  is  paid 
and  the  common  stock  has  received  a  dividend  equal  in  amount 
to  this  preferential  dividend,  then  any  further  dividends  belong 
to  and  must  be  paid  to  all  the  stock,  common  and  preferred 
alike.''  Preferred  stock  is  also  entitled  to  cumulative  dividends 
unless  otherwise  provided.  Preferred  stock  has  no  preference 
over  common  stock  in  the  distribution  of  assets  in  case  of  liqui- 
dation or  dissolution,  unless  such  preference  is  specifically  given 
by  statute  or  set  forth  in  the  authorizing  provisions. 

§  106.    Preferred  Stock  Compared  with  Bonds 

Preferred  stock  differs  from  a  bond  issue  in  the  very  material 
feature  that  interest  on  bonds  must  be  paid  when  due  and  can 
be  enforced  by  a  foreclosure  suit,  while  dividends  on  preferred 
stock  are  payable  only  from  net  profits  and,  if  profits  are  not 
made,  are  not  due  and  therefore  cannot  be  collected.  Also 
bonds  must  be  paid  on.  maturity,  while  preferred  stock  has  no 
fixed  due  date.  Bondholders  are  creditors  of  the  company.  The 
holders  of  preferred  stock  are  not  creditors  of  the  company, 
have  no  claim  against  the  company  except  for  dividends  when 
declared,  and  have  no  rights,  save  for  their  preferences,  superior 
to  those  of  the  common  stockholders,  s  For  these  reasons  the 
issue  of  preferred  stock  is  much  safer  for  the  ordinary  corpora- 
tion than  the  issue  of  bonds.  Preferred  stock  is  much  favored 
in  the  formation  of  industrial  trusts. 

Sometimes  an  attempt  is  made,  in  order  to  interest  investors, 
to  issue  special  forms  of  securities  which  shall  have  for  the 
investor  the  advantages  both  of  preferred  stock  and  of  bonds. 
So  far  all  such  attempts  have  been  unsuccessful.  The  courts 
will  not  permit  the  same  security  to  create  the  two  inconsistent 
relationships  of  stockholder  and  secured  creditor.  Irrespective 
of  what  the  security  may  be  called,  they  will  look  behind  the 


«See  I  III. 

'  I  Cook  on  Corp.,  {  271;  Warren  v.  King,  108  U.  S.  389  (1883);  St.  John  v.  Erie  Ry.  Co. 
22  Wall.  136  (1874);  Field  v.  Manufacturing  Co.,  162  Mass.  388  (1894};  Ellsworth  v.  Lyons, 
181  Fed.  55  (1910).  .  .  .  !;;JJ  i. 


<)b  CORPORATE  LAW  [Bk.  I- 

name,  determine  the  essential  character  of  the  security,  whether 
it  is  that  of  a  bond  or  of  stock,  and  limit  the  holder  to  such 
rights  as  lawfully  belong  to  that  class  of  security,  e 

In  many  states  there  are  statutory  provisions  relating  to 
preferred  stock  which  must  be  consulted  when  the  subject  is 
under  consideration,  these  statute  laws  taking  precedence  of 
the  general  or  common  law  herein  set  forth.  This,  for  instance, 
is  the  case  in  New  Jersey,  where  among  other  requirements  it 
is  provided  that  "at  no  time  shall  the  total  amount  of  the  pre- 
ferred stocks  issued  and  outstanding  exceed  two-thirds  of  the 
capital  stock  paid  for  in  cash  or  property."      ^^^^^^ 

Statutory  authorization  for  the  issue  of  -preferred  stock  is 
not  necessary.  7  The  provisions  creating  preferred  stock  should 
be  framed  with  care,  for  the  law  reports  abound  with  suits  aris- 
ing from  ill-defined  preference  stock  rights. » 

§  107.    Preference  as  to  Dividends 

The  following  extract  gives  a  common  form  of  charter  pro- 
vision authorizing  the  issue  of  a  simple  preferred  stock: 

Of  said  capital  stock,  five  hundred  shares  of  the  par  value 
of  fifty  thousand  dollars  shall  be  preferred  stock,  entitled  to 
receive  from  the  net  earnings  of  the  company  an  annual  dividend 
of  6  per  cent  before  any  dividends  are  paid  upon  the  common 
stock. 

The  holder  of  a  preferred  stock,  such  as  provided  in  the 
paragraph  quoted,  would  have  the  same  voting  right  as  the 
holder  of  common  stock;  his  dividends,  although  this  is  not 
specifically  stated  in  the  creating  clause,  would  be  cumulative, 
and  he  would  participate  in  any  general  dividends  in  excess  of 
the  preferential  dividend  already  received.  In  case  of  liquida- 
tion of  the  corporation  he  would  in  most  states  have  no  claim 


•  I  Cook  on  Corp.,  {  271. 

'Kent  V.  Quicksilver  Mining  Co.,  78  N.  Y.  159  (1879);  Roberts  v.  Robert-Wicks  Co., 
184  N.  Y.  257  (1906);  Equitable  Life  Assurance  Society  v.  tJnion  Pacific  R.  R.  Co.,  162  App. 
Div.  (N.  Y.)  8i  (1914);  Sterling  v.  Watson  Co.,  241  Pa.  St.  105  (1913);  /w  re  Fechheimer  Fishei 
Co.,  212  Fed.  3S7  (1914). 

'  I  Machen  on  Corp.,  }  549. 


Ch.  ii]  PREFERRED  STOCK  9I 

to  preference  on  the  distribution  of  assets,  but  would  come  in 
on  the  same  basis  as  the  holder  of  common  stock. 

Preference  as  to  dividends  may  be  as  to  time  and  amount, 
as  in  the  creating  clause  given,  or  may  be  as  to  profits  from 
certain  sources,  as  where  a  preferred  stock  is  to  receive  all  the 
profits  of  a  certain  plant  or  a  particular  branch  of  the  business. 

The  usual  rate  of  dividend  on  preferred  stock  ranges  from 
6  to  8%,  though  but  few  reliable  stocks  bear  this  latter  rate. 
In  some  states  the  rate  is  limited  by  statute  to  a  maximum  o;E. 

§  108.    Preference  as  to  Assets 

Unless  otherwise  specifically  provided,  preferred  stock  par- 
ticipates in  any  distribution  of  assets  upon  the  liquidation  of 
the  corporate  property  just  as  common  stock  does,  but  has  no 
preference. 9  Some  preference  in  this  respect  is  usual,  the  cus- 
tomary arrangement  requiring  the  pa)nnent  of  the  par  value  of 
preferred  stock  with  all  arrearages  of  dividends  before  anything 
is  paid  upon  the  common  stock.  In  some  states  preferred  stock 
carries  this  right  under  the  statute  law  unless  otherwise  specifi- 
cally provided  by  the  creating  provisions,  but  even  in  such 
states  it  would  be  better  to  incorporate  this  preference  in  the 
charter  to  prevent  any  mistake  or  misapprehension  as  to  the 
status  of  the  stock.i* 

§  109.    Cumulative  Dividends 

Preferred  stock  bearing  cumulative  dividends  is  sometimes 
called  "guaranteed  stock"  but  the  term  is  not  well  applied, 
being  used  with  greater  propriety  to  describe  stock  upon  which 
the  dividends  are  guaranteed  by  some  other  corporation.  This 
latter  form  of  stock  is  a  not  uncommon  expedient  in  arranging 
the  terms  of  railroad  combinations,  and  the  employment  of  the 


'  I  Morawetz  on  Corp.,  S  461;  i  Cook  on  Corp.,  5  278. 

"•  I  Machen  on  Corp.,  J  551;  Boardman  v.  Lake  Shore,  etc.,  R.  R.,  84  N.  Y.  157  (1881); 
Elkins  V.  Camden,  etc.,  Ry.  Co.,  36  N.  J.  Eq.  233  (1882). 


^2  CORPORATE  LAW  [Bk.  I- 

term  "guaranteed  stock"  in  that  connection  is  the  more  common 
as  well  as  the  better  use.  ''^ 

Preferred  stock  may  be  cumulative  or  non-cumulative.  If 
the  former,  its  dividends  are  not  payable  if  not  earned,  but 
when  profits  are  earned  its  unpaid  dividends,  past  or  present, 
are  a  first  charge  against  such  profits  and  must  be  paid  before 
the  common  stock  receives  anything.  If  preferred  stock  is  non- 
cumulative,  a  passed  dividend  is  lost  and  is  not  a  charge  against 
the  company  in  any  way.  Usually  a  non-cumulative  preferred 
stock  is  not  a  desirable  holding.  Its  existence  is  a  standing 
inducement  to  the  improper  passing  of  dividends.  The  courts 
sometimes  interfere  on  behalf  of  the  holders  of  non-cumulative 
stock  where  profits  have  been  made  and  the  directors  unjustly 
refuse  to  pay  dividends.  ,  ^ 

§110.    Non-Cumulative  Preferred  Stock 

Non-cumulative  preferred  stock  is,  as  stated,  undesirable. 
It  is,  in  fact,  a  standing  invitation  to  the  directors,  unless  their 
ethical  standards  are  high,  to  administer  the  corporate  finances 
to  the  advantage  of  the  common  stockholder.  Profits  that 
might  very  properly  have  been  appUed  to  the  preferred  divi- 
dends are  diverted  into  improvements  or  developments.  These 
redound  to  the  ultimate  advantage  of  the  company,  but  mean- 
while stand  in  the  way  of  the  dividends  on  the  non-cumulative 
preferred  stock  until  the  company  has  reached  a  point  where 
common  and  preferred  stock  dividends  are  both  possible  and 
can  be  paid  together.  The  preferred  stockholder's  dividends 
for  this  deferred  period  are  absolutely  lost  so  far  as  he  is  con- 
cerned. The  company  has  profited  at  his  expense.  The  direc- 
tors might  properly  have  paid  them  if  they  would,  but  decided 
in  favor  of  the  common  stockholder. 

If  investors  were  wise  there  would  be  no  sale  for  non- 
cumulative  stock,  for  there  is  no  legal  way  for  the  holder  of 
such  stock  to  prevent  the  directors  postponing  dividends  until 


Ch.  Ill  PREFERRED  STOCK  93 

the  common  stockholders  can  share  equally  or  even  receive 
more  than  do  the  holders  of  preferred  stock. n 

It  is  to  be  noted  that  if  the  preferential  dividend  is  to  be 
non-cumulative,  this  fact  must  be  clearly  expressed  in  the  char- 
ter provisions  by  which  the  stock  is  authorized.  Where  not  so 
expressed,  the  courts  have  held  the  preferential  dividends  to  be 
cumulative  and  payable  in  full  out  of  the  first  profits  before 
anything  is  received  by  the  common  stock.  The  cumulative 
feature  of  preferred  stock  is,  however,  for  the  sake  of  security 
and  definiteness  usually  covered  by  express  provision.  '• 

§  III.    Participation  in  General  Dividends 

As  already  stated,  unless  otherwise  expressly  provided,  pre-^ 
ferred  stock  participates  equally  with  the  common  stock  in  all 
dividends  after  both  common  and  preferred  have  received  an 
equal  dividend.  That  is,  if  the  preferred  stock  has  received 
its  preferential  dividend  of,  say,  6%  together  with  any  cumu- 
lated arrearages,  it  participates  no  further  in  dividends  until 
6%  has  been  paid  upon  the  common  stock  as  well,  but  thereafter 
both  classes  of  stock  stand  upon  exactly  the  same  basis  as  to  any 
further  dividends  declared  during  that  year.  If  such  further 
participation  on  the  part  of  the  preferred  stock  is  not  desired, 
it  must  be  expressly  denied.  , 

Such  participation  privilege  beyond  the  preferential  divi-{ 
dend  is  not  common.  It  is  sometimes  employed  to  advantage 
in  the  adjustment  of  interests  among  incorporating  parties,  but 
is  usually  found  only  where  the  stock  must  be  made  attractive 
above  the  common,  as  in  a  speculative  corporation  where  the 
risks  are  extra-hazardous,  or  under  other  conditions  necessi- , 
tating  unusual  inducements  to  investors.  " 

§  112.    Comparison  of  Participating  and  Bonus  Stock 

Sometimes  when  preferred  stock  is  to  be  made  attractive 
beyond  the  ordinary,  it  is  limited  to  its  preferential  dividend. 


"  But  see  Book  II,  fi  61,62. 


94  CORPORATE  LAW  [Bk.  I- 

but  a  common  stock  bonus  of  equal  amount  is  given  with  it. 
This  plan  is,  however,  much  less  advantageous  for  the  other 
stockholders  than  the  use  of  participating  preferred  stock,  as 
it  involves  (i)  the  payment  of  additional  dividends  on  stock 
equal  in  amount  to  the  preferred  stock,  (2)  an  additional  voting 
right  in  the  management,  (3)  in  event  of  liquidation  a  double 
claim  against  the  assets.  Further,  the  receipt  of  bonus  stock 
may  involve  the  holder  in  a  liability  to  creditors.12 

To  avoid  misunderstanding  when  a  participating  preferred 
stock  is  issued,  a  distinct  provision  in  the  authorizing  charter 
or  by-law  clause  should  cover  such  participation. 

§  113.    Redemption  Right 

Preferred  stock  is  often  issued  with  the  proviso  that  after 
a  certain  period  and  after  specified  notice,  the  corporation  shall 
have  the  right  to  buy  in  or  redeem  its  outstanding  preferred 
stock  at  some  previously  designated  price. 

Provisions  in  regard  to  the  redemptions  of  preferred  stock 
are  found  in  the  laws  of  a  number  of  states,  for  the  most  part 
referring  to  the  time  and  rate  of  redemption.  In  the  absence 
of  any  prohibition,  the  redemption  of  preferred  stock  under 
suitable  conditions  would  seem  to  be  entirely  within,  the  power 
of  the  corporation,  though  a  provision  of  this  kind  would  not 
be  permissible  in  a  state  where  corporations  are  forbidden  to 
acquire  their  own  stock.is  "The  relation  of  classes  of  stockhold- 
ers to  each  other  and  to  the  corporation  is,  unless  governed  by 
statute,  purely  contractual.  "1* 

It  is  also  to  be  noted  that  under  no  circumstances  would  the 
corporation  have  the  right  to  redeem  preferred  stock  when  by 
so  doing  it  would  impair  its  capital  stock  or  affect  the  rights  of 


«  Holcombe  v.  Trenton  White  City  Co.,  82  Atl.  (N.  J.)  618  (1912). 

"  Hackett  v.  North  Pac.  Ry.  Co.,  36  Misc.  (N.  Y.)  583  (1901).  In  this  case  a  foreign 
corporation  was  authorized  to  issue  preferred  stock  by  a  vote  of  a  majority  of  stockholders. 
A  condition  that  the  corporation  might  on  the  first  day  of  January  in  any  year  prior  to  1917 
retire  such  preferred  stock  at  par,  was  held  valid. 

"  Equitable  Life  Assurance  Society  v.  Union  Pacific  R.  R.  Co.,  162  App.  Div.  (N.  Y.) 
81  (1914). 


Ch.  it]  preferred  STOCK  95 

creditors.! 5  For  this  reason  such  redemption  should  be  made 
permissive,  not  mandatory,  as,  if  made  mandatory,  the  cor- 
poration might  later  find  itself  under  contract  obligation  to  do 
an  illegal  act. 

The  redemption  right  is  sometimes  of  considerable  import- 
ance, and  should  be  retained  if  it  can  be  done  without  injury 
to  the  sale  of  the  preferred  stock.  Dividend  rates  on  preferred 
stock  are  usually  higher  than  interest  rates  on  borrowed  money, 
and,  if  the  corporation  accumulates  surplus  profits,  the  pre- 
ferred stock  may  be  redeemed  and  its  high  preferred  dividends 
terminated  with  much  advantage.  If  the  redemption  period  is 
reasonably  remote,  say  five  years  or  more,  and  the  redemption 
price  is  attractive,  this  right  may  be  provided  without  detri- 
ment to  the  salability  of  the  stock  affected, 
i  The  redemption  price  of  preferred  stock  varies  with  the 
conditions.  Always,  as  a  prerequisite,  the  payment  of  any 
accrued  dividends  is  involved.  Frequently  the  price  is  fixed  at 
the  par  value  of  the  stock  plus  one  year's  dividend.  At  other 
times  it  is  arbitrarily  placed  at  a  figure  thought  attractive  or 
fair,  as  105,  no,  or  even  more  under  some  circumstances. 
Occasionally  the  holders  of  the  preferred  stock  will  be  given  the 
option  of  exchanging  their  stock  for  common  stock  instead  of 
taking  the  redemption  price. 

Preferred  stock  when  redeemed  is  no  longer  a  claim  against 
the  dividends  or  assets  of  the  company.  It  is,  however,  still  a 
part  of  the  capitalization  of  the  company,  and  might,  with  the 
assent  of  the  stockholders,  be  reissued. 

§  114.    Voting  Rights 

Unless  otherwise  expressly  provided,  preferred  stockholders 
have  exactly  the  same  right  to  participate  in  corporate  meet- 
ings and  to  vote  upon  their  stock  as  do  the  holders  of  common 
stock.16    Usually,  however,  this  voting  right  and  the  right  to 


"  Ellsworth  V.  Lyons,  181  Fed.  55  (1910). 
1*  I  Machen  on  Corp.,  {  570. 


96  CORPORATE  LAW  [Bk.  I- 

participate  in  stockholders'  meetings  is  denied  the  preferred 
stock,  the  power  of  management  being  reserved  to  the  common 
stock.  In  such  case  the  provisions  by  which  the  preferred  stock 
is  created  should  state  clearly  the  fact  of  its  non-voting  char- 
acter, and  this  fact  should  also  appear  plainly  upon  the  face  of 
the  certificate  by  which  such  preferred  stock  is  represented. 
Under  such  circumstances  the  preferred  stockholders  have  no 
more  voice  in  the  management  of  the  corporation  than  have 
its  bondholders. 

Unless  prohibited  in  some  way,  it  is  entirely  within  the 
power  of  the  corporation  to  deny  the  voting  power  to  preferred 
stock  before  issuance. 

"There  is  no  rule  of  public  policy  which  forbids  a  corporation 
and  its  stockholders  from  making  any  contract  they  please  in 
regard  to  restrictions  on  the  voting  power.  If  the  agreement  is 
made  by  unanimous  consent  it  is  legal,  "i^  In  California,  how- 
ever, the  statutes  provide  that  no  preference  as  to  voting  power 
may  be  granted  to  any  class  of  stock.is 

A  variation  of  the  plan  of  absolute  non-representation  is  to 
provide  that  the  holders  of  preferred  stock  shall  not  vote  so 
long  as  the  preferential  dividends  are  paid  with  reasonable 
regularity,  but  that  if  such  preferential  dividends  fail,  say  for 
two  consecutive  years,  then  the  holders  of  preferred  stock  shall 
thereafter  have  the  right  to  vote. 

This  plan  has  the  appearance  of  equity.  If  those  in  charge 
of  the  corporation  cannot  manage  the  corporate  business  so  as 
to  pay  dividends  on  even  the  preferred  stock,  it  would  seem 
but  reasonable  that  the  holders  of  preferred  stock,  who  suffer 
by  this  mismanagement,  should  be  allowed  a  voice  in  its  con- 
trol. If  interest  is  not  paid  on  a  bond  issue,  foreclosure  results 
and  the  bondholders  not  infrequently  buy  in  and  conduct  the 


"  2  Cook  on  Corp.,  i  622b,  cited  in  State  v.  Swanger,  190  Mo.  s6i  (190S);  People  ex  ret 
Brown  v.  Koenig,  133  A.  D.  (N.  Y.)  756  (1909);  Equitable  Life  Assurance  Society  v.  Union 
Pacific  R.  R.  Co.,  162  App.  Div.  (N.  Y.)  81  (1914)- 

"Film  Producers  Inc.  v.  Jordan,  IS4  Pac.  (Cal.)  60s  (1916). 


Ch.  ii]  PREFERRED  STOCK  97 

business.    Giving  the  preferred  stock  a  conditional  voice  in  the 
management  is  a  far  milder  application  of  the  same  principle.  . 

§  115.    Convertible  Stock 

Dr.  Dewing  says: 

Preferred  shares,  when  convertible,  are  almost  invariably  con- 
vertible into  common  shares.  The  conversion  privilege  in  such 
cases  is  usually  attached  to  the  preferred  stock  for  the  purpose 
of  attracting  the  elusive  "speculative  investor,"  as  the  genus  is 
caUed,  who  wants  security  and  regularity  of  income  at  the  same 
time  that  he  holds  the  opportunity  of  participating  in  any  extra- 
ordinary profits  to  be  realized  in  the  future.  Clearly  such 
convertible  preferred  shares  are  of  commonest  occurrence  in  the 
manufacturing  field,  where  the  lure  of  sudden  and  marvelous  profits 
holds  more  promise  than  in  the  prosaic  fields  of  the  railroad  and 
public  service  industries. i' 

In  New  Jersey,  by  statutory  enactment  corporations  answer- 
ing to  certain  descriptive  conditions  were  allowed  to  redeem  their 
preferred  stock — the  holders  consenting — with  bonds.  By  a 
singular  coincidence,  the  United  States  Steel  Corporation  was 
found  to  be  within  the  descriptive  prescriptions,  and,  with  the 
consent  of  two-thirds  of  its  outstanding  voting  stock,  it  offered 
the  holders  of  its  7%  preferred  stock  the  privilege  of  exchanging 
such  stock  for  5%  bonds.  The  exchange  was  entirely  optional 
with  the  holders  of  the  preferred  stock,  but  the  measure  aroused 
bitter  opposition  and  litigation.  The  exchange  was  finally 
upheld, 20 

In  the  absence  of  permitting  statutory  provisions,  any  such 
exchange  or  arrangement  for  such  exchange  would  be  illegal. 

§  116.    Founders*  Shares 

In  England,  founders'  shares,  a  kind  of  preferred  stock  which 
may  be  described  as  a  privileged  deferred  stock,  are  frequently 
issued.2i 


*•  I  Dewing  on  Finan.  Policy  of  Corp.,  p.  140. 

">  Berger  v.  U.  S.  Steel  Corp.,  63  N.  J.  Eq.  506;  s.  c,  809  (1902). 

"See  Book  II.  } J  54.  SS, 


98  CORPORATE  LAW  [Bk.  I- 

\ 
''  To  illustrate,  a  corporation  capitalized  at  $300,000  with 
$100,000  of  this  as  preferred  stock  and  $200,000  as  common 
stock,  might  have  $25,000  of  this  common  stock  set  aside  as 
founders'  shares  with  specified  dividend  rights  equal  perhaps 
to  all  the  other  common  stock.  That  is,  under  the  supposed 
arrangement,  after  the  preferred  stock  had  received  its  dividend, 
any  further  dividends  would  be  divided  into  two  equal  parts, 
one  of  which  would  go  to  the  ordinary  common  stock,  the  other 
to  the  founders'  shares.  Under  this  arrangement  the  $25,000 
of  founders'  shares  would  equal  $175,000  of  the  ordinary  shares 
so  far  as  participation  in  dividends  was  concerned. 

Under  such  conditions  the  founders'  shares  might  have  a 
value  many  times  in  excess  of  that  of  the  common  stock.  Where 
employed,  such  shares  are  usually  reserved  as  an  emolument 
for  the  promoters  of  the  enterprise,  or  as  compensation  to  men 
of  eminence  or  financial  repute  for  the  use  of  their  names. 

§  117.    Founders'  Shares  in  This  Country 

It  is  supposed  that  under  the  New  Jersey  laws,  and  under 
the  laws  of  some  other  states,  these  founders'  shares  might  be 
legally  issued.  Some  few  companies  have  been  organized  upon 
this  basis,  but  it  does  not  appear  that  the  subject  has  ever  come 
up  for  adjudication  in  this  country,  and  it  is  not  certain  what 
view  might  be  taken  of  the  matter  by  the  courts.  Probably,  if 
accomplished  by  proper  charter  provisions  and  with  the  full 
knowledge  of  the  stockholders  generally  and  with  all  due  pub- 
licity, the  arrangement  would  stand.  As  everything  to  be 
secured  by  the  use  of  the  founders'  shares  can,  however,  be 
accomplished  by  the  skillful  but  recognized  and  adjudicated  use 
of  common  and  preferred  stock,  it  would  hardly  seem  wise  to 
venture  on  ground  that  is,  at  the  best,  experimental  and  of 
doubtful  utility. 


CHAPTER  XII 
* 

FULL-PAID  STOCK 

§  ii8.    General 

A  subscriber  to  stock  on  its  original  issue,  when  his  subscrip- 
tion is  accepted,  becomes  a  stockholder.  He  may  pay  for  his 
stock  at  once,  or  in  instahnents,  or  as  assessments  are  laid  by  the 
directors.  Until  its  par  value  is  paid,  each  subscriber  is  liable 
for  the  amount  unpaid.  The  subscriber  must*  pay  its  par  or 
nominal  value  under  penalty  of  possible  liability  to  the  corpora- 
tion or  its  creditors  for  the  amount  necessary  to  make  up  the  full 
face  value  of  any  stock  partly  or  wholly  unpaid 

In  most  states  full-paid  stock  carries  no  liability,  either  in 
favor  of  the  issuing  corporation  or  of  the  creditors  of  that  corpor- 
ation.i 

§  119.    Watered  Stock 

Watered  stock  is  stock  issued  without  adequate  supporting 
values  therefor  having  come  into  the  possession  of  the  corpora- 
tion. Many  states  explicitly  prohibit  its  issuance  by  statute. 
Where  not  prohibited,  watered  stock  may  be  created : 

1.  By  the  issue  of  "full-paid"  stock  for  cash  at  less  than  its 

par  value. 

2.  By  its  issuance  as  a  stock  dividend  without  sufficient 

increase  of  the  corporate  property  to  support  the  issue. 

3.  By  its  issuance  as  a  bonus  with  preferred  stock  or  bonds. 

4.  As  is  the  method  in  the  great  majority  of  cases,  by  its 

issuance  for  property  or  services  at  an  overvaluation. 

The  most  obvious  form  of  watered  stock  is  the  stock  dividend 
occasionally  issued  by  the  large  public  utility  corporations  where 

'  See  I  121. 

99 


lOO  CORPORATE  LAW  [Bk.  I- 

there  is  no  pretense  of  any  increased  value  in  the  property  behind 
the  stock,  the  issue  being  justified  only  by  an  earning  capacity 
sufficient  to  pay  dividends  upon  the  increased  capitalization.  If 
the  corporation  wefe  forced  into  liquidation,  the  stock  would 
receive  only  a  fraction  of  its  face  value.  Such  a  stock  dividend 
must  be  distinguished  from  a  stock  dividend  paid  in  lieu  of  cash 
dividends  of  equal  amount,  where  the  reserved  cash  or  equivalent 
property  is  added  to  the  working  capital  of  the  company.  In 
such  case  the  issued  stock  represents  actually  increased  values, 
capable  of  realization  in  event  of  the  liquidation  of  the  company. 
The  most  common  form  of  watered  stock  is  stock  issued  in 
the  purchase  ©f  property  at  an  overvaluation.  Such  stock  is 
nominally  full-paid,  and  in  some  cases  by  the  subsequent  pros- 
perity of  the  corporation  the  anticipations  of  its  promoters  are 
realized  and  the  stock  is  removed  from  the  category  of  watered 
stock.  In  the  majority  of  cases,  however,  the  corporation  does 
not  meet  the  expectations  of  its  organizers,  and  the  issued  stock 
is  left  with  but  little  support.  In  such  case,  if  the  undertaking 
is  of  sufficient  value  in  actual  property  or  in  possible  profits  to 
justify  the  step,  a  reorganization  takes  place,  the  capital  stock  is 
greatly  reduced,  thereby  "squeezing"  the  water  out  of  it,  and  the 
corporation  is  placed  on  a  decreased,  but  usually  much  sounder, 
basis.2 

§  120.    Legal  Status  of  Watered  Stock 

Stock  issued  for  less  than  its  full  face  value  without  agree- 
ment between  the  parties  thereto  as  to  the  nature  of  such  stock, 
is  partly  paid  stock,  and  the  purchaser  is  liable  to  the  corporation, 
or  in  event  of  the  insolvency  of  the  corporation  to  its  credi- 
tors, for  the  amount  necessary  to  make  up  the  full  face  value  of 
such  stock.  If,  however,  it  is  agreed  between  the  purchaser  and 
the  corporation  that  the  price  paid  shall  be  in  full  settlement  of 
the  claims  of  the  corporation  against  such  stock,  then  as  between 

'See  S  125. 


Ch.  12]  FULL-PAID  STOCK  lOl 

these  parties  the  stock  Is  full-paid,  and  In  the  absence  of  fraud 
the  holder  is  under  no  Hability  to  the  corporation. » 

This  is  true  as  to  the  corporation  but  not  as  to  its  subsequent 
creditors  unless  by  agreement  of  these  latter.  In  event  of  the 
insolvency  of  the  corporation,  these  creditors  might  proceed 
against  the  original  purchasers  of  any  watered  or  partly  paid 
stock  so  long  as  such  stock  remained  in  their  hands,  and  collect 
from  them  the  amount  necessary  to  render  -their  stock  full-paid.  * 

This  possible  liability  follows  the  unpaid  stock  into  the  hands 
of  transferees  purchasing  such  stock  with  a  knowledge  of  its 
character,  but  does  not  follow  it  into  the  hands  of  an  innocent 
purchaser  for  value. s 

It  is  to  be  noted  that  the  general  doctrine  as  stated  requires 
modification  in  those  cases  where  the  board  of  directors  of  a  cor- 
poration has  issued  stock  for  property  or  services,  in  good  faith 
and  without  fraud,  and  later  developments  prove  the  considera- 
tion to  have  been — or  to  be — worth  less  than  the  face  value  of 
the  stock. 6  In  most  states  of  the  Union,  if  it  can  be  shown  that 
the  directors  exercised  proper  care  in  the  investigation  and 
acceptance  of  the  property,  the  courts  refuse  to  hold  the  recipi- 
ents of  the  stock  liable  on  the  ground  of  failure  or  insufl&ciency  of 
the  consideration.^ 

§  121.    Legal  Status  of  Full-Paid  Stock 

Full-paid  stock  carries  no  liability  of  any  kind,  either  to  the 
corporation  or  its  creditors,  save  in  those  few  states  where  by 
statute  special  liabilities  have  been  created.  This  freedom  from 
liability,  no  matter  what  the  vicissitudes  of  the  corporation,  gives 
to  stock  its  desirability  as  a  form  of  investment.  As  this  feature 
pertains  only  to  full-paid  stock,  it  is  a  great  object  in  the  organi- 
zation of  a  new  corporation  to  render  its  stock  full-paid. 


,  •  I  Cook  on  Corp.,  {{  30,  46;  Scovill  v.  Thayer,  105  U.  S.  143  (1881);  Christensen  v.  Eno, 
106  N.  Y.  97  (1887);  Southworth  v.  Morgan,  205  N.  Y.  293  (1912). 

•Cohen  v.  Toy  Gun  Mfg.  Co.,  172  111.  App.  330  (1912);  Gilson  v.  Appleby,  82  N.  J.  L. 
400  (191 1 ). 

'  See  i  122. 

•  Douglass  V.  Ireland,  73N.  Y.  100  (1878);  Hayes  v.  Iron  Co.,  16s  Pa.  St.  489  (189s). 

»  Holcombe  v.  Trenton  White  City  Co.,  82  Atl.  (N.  J.)  618  (1912);  Whitlock  v.  Alexander, 
160  N.  C.46S  (1912). 


I02  CORPORATE  LAW  [Bk.  I- 

Where  stock  is  Issued  at  par  for  cash,  which  with  financial 
institutions  is  usually  a  matter  of  statutory  obligation,  or  for 
cash  and  substantial  property  equaling  the  actual  face  value  of 
the  stock  as  in  the  case  of  solid  business  corporations,  the  ques- 
tion does  not  arise.  The  ordinary  corporation,  however,  cannot 
as  a  rule  sell  its  stock  at  par,  particularly  when  it  is  organized  for 
the  development  of  some  new  or  speculative  enterprise.  To 
issue  such  stock  direct  for  less  than  par  would  leave  the  pur- 
chasers— if  purchasers  could  be  found — liable  for  the  difference. 
Various  expedients  are  therefore  utilized  to  render  this  stock  full- 
paid  before  it  is  sold  to  the  actual  purchasers  for  cash,  and  the 
methods  adopted  to  secure  this  end  have  given  rise  to  most,  if 
not  all,  of  the  litigation  relating  to  the  full  payment  of  stock. » 

§  122.    Certificates  for  Full-Paid  Stock 

When  stock  is  full-paid  the  securities  by  which  it  is  repre- 
sented usually  bear  upon  their  face  the  words  "full-paid  and 
non-assessable."  There  is  no  legal  requirement  that  the  cer- 
tificates shall  be  so  inscribed,  but  if  they  were  not  the  purchasers 
would — and  very  properly — be  suspicious  of  the  stock.  The 
direct  and  legitimate  inference  from  the  omission  would  be  that 
such  stock  was  not  full-paid  and  non-assessable  and  might  carry 
latent  habilities.  If  stock  is  not  full-paid,  the  label  will  not 
shield  stockholders  who  know  the  facts. 

On  the  other  hand,  where  certificates  are  marked  "full-paid 
and  non-assessable,"  such  stock  may  be  bought  in  the  open 
market  from  a  lawful  holder  with  full  confidence  that  its  purchase 
involves  no  unknown  Habihties.  Even  should  it  later  prove  to 
have  been  but  partly  paid,  or  not  paid  at  all,  the  innocent  pur- 
chaser for  value  could  not  be  held  liable  on  that  account.  He 
purchased  on  the  faith  of  the  unquestioned  statement  on  the 
stock  certificate  that  such  stock  was  full-paid,  and  so  far  as  he  is 
concerned  the  stock  will  be  held  to  bear  that  character.  9    If, 


*  See  Ch.  XIII,  "Treasury  Stock." 

•  I  Cook  on  Corp.,  }§  so,  257,  note  4;  Sprague  v.  National  Bank  of  Amer.,  172  111.  149 
(1898);  French  v.  Harding,  83  Atl.  (Pa.)  586  (1912). 


Ch.  12]  FULL-PAID  STOCK  103 

however,  the  purchaser  knew  that  the  stock  had  not  been  hon- 
estly full-paid,  he  would,  as  already  stated,  take  with  notice  and 
might  be  held  liable  for  any  deficiency.io  Where  the  statute 
requires  a  certificate  of  full  payment  to  be  filed  in  a  public  office, 
the  fact  that  such  certificate  has  not  been  filed  has  been  held  to 
be  sufficient  to  give  a  purchaser  notice  that  the  stock  was  not 
fully  paid.  11 

The  impressive  word  "non-assessable"  merely  indicates  that 
the  corporation  has  either  received  full  payment  of  the  stock  in 
question,  or  otherwise  that  it  has  relinquished  any  claim  it  might 
have  on  such  stock  for  further  pa)rments  or  assessments  of  any 
kind.  Full-paid  stock  is  non-assessable  under  any  circumstances 
except  in  California  and  a  limited  number  of  other  states  where 
the  statutes  permit  the  corporation  to  levy  assessments. 

In  some  few  states  certificates  representing  stock  issued  for 
property  must  bear  the  legend  "issued  for  property"  or  some 
equivalent  statement.  Elsewhere  this  is  neither  necessary  nor 
desirable.  Such  stock  is  of  no  dififerent  nature  or  legal  status 
from  any  other  stock,  and  to  inscribe  it  in  the  manner  indicated 
conveys  the  impression  that  some  difference  actually  exists. 


'»  See  J  120;  also  i  Cook  on  Corp.,  §  49;  2  Clark  &  Marshall  on  Corp.,  {  401k;  Wallace  v. 
Carpenter,  etc.,  Co.,  70  Minn.  321  (1897);  Coleman  v.  Howe,  154  111.  458  (1895);  Gillett  v. 
Chicago  Title  &  Trust  Co.,  230  III.  373  (1907). 

"  White,  Corbin  &  Co.  v.  Jones,  167  N.  Y.  158  (1901). 


CHAPTER  XIII 

TREASURY  STOCK 

§  123.    Unissued  Stock 

The  term  "treasury  stock"  is  employed  very  loosely  by  busi- 
ness men  and  accountants  to  describe  unissued  stock.  It  would 
be  better  to  use  the  term  to  designate  the  issued  and  outstanding 
stock  of  the  company  that  has  been  donated  to  or  purchased  by 
the  corporation  and  which  is  held  subject  to  disposal  by  the 
directors.  Such  stock  is  properly  treasury  stock,  is  the  property 
of  the  company,  and,  technically  at  least,  is  an  asset  on  the  books 
of  the  company .1 

To  style  unissued  stock  "treasury  stock"  is  obviously  a  mis- 
nomer. Unissued  stock  is  merely  the  privilege  of  creating  a 
liabiUty.  It  is  not  in  any  sense  of  the  word  an  asset.  For  $20 
the  state  of  Arizona  will  charter  a  corporation  and  authorize  it 
to  issue  stock  to  the  face  value  of  $25,000,000  or  more.  Such  a 
company  on  organization  would  have  an  overplentiful  supply  of 
unissued  stock,  but  no  assets  whatever.  The  absurdity  of  re- 
garding its  unissued  stock  as  an  asset  is  obvious. 

§  124.    Issued  Stock 

Stock  that  has  been  once  legally  issued  for  full,  honest  value, 
however,  is  of  a  very  different  nature.  It  is  then  full-paid  stock 
and  represents  a  certain  interest  in  the  corporate  property.  If 
any  of  it  comes  back  into  the  possession  of  the  company  it  is  still 
"full-paid  stock"  and  is  then  with  some  logical  correctness  con- 
sidered an  asset.  Such  stock  is  properly  classified  as  treasury 
stock  and  may  be  sold  below  par  to  raise  funds  for  the  operations 


•  See  t  98;  also  Book  III,  Ch.  IX,  "Treasury  Stock  with  a  Par  Value";  see  also  Mont- 
gomery on  Auditing,  p.  206. 

104 


Ch.  13]  TREASURY  STOCK  105 

of  the  company,  may  be  given  away  as  a  bonus  with  preferred 
stock  or  bonds,  or  be  otherwise  used  without  involving  the  recip- 
ient in  any  liabihty  to  creditors  of  the  corporation.2 

In  case  such  treasury  stock  were  originally  issued  for  property 
at  an  overvaluation,  an  innocent  purchaser  for  value  cannot  be 
held  liable,  but  a  purchaser  with  knowledge  of  the  overvaluation 
might  be.3 

§  125.    Origin  of  Treasury  Stock 

If  a  corporation  were  organized  upon  a  strictly  cash  basis, 
each  subscriber  paying  the  par  value  for  his  stock,  it  would  have 
no  treasury  stock  at  the  time  of  organization.  Later,  should  a 
portion  of  this  issued  stock  come  back  into  the  possession  of  the 
company  in  settlement  of  some  debt  or  through  other  negotia- 
tion, such  returned  stock  would  be  treasury  stock  and  from  the 
bookkeeping  standpoint  an  asset  of  the  company. 

Unless  expressly  prohibited  by  statute,  a  corporation  may 
purchase  its  own  issued  stock.  Such  a  purchase  can  be  made 
only  with  surplus  or  profits,  and  must  imder  no  circumstances 
impair  the  capital  stock  of  the  company;  also  it  must  be  made 
in  good  faith  and  with  due  regard  to  the  rights  of  other  stock- 
holders and  of  creditors.  Such  a  purchase  may  be  made  to 
retire  an  officer.  *  Stock  so  purchased  would  be  treasury  stock 
and  an  asset  of  the  company. 

When,  however,  as  is  so  frequently  the  case,  a  corporation  is 
organized  under  the  usual  plan  to  exploit  some  mine,  invention, 
or  other  enterprise,  or  to  make  a  combination  of  existing  corpor- 
ations, it  issues  all  or  a  large  portion  of  its  stock  in  payment  for 
the  property  assigned  to  the  corporation.  This  stock  is  thereby 
rendered  nominally  full-paid.  Then  by  agreement,  or  by  under- 
standing, the  recipient  of  this  stock  assigns  back  to  the  corpora- 


'  I  Cook  on  Corp.,  SM6-S0;  i  Morawetz  on  Corp.,  {  306;  2  Clark  &  Marshall  on  Corp., 
i  39oe;  Lake  Superior  Iron  Co.  v.  Drexel,  90  N.  Y.  87  (1882);  Insurance  Press  v.  Montauk,  etc., 
Co.,  103  A.  D.  (N.  Y.)  472  (190S). 

•Ailing  V.  Wenzel,  133  111.  264  (1890);  Coleman  v.  Howe,  154  111.  458  (189s);  Berry  v. 
Rood,  168  Mo.  316  (1901). 

♦Joseph  V.  Rafif,  82  App.  Div.  (N.  Y.)  47  (1903);  Vail  v.  Hamilton,  85  N.  Y.  453  (1881). 


lo6  CORPORATE  LAW  [Bk.  I- 

tion,  or  to  some  trustee  for  the  corporation,  a  proportion  of  this 
full-paid  stock  to  be  used  for  company  purposes.  This  is  treas- 
ury stock  of  the  company  and  in  the  present  day  it  is  thus,  as  a 
general  rule,  that  treasury  stock  is  obtained.  Such  stock  is 
usually  a  clear  donation,  the  disposition  to  be  made  of  the  stock 
being  sometimes  prescribed,  but  generally  left  to  the  discretion 
of  the  board  of  directors.  Such  procedure  is  not  always  disap- 
proved by  the  courts. 

The  individual  defendants  then  transferred  back  to  the 
company  a  certain  amount  of  stock  which  was  to  become  the 
property  of  the  company,  and  to  be  disposed  of  by  it  for  its  own 
benefit.  Such  a  condition  is  not  unusual  in  companies  of  this 
character.  In  order  to  make  its  stock  of  any  value,  it  was 
essential  that  the  company  should  have  a  working  capital  in 
addition  to  the  patents,  and  the  persons  who  had  exchanged 
their  patents  for  the  stock  of  the  company  were  wi  ling  to  give 
to  the  company  a  portion  of  their  stock  so  that  the  working 
capital  could  be  secured  and  thus  give  value  to  the  remainder 
of  the  stock.  5 

§  126.    The  Present  Attitude  of  the  Courts  "' 

It  is  to  be  noted,  hovi^ever,  that  in  harmony  with  the  present 
general  trend  towards  stricter  regulation  of  corporations,  the 
courts  are  scrutinizing  "full-paid"  stock  of  this  character  much 
more  carefully  than  heretofore.  , 

In  a  recent  pamphlet, e  it  is  said: 

It  is  not  an  uncommon  practice  in  organizing  corporations     'f' 
having  shares  with  par  value,  to  place  such  a  monetary  valuation     10 
on  properties  to  be  acquired  through  stock  issues,  that  it  seems     fjj 
almost  apparent  that  the  properties  have  been  grossly  overvalued.      u 
In  cases  of  this  sort,  counsel's  reliance  is  placed  upon  the  statutory 
provision  common  in  many  states  to  the  effect  that  the  judgment 
of  the  board  of  directors  as  to  the  valuation  placed  upon  property       ^ 
turned  in  as  payment  for  stock,  is  conclusive  in  the  absence  of 
actual  fraud  in  the  transaction.    The  decisions  of  various  courts 


'  Justice  Ingraham  in  Insurance  Press  v.  Wire  Co.,  103  App.  Div.  (N.  Y.)  472,  476  (1905). 
'  "Shares  Without  Par  Value,"  published  by  the  Corporation  Trust  Conrpany,  New  York. 


Ch.  13]  TREASURY  STOCK  107 

P  on  the  question,  however,  have  impressed  counsel  with  the 
importance  of  requiring  directors  to  act  within  reasonable  limits 
in  arriving  at  values  of  this  nature.  Where  a  patent  or  mine,  or 
'  other  property  of  more  or  less  uncertain  value  and  possibilities  is 
'•  arbitrarily  valued  by  directors  at  a  substantial  sum  in  order 
to  dispose  of  the  question  of  stock  liability,  there  are  still  grave  legal 
doubts  that  their  appraisal  will  stand  the  test  of  udicial  scrutiny. 

This  is  particularly  true  in  New  Jersey,  where  it  was  formerly 
supposed  that  "in  the  absence  of  actual  fraud  in  the  transaction, 
the  judgment  of  the  directors  as  to  the  value  of  the  property 
purchased  shall  be  conclusive'" — and  this  with  but  little  regard 
as  to  how  this  judgment  was  reached.  Recent  decisions  have, 
however,  rudely  disturbed  this  pleasing  supposition.  It  is  now 
held  that  the  directors'  judgment  must  be  based  on  something 
more  tangible  than  promoters'  statements  or  vague  suppositions. 
As  laid  down  by  the  court  in  a  recent  case : 

It  was  their  duty  to  have  acted  as  an  independent  board  of 
[  directors,  with  full  knowledge,  would  have  acted,  namely,  to  have 
made  a  careful  inventory  and  appraisement  of  all  property  to  be 
purchased  with  stock  or  for  cash,  and  to  have  either  issued  stock 
or  paid  cash,  measure  for  measure,  value  for  value.  This  they 
neglected  to  do,  with  the  result  that  those  whom  they  sought  to 
protect  are  not  protected,  themselves  included.* 

In  this  case,  treasury  stock  supposedly  full-paid  by  property 
in  exchange  for  which  it  was  originally  issued,  was  held  not  to 
have  been  fully  paid  thereby,  and  parties  to  whom  it  was  subse- 
quently issued  as  treasury  stock  were  held  liable  to  the  company's 
creditors  for  the  unpaid  balance. 

§127.    Transfers  to  Corporation 

When  stock  is  donated  or  otherwise  transferred  to  the  corpor- 
ation, the  certificates  should  not  be  assigned  to  the  treasurer  by 
name,  as  to  "John  Wilson,  Treasurer,"  as  at  a  subsequent  elec- 


'  p.  L.  (N.  J.)  1893,  p.  444,  as  amended  by  Laws  of  1896,  p.  294. 
•Holcombe  v.  Trenton  White  City  Co..  82  Atl.  (N.  J.)  618  (1912), 


lo8  CORPORATE  LAW  [Bk.  I- 

tion  the  position  of  treasurer  may  be  filled  by  some  other  person 
and  the  too  definite  indorsement  may  then  cause  trouble.  Such 
stock  is  better  indorsed  to  the  company  itself,  as  "The  Caswell 
Company,"  or  to  its  treasurer,  as  "Treasurer  of  The  Caswell 
Company." 

A  plan  that  is  sometimes  pursued  when  stock  is  thus  turned 
over  for  the  benefit  of  the  company,  is  to  assign  it  to  trustees  to 
hold  and  sell  such  stock  for  the  benefit  of  the  company,  either  at 
their  own  discretion  or  under  the  superintendence  of  the  directors, 
the  funds  so  received  being  paid  over  to  the  treasurer  of  the  cor- 
poration. This  plan  relieves  the  corporation  of  all  responsibility 
as  to  the  details  of  the  matter,  the  transaction  not  appearing  on 
the  company's  books  until  the  money  from  the  sale  of  the  stock 
is  turned  over.9 

§  128.    How  Treasury  Stock  Is  Held 

When  certificates  representing  treasury  stock  are  received  by 
the  corporation,  they  should  bear  the  proper  indorsements,  and 
are  then  usually  turned  over  to  the  secretary.  This  official 
should  enter  the  transfer  in  the  stock  book,  cancel  the  old  certifi- 
cates and  return  them  to  the  stock  certificate  book,  and,  if  de- 
sired, issue  new  certificates  in  the  name  of  the  corporation  or  of 
the  official  by  whom  the  stock  is  to  be  held.  It  is  to  be  noted 
that  new  certificates  need  not  necessarily  be  issued  at  all  until 
sales  of  treasury  stock  are  made,  when  the  certificates  represent- 
ing stock  sold  might  be  issued  directly  to  the  purchasing  party. 
In  such  case,  until  the  time  of  sale  the  stock  book,  in  connection 
with  the  canceled  certificates  of  the  stock  certificate  book,  is 
sufiicient  evidence  of  the  status  and  ownership  of  such  treasury 
stock. 

§  129.    Transfers  from  Corporation 

When  treasury  stock  is  sold  the  formalities  are  simple.  The 
sale  being  duly  authorized  by  the  directors,  the  treasurer  would, 


•  Wood  V.  Sloman,  150  Mich.  177  (1907). 


Ch.  13]  TREASURY  STOCK  109 

if  the  stock  were  held  by  him  and  the  original  certificates  had 
been  canceled  without  reissue,  merely  give  the  purchaser  an 
order  for  the  required  certificates,  or  instruct  the  secretary  in 
writing  to  issue  such  new  certificates.  If  the  original  had  been 
canceled  and  new  certificates  issued  to  the  treasurer,  this  latter 
official  would  merely  assign  one  of  his  certificates,  if  of  the  right 
denomination.  If  otherwise  he  would  have  one  broken  up,  the 
proper  number  of  shares  being  issued  therefrom  to  the  new  pur- 
chaser, and  the  unsold  remainder  being  issued  to  the  treasurer. 
If  the  certificates  had  been  held  in  the  name  of  the  corporation, 
the  treasurer  or  such  other  official  or  officials  as  were  designated 
by  the  board  would  make  the  proper  assignments, 

§  130.    Legal  Status  of  Treasury  Stock 

When  its  own  stock  is  returned  to  and  is  held  by  the  corpora- 
tion, or  by  trustees,  or  by  its  own  officers  for  the  corporation, 
such  stock  is  not  unissued  stock,  nor  do  the  stockholders  as  such 
have  any  subscription  or  participation  rights  when  it  is  reissued.io 
So  long  as  such  stock  is  held  by  the  corporation,  it  is  inert  and 
can  neither  vote  nor  participate  in  dividends.^  Should  the  stock 
be  voted,  such  action  would  be  illegal  and  any  action  or  election 
decided  by  such  vote  of  treasury  stock  would  be  illegal  and  might 
be  set  aside.  If  the  system  of  accounting  logically  required  that 
dividends  be  collected  on  treasury  stock  held  by  the  corporation 
no  law  would  prevent  such  action,  as  the  money  so  paid  would 
come  directly  back  into  the  treasury  of  the  corporation. 

§  131.    Stock  of  Other  Corporations  Held  in  Treasury 

It  is  to  be  noted  that  the  comments  of  the  preceding  sectiop 
do  not  in  any  way  apply  to  stock  of  other  corporations  which 
may  be  owned  and  held  in  the  treasury  of  any  particular  corpora- 
tion.    Where  the  corporation  has  power  to  hold  the  stock  of 


'"Crosby  v.  Stratton,  17  Colo.  App.  212  (1902);  Hartley  v.  Pioneer  Iron  Works,  181 
N.  Y.  73  (190S). 

"  3  Clark  &  Marshall  on  Corp.,  (  6s3l;  Vail  v.  Hamilton,  8s  N.  Y.  453  (i88i);  Am.  etc.,, 
Co.  V.  Haven,  loi  Mass.  398  (1869);  O'Connor  v.  Int.  Silver  Co.,  68  N.  J.  Eq.  67  (1904). 


no  CORPORATE  LAW  [Bk.  I- 

other  companies,  it  holds  such  stock  as  an  individual  would  do, 
and  has  the  same  right  to  vote  upon  it  and  to  receive  dividends 
on  it- 
It  is  to  be  noted,  however,  that  a  corporation  cannot  legally 
hold  the  stock  of  another  corporation  unless  specifically  auth- 
orized by  statute,  as  in  Delaware,  or  by  charter  provision  allow- 
able under  the  statutes,  as  in  New  York.12 

"  Dunbar  v.  Amer.  Tel.  Co.,  238  111.  456  (1909);  see  also  discussion  in  Ch.  LVII,  "Holding 
Companies." 


H'No  ?Ji  aoA'ff 


Jit'^u(f  l>ii/;  ! 


sioqio  J 


•  n 


CHAPTER  XIV 

SHARES  WITHOUT  PAR  VALUE 

§  132.    The  Theory  of  No-Par  Sharesi 

1      In  his  recent  work,  "The  Financial  Policy  of  Corporations," 
Dr.  Dewing  of  Harvard  says:  "  '  ' 

Capital  stock  .  .  .  involves  two  distinct  ideas^a  participation 
in  the  rights  of  ownership,  and  a  valuation  of  this  participation. 
'■'       This  latter  is  the  par  value.    It  is  the  less  important.    The 
stockholder  can  never  collect,  like  the  bondholder,  the  par  value  of 
his  security  from  the  corporation .     Even  though  paid  for  in  full  and 
representing  for  a  short  time  the  full  and  actual  valae,  the  equality  adi 
passes  with  the  first  business  transaction,  for  the  value  of  the 
corporation  property  changes  with  every  success  or  failure  of  the 
corporation,  .  .  .    The  essential  character  of  the  capital  stock  , 
that  remains  permanent  whatsoever  the  fortunes  of  the  actual   ''*' 
capital,  is  that  it  stands  for  a  definite  proportion  of  the  corporate  ^*^'^ 
property  and  earnings.    This  involves  no  par  value.     The  purpose  •  1  jr  I 
of  the  stock  would  therefore  be  fully  accomplished  if  the  shares  i.,!) 
were  merely  proportionate  parts  of  a  total,  in  other  words,  shares 
without  par  value. 

There  could  be,  aside  from  doing  away  with  the  meaningless- 
ness  of  par  value,  certain  specific  advantages.  The  most  con- 
spicuous is  that  of  truthfulness.  Without  par  value  there  is  no 
pretense  that  the  actual  property  of  the  corporation  is  equivalent 
to  the  par  value  of  its  shares  after  the  liabilities  are  met,  and 
there  is  no  insinuation  of  overcapitalization  or  undercapitalization. 
In  other  words,  the  capital  stock  would  stand  merely  for  propor- 
tionate shares  in  the  earnings  of  the  corporation,  and,  if  the 
corporation  be  liquidated,  the  proportionate  shares  in  the  equity 
remaining  after  all  other  claims  had  been  satisfied. 


'  In  the  Oct.  and  Nov.  192 1,  numbers  of  the  American  Bar  Association  Journal  are  to  be 
found  a  full  and  interesting  discussion  of  the  uses  of  no-par-value  shares.  Cook,  author  of 
Cook  on  Corporations,  questions  the  wisdom  of  the  whole  systsm.  Other  members  of  the  bar 
argue  ably  for  the  utility  and  value  of  the  plan. 


112  CORPORATE  LAW  iBk.  I- 

§  133.    The  "Dollar-Marked"  Stock  Certificate 

One  of  the  ends  gained  by  the  use  of  stock  without  par  value 
is  the  abolition  of  the  dollar-marked  stock  certificate  with  its 
assumption  of  a  fixed  and  too  often  purely  fictitious  value- 
As  a  matter  of  fact,  many  of  the  stock-selHng  schemes  which 
have  drawn  so  much  from  those  who  cannot  afford  the  loss,  have 
owed  most  of  their  effectiveness  to  the  use  of  this  dollar-marked 
stock  certificate.  A  $100  share  of  stock  at  $50  sounds  like  a 
bargain.  The  purchaser  should  know,  and  if  he  stops  to  think, 
does  know,  that  the  certificate  marked  $100  may  be  worth  $100 
or  may  be  worth  more  or  less.  He  should  investigate  for  him- 
self and  find  out  the  real  value  of  the  dollar-marked  stock  cer- 
tificate. In  practice  he  usually  does  nothing  of  the  kind.  He 
buys  on  its  face  value  and  is  deceived. 

To  avoid  these  frauds  on  the  public,  and  to  provide  a  share 
that  would  truthfully  represent  the  corporate  interests  of  those 
who  own  it,  the  plan  of  no-par- value  stock  was  devised — a  stock 
that  has  no  dollar  value  printed  on  the  stock  certificate  and  that 
only  purports  to  entitle  the  holder  to  a  certain  fractional  inter- 
est in  the  enterprise.  The  stock  may  be  worth  much  or  little, 
but  on  the  face  of  the  certificate  it  only  claims  to  represent  a 
definite  but  unvalued  interest  in  the  corporation. 

§  134.     History 

It  is  probable  that  the  theory  of  no-par-value  shares  origi- 
nated with  the  so-called  "founders'  shares"  that  are  commonly 
used  in  English  promotions  to  represent  the  speculative  and 
contingent  interests  in  their  enterprises.  These  have  been 
described  else  where. 2 

In  the  matter  of  authorizing  no-par-value  stock.  New  York 
was  the  pioneer.  The  plan  was  first  agitated  before  the  New 
York  State  Bar  Association  many  years  ago,  and  a  committee 
report  made  early  in  1892  suggested  capital  stock  without  money 

2  See  \  116. 


Ch.  14]  SHARES  WITHOUT  PAR  VALUE  II3 

denomination.  Fifteen  years  after  this,  in  1907,  the  Bar  Asso- 
ciation committee,  consisting  of  Victor  Morawetz,  Francis  L. 
Stetson,  Edward  M.  Shepard,  and  later,  Louis  Marshall,  drafted 
a  bill  which  was  passed  by  the  New  York  legislature  that  same 
year.  Unfortunately,  this  was  vetoed.  The  same  bill,  with 
some  changes,  was  brought  up  again  and  passed  April  15,  191 2. 
Since  then  it  has  been  in  continuous  effect  in  New  York,  and 
many  solid  corporations  have  been  incorporated  and  authorized 
to  issue  this  kind  of  stock. 

§  135.    Present  Status 

The  growth  of  no-par- value  stock  issuance  in  the  country  at 
large  is  evidenced  by  the  following  schedule  showing  which 
states  have  followed  New  York  and  when  each  authorized  the 
issuance  of  shares  of  no  par  value : 

1 916  Maryland 

191 7  California,  Delaware,  and  Maine 

19 1 8  Virginia 

191 9  Illinois,  Pennsylvania,  New  Hampshire,  and  Ohio 

1920  Massachusetts,  New  Jersey,  Rhode  Island,  West  Virginia, 

and  Wisconsin 

192 1  Alabama,  Colorado,  Idaho,  Kansas,  Maine,  Michigan, 

Missouri,    North    Carolina,    Oklahoma,    Utah,    and 
Virginia 

At  the  present  time  stock  with  no  par  value  is  being  used  for 
a  large  proportion  of  the  important  incorporations  of  these 
twenty-three  states.  Some  of  the  most  representative  of  these 
no-par-value-stock  corporations  are:  Kennecott  Copper,  Colum- 
bia Graphophone,  Consolidated  Textile,  Cuba  Cane  Sugar, 
General  Motors  Corporation,  Loew's  Incorporated,  Radio  Cor- 
poration of  America,  Sinclair  Consolidated  Oil  Corporation, 
United  Retail  Stores,  Wilson  and  Company,  Inc.,  and  the 
Vanadium  Corporation.  Almost  every  line  of  business  and 
industry  is  represented  among  the  no-par-value-share  corpora- 
tions. 


114  ;/  CORPORATE  LAW    ■  [Bk.  I- 

Stocks  of  corporations  organized  under  these  statutes  are 
quoted  on  the  Exchange,  side  by  side  with  those  with  a  par  value, 
and  are  dealt  in  without  seeming  discrimination.  The  number 
of  corporations  taking  advantage  of  this  statute  is  increasing,  as 
confidence  in  the  benefits  of  the  no-par-value  stock  is  established.* 

The  probabilities  are  that  the  other  states  in  the  Union  will 
follow  the  example  of  the  states  mentioned;  and  it  would  appear 
from  the  progress  made  in  securing  laws  authorizing  stock  with 
no  par  value  in  the  most  important  states  of  the  Union,  and  its 
use  by  corporations  of  unquestioned  solvency  and  business 
repute,  that  this  form  of  stock  is  likely  to  be  a  permanent  feature 
of  our  modern  corporate  system. 

§  136.     Judicial  Indorsement 

When  corporations  with  no-par-value  stock  first  sought  per- 
mission to  do  business  in  other  states,  the  authorities  in  several 
states  declined  to  admit  them  on  any  terms. 

In  Kansas  and  Missouri,  the  corporations  rejected  brought 
suit  before  the  supreme  court  of  each  state,  which  in  both  cases 
decided  in  favor  of  the  corporations  and  issued  a  mandamus 
forcing  the  too  conservative  state  authorities  to  admit  them  to 
do  business  on  the  same  terms  as  other  foreign  corporations. 

The  following  extracts  from  the  decision  of  the  Kansas 
Supreme  Court  are  given  to  show  that  the  legality  of  the  form  is 
unquestionable,  and  that  in  the  highest  courts  of  states  having 
no  such  law  they  have  been  adjudged  absolutely  legal : 


The  defendants  say  that  because  the  shares  of  stock  of  the 
plaintiff  have  no  fixed  or  nominal  par  value  it  will  be  difficult  for 
the  officials  of  this  state  to  determine  the  amount  of  annual  fees 
that  the  corporation  should  pay,  and  that  there  is  no  means  of 
knowing  what  the  capital  stock  of  the  plaintiff  is,  without  an 
examination  of  its  assets.  These  objections  arise  out  of  the  fact 
that  the  plaintiff  corporation  is  organized  on  a  plan  that  does  not 


//J 


'  21  Columbia  Law  Review,  (March.  1921),  p.  278. 


Ch.  14]  SHARES  WITHOUT  PAR  VALUE  115 

call  for  a  division  of  its  capital  into  shares,  each  representing  so 
many  dollars  of  capital.  Under  the  plaintiff's  plan  of  organization, 
the  capital  may  be  much  or  little,  and  that  capital  is  not  divided 
into  money  shares,  but  into  fractional  parts. 

The  problem  of  determining  the  solvency  and  bona  fide  capital- 
ization of  the  plaintiff  presents  no  unusual  difficulty.  The  fact 
that  the  shares  of  its  stock  have  no  nominal  par  value  is  of  little 
consequence.  Any  prudent  charter  board,  in  determining  whether 
a  foreign  corporation  is  worthy  of  admission  to  do  business  in 
Kansas,  would  attach  little  importance  to  the  nominal  value  of 
its  shares  of  stock,  even  if  they  have  a  nominal  value.  As  in  all 
other  cases,  the  charter  board  should  concern  itself  earnestly  to 
ascertain  the  genuine  capital — those  assets  permanently  devoted 
to  the  corporate  business  as  a  basis  for  its  business  credit,  and 
upon  which  its  hope  of  profits  is  rationally  founded.  .  .  . 

The  defendants  contend  that  the  plaintiff  is  not  such  an 
organization  as  is  called  a  corporation  in  the  constitution  and  laws 
of  this  state.  The  answer  to  this  contention  is  that  corporations 
without  capital  stock  and  without  shares  of  stock  are  not  new; 
they  are  as  old  as  corporations  themselves,  and  have  existed  in 
England  and  in  this  country  for  many  years;  our  constitution 
recognizes  them,  and  we  have  laws  for  their  control  and  govern- 
ment.* 

In  Missouri  the  same  situation  arose,  was  referred  to  the 
courts,  and  was  decided  in  the  same  way. 

In  a  few  states  the  authorities  may  still  decline  to  admit  for- 
eign corporations  with  no-par-value  shares  to  do  business,  but 
it  is  probable  that  the  courts  of  these  states  would  compel  them 
to  reverse  any  such  adverse  position. 

§  137.    General  Characteristics 

It  is  worth  while  to  note  the  usual  characteristics  of  the  laws 
that  authorize  shares  with  no  par  value : 

I.  Authorization  may  be  secured  upon  organization  by 
charter  provision,  or  by  amendment  of  an  existing  charter.  This 
latter  method  facilitates  reorganization. 


*  Petroleum  Co.  v.  State  Charter  Board,  105  Kans.  i6i. 


Il6  CORPORATE  LAW  IBk.  I- 

2.  The  privilege  is  generally  limited  to  what  are  termed  in 
New  York  "business  corporations,"  that  is,  corporations  organ- 
ized for  mining,  manufacturing,  and  mercantile  ventures.  There 
would  seem  to  be  no  reason  why  such  shares  should  not  be  issued 
by  public  utility  corporations,  but  as  yet  it  has  not  been  done  and 
is  not  authorized  in  any  of  the  more  important  states. 

3.  The  statutes  provide  that  in  all  cases  such  shares  shall  be 
equal  in  all  respects.  This  would  be  the  common  law,  and  it  has 
been  reaffirmed  in  each  state  where  a  no-par-value-stock  law  has 
been  enacted.  Each  share  is  equal  in  rights  and  privileges  to 
every  other  share. 

4.  Under  these  equal  rights  and  privileges  any  holding  of 
stock  entitles  the  holder  to  one  vote  for  each  share  held,  to  notice 
of  corporate  meetings,  to  inspection  of  the  corporate  books,  to 
participate  proportionately  in  dividends  after  preferred  dividends 
are  paid,  and  to  share  proportionately  in  the  surplus  after  debts 
are  paid  and  after  the  preferred  stockholders  have  been  paid 
their  principal  and  all  accumulated  dividends. 

5.  The  certificates  of  shares  with  no  par  value  must  give  the 
number  of  shares  to  which  the  holder  is  entitled  and  should  give 
the  whole  number  of  shares  authorized  to  be  issued.  As  the 
shares  have  no  par  value,  it  would  seem  that  the  holder  should 
be  informed  as  to  whether  his  shares  are  each  one-hundredth, 
one-thousandth,  or  one-millionth.  In  New  York  this  informa- 
tion must  be  given  but  in  no  other  state  is  it  compulsory. 

6.  All  the  states  prescribe  some  method  of  fixing  a  selling 
price,  but  there  is  a  curious  diversity  of  methods.  It  may  be 
prescribed  in  the  charter,  but  this  is  objectionable,  as  one 
advantage  of  stock  without  par  value  is  that  the  corporation  may 
sell  it  for  any  price  it  will  bring,  and  under  this  plan  any  change 
in  price  would  require  an  amendment  of  the  charter.  Another 
plan  is  to  have  the  price  fixed  by  the  directors,  and  sometimea 
this  must  be  authorized  or  confirmed  at  a  majority  meeting  of 
the  stockholders.  In  some  states  the  stockholders  by  a  two- 
thirds  vote  may  fix  the  price. 


Ch.  14]  SHARES  WITHOUT  PAR  VALUE  II7 

7.  The  organization  tax  varies.  In  most  of  the  states  the 
tax  on  organization  is  computed  by  assuming  that  each  no-par- 
value  share  has  a  par  value  of  $100. 

8.  Another  problem  has  been  to  fix  a  valuation  of  the  stock  in 
a  corporation  having  shares  with  no  par  value,  for  the  purpose 
of  annual  taxation.  In  New  York  the  rule  is  to  take  the  out- 
standing preferred  stock  at  its  par  value  and  add  the  actual  sales 
price  of  all  no-par-value  shares  that  have  been  sold.  In  Penn- 
sylvania the  same  rule  holds.  Generally,  in  assessing  taxes  the 
no-par-value  shares  are  arbitrarily  considered  to  be  worth  $100 
each.  If  a  corporation  issuing  such  shares  desires  to  do  business 
in  another  state,  its  no-par-value  shares  are  generally  treated 
as  if  they  were  $100  shares. 

9.  In  only  a  few  states  is  any  provision  made  for  preferred 
stock  without  par  value.  Instead,  where  provision  is  made  for 
the  issuance  of  preferred  stock  it  is  usually  also  provided  that 
such  stock  shall  be  of  specified  par  value  and  shall  likewise  be 
preferred  in  distribution  of  assets.  In  such  case  the  preferred 
stock  has  preference  in  assets  over  any  no-par-value  stock.  No 
good  reason  exists  why  preferred  stock  should  not  be  issued 
without  par  value.  If  the  preference  is  as  to  amount  of  dividend 
paid  it  could  be  expressed  as  so  many  dollars  a  share  instead  of 
being  expressed  as  a  percentage. 

§  138.    When  Shares  Without  Par  Value  Are  Used 

When  a  partnership  is  incorporated,  and  stock  is  issued  to 
the  new  members  of  the  firm  in  exchange  for  the  appraised  value 
of  the  partnership  assets,  there  would  be  no  object  in  issuing 
anything  but  the  usual  par  value  stock.  In  organizing  a  bank 
or  other  moneyed  institution,  there  would  be  no  advantage  in 
no-par-value  stock,  even  if  the  state  laws  permitted.  In  any 
other  business  where  each  share  is  to  be  paid  for  in  full  at  its  par 
value,  the  usual  stock  would  answer. 

The  most  obvious  case  in  which  to  utilize  no-par-value  stock 
is  where  a  corporation  is  organized  to  undertake  some  speculative 


Il8  CORPORATE  LAW  [Bk.  I- 

venture,  such  as  a  patent,  a  mine,  or  a  real  estate  development. 
In  such  case  preferred  stock  might  be  issued  for  any  actual  cash 
that  was  invested,  and  then  no-par- value  stock  be  issued  to 
represent  the  contingent  or  possible  interests  of  the  promoters. 
This  would  be  issued  in  exchange  for  the  invention,  the  mine,  or 
other  opportunity,  and  would  only  give  the  holders  an  interest 
in  future  profits.  If  sold  to  outsiders,  it  would  be  sold  as  an 
unvalued  share  in  future  profits,  and  would  represent  merely  a 
business  chance  without  any  untrue  statement  that  it  repre- 
sented $ioo,  or  $50,  or  other  definite  amount. 

In  various  mercantile  or  manufacturing  ventures,  where 
management,  business  skill,  salesmanship,  and  ability  to  make 
the  most  of  opportunity  count  for  more  than  tangible  capital, 
shares  representing  only  a  proportionate  interest  in  the  intangi- 
bles could  be  issued  to  those  who  furnished  these  qualities; 
while  for  any  actual  cash  or  values,  preferred  stock  in  the  usual 
form  could  be  issued. 

It  will  be  found  on  analysis  that  most  business  ventures 
require  two  essential  things.  They  must  have  (i)  the  use  of 
capital  and  (2)  the  application  of  business  skill  and  initiative  in 
varying  degrees.  Thus,  in  probably  a  majority  of  business 
enterprises  we  have:  t 

1.  The  investment  interest  of  those  who  have  paid  in  cash 

and  whose  investment  is  properly  represented  by  fuU- 
paid  stock. 

2.  The  contingent  interest  of  those  who  have  devised  and 

promoted   the  enterprise  and  who  probably  take  an 
active  part  in  the  management. 

For  many  years  past  those  who  have  contrived  or  originated 
the  corporate  plans,  or  who  have  undertaken  the  management, 
have  always  felt  that  if  successful  they  deserved  some  reward  for 
their  business  initiative  over  and  above  the  return  on  any  per- 
sonal cash  investment  they  may  have  made.  This  has  seemed 
but  fair  and  has  usually  resulted  in  issues  of  common  stock  that 


Ch.  14J  SHARES  WITHOUT  PAR  VALUE  II9 

really  represented  only  this  contingent  or  residuary  interest  in 
the  ultimate  success  of  the  enterprise. 

In  all  such  cases,  the  use  of  stock  without  par  value,  justly 
and  without  unfairness  to  anyone,  recognizes  and  provides  for 
those  whose  ability  and  industry  makes  the  venture  successful. 

In  addition  to  the  cases  suggested,  there  are  mergers  and 
reorganizations  in  which  there  are  nearly  always  interests  that 
can  be  represented  more  fairly  by  stock  without  par  value  than 
in  any  other  way. 


imi  jajii  (i^j 


n  adi  v 


CHAPTER  XV 

NO-PAR-VALUE  SHARES— ADVANTAGES 

§  139.    Contingent  Interests  Fairly  Represented 

In  the  Harvard  Law  Review  for  June,  1913,  Victor  MorawetZj 
one  of  the  distinguished  lawyers  who  drafted  the  New  York 
statute,  expressed  himself  as  follows: 

The  policy  of  the  New  York  statute  is  sound.  It  recognizes 
that  shares  in  a  corporation  represent  only  aliquot  interests  in 
its  capital,  whatever  that  may  be,  and  that  their  nominal  or  par 
value  is  no  indication  of  their  actual  value  or  of  the  actual  capital 
of  the  corporation.  It  requires  the  amount  of  the  actual  capital  of 
a  corporation  formed  under  the  law  to  be  stated  in  the  certificate  of 
incorporation,  and  imposes  a  severe  penalty  upon  the  directors,  in 
case  of  the  creation  of  indebtedness  before  receiving  the  prescribed 
capital.  Thus  it  furnishes  to  creditors  and  to  the  public  generally  a 
measure  of  protection  greater  than  that  furnished  by  the  generally 
prevailing  incorporation  laws. 

The  use  of  the  share  without  par  value  simplifies  the  cor- 
poration organization  in  that  the  actual  investment  may  be 
represented  by  preferred  stock  of  par  value  and  possibly  a 
bond  issue,  while  the  contingent  interest  in  the  profits  is  repre- 
sented by  the  no-par-value  shares.  If  the  business  is  successful 
so  as  to  yield  returns  over  and  above  the  agreed  compensation 
to  the  holders  of  preferred  stock,  those  who  have  managed  it  so 
well  receive  an  adequate  reward  in  dividends  on  their  no-par- 
value  shares.  If  it  does  not  succeed  so  well,  the  shares  being  of 
no  published  value,  a  failure  to  pay  adequate  dividends  is  not 
so  much  to  the  public  discredit  of  the  corporation. 

§  140.    Exchange  for  Property 

The  use  of  no-par-value  stock  avoids  the  clumsy  and  ofttimes 
fraudulent  issue  of  stock  for  property  to  make  it  full-paid.    Even 


Ch.  15]  NO-PAR- VALUE  SHARES— ADVANTAGES  121 

where  the  directors  are  conscientious  about  contracts,  patents, 
etc.,  offered  in  exchange  for  common  stock,  the  transaction  does 
not  look  well  on  the  corporate  records  and  really  requires  a 
false  statement  on  the  books.  The  methods  by  which  treasury 
stock  issued  for  property  of  uncertain  value  was  made  full- 
paid  on  the  books  have  always  been  an  embarrassment  to  the 
conscientious  accountant.^ 

§  141.    Prevention  of  Fraudulent  Stock  Sales 

The  use  of  shares  without  par  value  prevents  frauds  on 
common  people  by  treasury  stock  being  sold  below  par.  As 
already  stated,  the  public  have  always  been  deceived  by  this 
procedure,  feeling  that  stock  marked  $100  must  in  some  way 
be  worth  $100,  and  that  if  they  could  get  it  at  a  discount  they 
were  being  let  in  on  the  ground  floor.  -  « 

Another  cardinal  advantage  would  be  that  of  forcing  the  pros- 
pective investor  to  examine  the  real  value  of  stock,  and  not  be 
deluded  into  thinking  that  there  is  some  necessary  connection 
between  the  par  value  and  the  real  intrinsic  value.' 

The  creation  of  shares  without  par  value  has  the  advantage 
of  truthfulness.  It  makes  no  claims  to  represent  anything  but 
the  right  to  a  proportional  share  in  the  net  profits  of  the  cor- 
poration, if  any,  and  in  event  of  dissolution,  to  share  in  like 
proportion  in  any  division  of  the  net  assets. 

§  142.    Corporate  Records  Are  Simplified 

Issues  of  shares  having  no  par  value  are  true  to  the  facts 
and  true  on  the  corporate  records.  With  such  stock,  what  is 
received  is  entered  on  the  books  just  as  it  is  paid,  and  in  neither 
the  accounts  nor  the  statements  made  is  there  deception  or 
stultification.  No  question  of  overcapitalization  or  under- 
capitalization can  arise. 


>  See  Ch.  XIII,  "Treasury  Stock";  also  Book  .III.  Ch.  XI,  "Capital  Stock  Without  Par 
Value." 

'  I  Dewing  on  Pinan.  Policy  of  Corp.,  p.  14. 


iii  CORPORATE  LAW  [Bk  I 

The  use  of  no-par-value  shares  involves  no  accounting  diffi- 
culties. The  object  is  to  simplify  and  make  possible  the  issu- 
ance of  stock  to  represent  contingent  or  speculative  interests  in 
the  business.  This  simplicity  and  directness  is  shown  by  the 
straightforward  and  comprehensible  entries  for  its  issuance. 

In  recording  stock  of  no  par  value  on  the  books  and  setting  up 
values'  in  the  statements  of  assets  and  liabilities,  it  does  not  seem 
that  any  difficulties  are  presented.  The  capital  account  should 
reflect  the  value  at  which  the  stock  was  issued — whether  for  cash, 
property  or  services.  The  only  other  account  representing  a 
measure  of  value  in  the  outstanding  stock,  outside  of  certain  reserve 
accounts,  would  be  the  surplus  account.  In  my  opinion  this  ac- 
count should  at  all  times  represent  undistributed  net  earnings  of 
the  corporation.'' 

§  143.    Stock  Certificates  Are  Not  Deceptive 

Neither  creditors  nor  purchasers  of  stock  can  be  deceived  by 
no-par-value  stock.  The  stock  certificates  do  not  claim  to 
represent  anything  except  an  interest  in  the  company  and  its 
possible  profits.  On  the  books  of  the  company  there  is  no  ficti- 
tious capital,  and  creditors  know  that  what  they  have  to  look 
to  is  only  the  par  value  received  for  preferred  stock,  plus  any 
amount  of  cash  or  property  actually  paid  on  the  no-par-value 
stock;  that  is,  the  real  capital  stock  of  the  company  is  shown 
by  true  entries  of  the  actual  sales  receipts. 

§  144.    Stock  May  Be  Sold  at  Any  Price 

Stock  without  par  value  may  be  sold  at  any  desired  price. 
After  the  purchaser  has  paid  the  agreed  price  he  cannot  be 
involved  in  any  liability.  The  sale  at  a  low  price  does  not  dis- 
credit the  corporation  nor  does  it  deceive  the  buyer. 

§  145.    Mergers  and  Reorganizations  Are  Simplified 

The  use  of  no-par-value  shares  facilitates  mergers  and  reor- 
ganizations.    When  the  great  combinations  were  formed  they 


•  F.  H.  Hurdman,  "Capital  Stock  of  No  Par  Value,"  Journal  of  A  ccounlancy,  October,  i  pig. 


Ch.  15]  NO-PAR-VALUE  SHARES— ADVANTAGES  123 

were  usually  planned  so  that  actual  assets  were  shown  by  the 
preferred  stock  or  bonds  of  the  combination  and  the  common 
stock  represented  only  the  expectation  of  profits.  Now  this 
same  result  can  be  secured  much  more  accurately  by  the  issue 
of  preferred  stock  and  bonds  in  conjunction  with  the  issue  of 
stock  having  no  par  value;  and  the  excessive  capitalization  and 
deceptive  issues  of  common  stock  that  characterized  the  old 
system  are  avoided. 

§  146.    Disadvantages 

So  far,  the  plan  seems  to  have  met  general  favor  among 
those  who  are  using  the  corporate  form  for  legitimate  business 
and  who  do  not  desire  to  take  advantage  of  ignorant  investors. 

Practice  so  far  seems  to  have  developed  no  material  objection 
to  the  use  of  the  no-par-value  share  by  the  ordinary  corporation. 
In  some  cases  the  shares  may  be  more  difficult  to  sell  from  the  very 
fact  that  they  carry  no  dollar  indication  of  their  value,  or  they  may 
be  unacceptable  because  of  their  novelty,  or  they  may  be  found 
objectionable  from  the  standpoint  of  taxation.  All  these  things 
are  to  be  considered.* 

That  the  law  should  work  smoothly  in  practice  is  owing  to 
the  fact  that  it  was  originally  drafted  by  a  committee  composed 
of  some  of  the  best  lawyers  in  the  United  States,  to  meet  a 
specific  need  and  to  avoid  certain  specific  corporate  ills.  Its 
use  has  been  entirely  optional.  It  has  been  accepted  by  the 
business  world  on  its  merits.  It  has  been  extensively  used  and 
no  serious  objections  have  developed.  It  is  not  unjustifiable  to 
assume  that  the  plan  is  successful  and  that  stock  with  no  par 
value  will  hereafter  be  a  permanent  and  esteemed  feature  of 
our  corporate  law  and  practice. 


*  2  Financing  an  Enterprise,  by  H.  R.  Conyngton,  p.  395, 


CHAPTER  XVI 

NO-PAR-VALUE  SHARES— PROCEDURE 

§  147.    Authorization  for  Issue  of  No-Par- Value  Shares 

The  authorization  of  shares  without  par  value  is  a  matter 
of  state  regulation,  and  there  is  some  diversity  in  the  statutes 
of  the  states  that  have  legislated  on  the  subject.  New  York  was 
the  first  state  to  pass  such  laws,  and  the  laws  on  the  subject 
there  have  been  more  thoroughly  tested  by  usage  than  in  other 
states.  Such  defects  as  developed  in  the  law  have  been  corrected 
by  amendment.  A  summary  of  the  essential  features  of  the 
New  York  legislation  is  given  below  :i 

(Section  19.)  Upon  formation  or  reorganization,  any  busi- 
ness corporation  may  provide  for  the  issuance  of  unvalued  shares 
(other  than  preferred  shares)  without  any  nominal  or  par  value, 
by  stating : 

1.  The  number  of  shares  that  may  be  issued,  and  if  any 

stock  is  preferred,  the  preferences,  with  the  amount, 
character,  and  par  value  of  such  preferred  stock,  which 
shall  be  $5  or  some  multiple  of  $5  up  to  but  not  ex- 
ceeding $100. 

2.  The  amount  of  capital  which  it  will  use  in  conducting  its 

business.    This  must  be  not  less  than  $500  and  not  less 
than  the  par  value  of  the  preferred  stock,  plus  $5  or 
some  multiple  of  $5  for  every  share  of  other  (unvalued) 
'    stock. 

Each  share  of  unvalued  stock  must  be  equal  and  each  certifi- 
cate shall  have  written  or  printed  thereon  the  niunber  of  un- 


'  stock  Corporation  Law  (Consol.  Laws,  Ch.  59),  as  amended  by  Ch.  694,  Laws  of  1921. 

124 


Ch.  i6]  NO-PAR-VALUE  SHARES— PROCEDURE  125 

valued  shares  represented  by  it,  and  the  entire  number  of  such 
shares  authorized. 

The  corporation  may  sell  such  unvalued  shares,  (i)  for  such 
consideration  as  may  be  prescribed  in  the  charter;  or  (2)  at 
their  fair  market  value,  the  judgment  of  the  board  of  directors 
as  to  such  fair  market  value  being  conclusive  in  the  absence  of 
fraud;  or  (3)  the  price  may  be  fixed  by  consent  of  two- thirds 
of  each  class  of  shares  voting  at  a  duly  assembled  stockholders' 
meeting. 

All  unvalued  stock  so  issued  shall  be  deemed  full-paid  and 
non-assessable. 

(Section  20.)  Such  corporation  shall  not  begin  business  or 
incur  debt  until  the  amount  of  capital  stated  in  the  charter 
shall  have  been  paid  in  money  or  property  at  actual  value. 
Violation  of  this  prohibition  makes  directors  assenting  person- 
ally liable. 

(Section  21.)  The  organization  tax  on  such  corporations 
shall  be  5  cents  on  each  share  of  unvalued  stock.  The  stamp 
transfer  tax  shall  be  2  cents  on  each  share. 

The  use  of  the  unvalued  share  is  of  course  optional,  the  law 
merely  giving  the  right  to  organize  under  its  provisions  if 
desired. 

Few  of  the  other  states  have  passed  as  satisfactory  laws  on 
this  subject  as  the  amended  laws  of  New  York.  Few  states 
have  provided  for  the  statement  of  the  amount  of  capital 
necessary  to  begin  business,  or  have  made  directors  who  begin 
business  personally  liable  if  they  authorize  business  or  the  in- 
curring of  debt  before  the  amount  stated  has  actually  been 
paid  in. 

In  a  state  where  the  law  does  not  authorize  corporations  to 
issue  no-par-value  shares,  the  privilege  may  be  secured  by 
organization  in  Delaware,  New  Jersey,  Maine,  or  some  other 
state  where  the  statutes  provide  for  its  issuance,  the  corpora- 
tion then  doing  business  in  the  state  which  would  otherwise  be 
its  home  state  as  a  foreign  corporation. 


126  CORPORATE  LAW  [Bk.  I- 

§  148.     Organization  Tax  for  No-Par- Value  Shares 

The  organization  tax  varies  widely.  In  New  York  the  rate 
is  5  cents  for  each  share  authorized.  This  is  the  same  amount 
that  is  charged  for  shares  of  $100  par  value.  Massachusetts  and 
Rhode  Island  also  charge  5  cents  a  share.  In  many  of  the  states 
the  tax  is  based  on  the  same  theory,  and  all  no-par-value  shares 
are  treated  as  if  they  were  of  $100  par  value.  This  is  the  case 
in  Alabama,  Delaware,  Illinois,  Maryland,  Missouri,  North 
Carolina,  Pennsylvania,  Rhode  Island,  and  Virginia.  In  New 
Jersey  the  organization  tax  is  but  i  cent  a  share. 

§  149.     Fixing  the  Selling  Price 

In  fixing  the  selling  price,  these  states  vary  little.  In  New 
York  the  selling  price  may  be  fixed  (i)  by  the  charter,  (2)  by 
the  board  of  directors,  or  (3)  by  the  consent  of  two-thirds  of  all 
the  stockholders  at  a  duly  assembled  meeting. 

In  California  the  selling  price  must  be  fixed  in  the  charter. 
This  destroys  one  valuable  feature,  the  power  to  sell  for  such 
figure  as  can  be  obtained.  It  amounts  to  fixing  a  par  value  for 
the  stock.  In  most  of  the  states  the  law  authorizes  the  directors 
to  act,  or  the  charter  may  authorize  them  to  act,  or  the  stock- 
holders may  authorize  the  board  to  fix  the  selling  price. 

§  150.    Rights  of  Holders  of  No-Par- Value  Shares 

The  rights  of  holders  of  no-par-value  shares  are  exactly  the 
same  as  those  of  a  holder  of  common  stock,  which  have  already 
been  set  forth  at  some  length. 

§  151.    Rights  When  Preferred  Stock  Is  Outstanding 

When  preferred  stock  and  stock  without  par  value  have 
been  issued,  the  preferred  stock  takes  precedence  in  dividends 
and  in  any  distribution  of  the  assets.  In  such  case  the  no-par- 
value  stock  has  the  same  rights  as  common  stock  would  have 
if  there  were  no  shares  without  par  value. 

2  See  Ch.  XVII,  "Stockholders." 


Ch.  i6]  NO-PAR-VALUE  SHARES— PROCEDURE  127 

In  event  of  liquidation,  after  the  preferred  stock  has 
been  paid  in  full  and  all  accumulated  dividends  have  been  satis- 
fied, if  any  assets  remain  they  are  either  surplus  profits  or  else 
capital  contributions  from  no-par-value  stock,  and  whichever 
is  the  case,  the  holders  of  the  no-par-value  stock  are  entitled 
each  to  his  proportionate  share.  If  no  preference  as  to  assets 
is  given  preferred  stock,  the  holders  of  no-par-value  shares 
would  be  entitled  to  an  interest  in  assets  proportionate  to  the 
amount  actually  paid  in  on  such  shares.  If  there  were  surplus 
profits  above  the  par  value  of  the  preferred  stock  and  above  the 
accumulated  dividends  to  preferred  stockholders,  the  surplus 
profits  would  be  divided  among  the  holders  of  the  no-par-value 
shares. 

§  152.    Certificates  of  No-Par- Value  Stock  "'""'  -  •  - 

The  New  York  statute  prescribes  that  "every  certificate  for 
such  shares  without  normal  or  par  value  shall  have  plainly 
written  or  printed  on  its  face  the  number  of  such  shares  which 
it  represents,  and  no  such  certificate  shall  express  any  nonnal 
or  par  value  of  such  shares,  or  express  any  rate  of  dividend  in 
terms  of  percentage  of  any  normal  or  par  value." 

Unfortunately,  the  other  states  that  have  adopted  the  plan 
have  failed  to  make  similar  provision.  In  practice  it  is  probable 
that  where  such  stock  is  issued,  the  number  of  shares  authorized 
would  be  printed  plainly  on  the  certificate,  otherwise  the  pur- 
chaser would  not  know  what  fractional  interest  in  the  profits  he 
was  buying. 

If  1,000  shares  are  issued  it  would  be  necessary,  in  order  to 
pay  dividends  of  $8  a  share  on  the  no-par-value  shares,  for  the 
corporation  to  make  surplus  profits  (above  anything  required 
to  pay  preferred  dividends)  of  $8,000;  while  if  there  were' 
10,000  shares  of  no-par-value  stock,  it  would  take  $80,000  to 
pay  the  same  dividend. 

In  other  words,  each  share  of  unvalued  stock  means  merely 
A  fractional  interest  in  future  profits,  and  the  more  there  are 


128  CORPORATE  LAW  [Bk.  I- 

the  smaller  the  fraction;    hence  the  purchaser  should  be  in- 
formed as  to  just  what  the  fractional  interest  will  be. 

§  153.    Annual  Taxation  for  Domestic  Corporations 

For  purposes  of  taxation,  the  usual  plan  is  to  account  that 
each  no-par-value  share  has  a  par  value  of  $100.  In  New  York 
the  income  tax  applies  to  all  corporations  alike  and  the  character 
of  stock  issued  is  immaterial.  In  New  Jersey  the  annual  tax 
is  3  cents  a  share  up  to  20,000  shares,  above  that  the  tax  de- 
creases to  2^^  mills  for  all  above  50,000  shares.  In  Colorado, 
for  taxation  purposes,  shares  are  deemed  to  be  of  the  par  value 
of  $1  each.  In  Maine,  5  mills  for  each  share,  with  a  minimum 
of  $10. 

§  154.    Taxation  When  Operating  in  Other  States 

When  corporations  with  shares  without  par  value  under- 
take to  operate  as  foreign  corporations  in  states  other  than  the 
state  of  incorporation,  they  are  usually  treated  as  if  the  no- 
par- value  shares  were  shares  for  $100.  In  a  few  states  they 
have  been  refused  recognition.  In  Missouri  and  Kansas,  as 
already  stated,  suit  was  brought,  and  the  courts  decided  that 
they  should  be  admitted  to  do  business  without  discrimination, s 
Curiously  enough,  each  of  these  states  has  within  the  past  year 
authorized  the  incorporation  of  corporations  w'th  no-par-value 
stock.  It  is  said  that  at  the  present  time  South  Carolina  and 
Washington  are  the  only  states  where  authority  to  do  business 
would  be  refused  to  a  corporation  with  no-par-value  shares. 

§  155.    Preferred  No-Par- Value  Stock 

In  issuing  preferred  stock  without  par  value,  it  is  necessarj'^ 
to  state  not  only  the  preference  in  dividends,  but  also  what 
preferences,  if  any,  preferred  stock  is  to  have  in  case  of  liqui- 
dation. If  no  preference  is  given  in  case  of  liquidation,  the 
preferred  share  and  the  common  share  would  participate  on  the 

»  See  S  136. 


Ch.  i6]  NO-PAR-VALUE  SHARES— PROCEDURE  1 29 

same  basis  in  whatever  assets  remained  after  paying  all  debts. 
The  preference  in  dividends  would  have  to  be  stated  in  dollars 
and  not  as  a  percentage. 

§  156.    Accounting  Entries* 

If  common  stock  or  preferred  stock  having  a  par  value  is 
issued,  it  is  issued  for  its  face  value  and  the  amount  is  credited 
to  a  capital  stock  account.  If  stock  without  par  value  is  issued 
the  amount  received,  whatever  it  may  be — cash,  property,  or 
services — is  likewise  credited  to  a  capital  stock  account.  Any 
profits  made  go  to  the  capital  or  surplus  account,  increase  the 
value  of  the  outstanding  stock,  and  represent  the  amount 
available  for  dividends. 

As  the  amount  received  from  the  sale  of  no-par-value  stock 
may  vary,  successive  sales  may  change  the  value  of  all  the  no- 
par- value  stock  outstanding.  For  example,  if  1,000  shares  were 
sold  at  $10  per  share,  and  then  a  year  later  1,000  more  shares 
were  sold  for  $20  per  share,  there  would  be  outstanding  2,000 
shares.  Then  ignoring  any  profits  or  losses  resulting  from  opera- 
tions, this  stock  would  be  worth  $15  per  share.  Then  two  years 
later,  in  time  of  depression,  if  the  corporation  were  compelled 
to  sell  3,000  shares  for  $5  a  share,  there  would  be  outstanding 
6,000  shares  worth  $7.50  each. 

In  like  manner  the  profits  or  losses  of  the  corporation  cause 
fluctuations  in  the  value  of  the  stock.  Thus,  if  3,000  shares  were 
sold  for  $45,000  but  in  managing  the  business  one- third  of  the 
assets  were  lost,  the  outstanding  stock  wpuld  be  worth  but 
$10  a  share. 

All  this  is,  of  course,  just  as  true  for  stock  with  a  par  value. 
Its  book  value  changes  with  every  change  in  the  net  worth  of 
the  business.  These  changes  are  not  so  easily  seen  as  in  the 
case  of  no-par-value  stock,  because  obscured  by  the  fixed  and 
meaningless  par  value. 


*  See  Book  III,  Ch.  XI,  "Capital  Stock  Without  Par  Value." 


I30  CORPORATE  LAW  [Bk.  I- 

§  157.    Valuing  No-Par- Value  Shares 

When  for  purposes  of  paying  taxes  or  for  any  other  reason 
it  is  necessary  to  ascertain  the  value  of  no-par-value  shares,  it 
may  be  done  by  ascertaining  the  net  worth  of  the  corporate 
business,  and  deducting  from  it  the  face  value  of  any  preferred 
or  common  stock  with  par  value,  and  any  preferred  stock 
without  face  value  entitled  to  a  specific  amount  on  liquidation, 
and  dividing  the  remainder  by  the  entire  number  of  no-par- 
value  shares  outstanding.  The  result  will  equal  the  book  value 
of  each  share  at  the  time.  If  new  stock  is  to  be  sold  at  any  time, 
it  would  not  ordinarily  be  sold  at  less  than  the  book  value  of 
the  stock  already  outstanding. 


Part  IV— Corporate  Control 


CHAPTER  XVII 

STOCKHOLDERS 

§  158.    General 

An  investor  in  a  corporate  enterprise  becomes  a  stockholder 
or  shareholder.  He  may  become  a  stockholder  either  by  original 
subscription  or  later  by  buying  stock  from  a  stockholder  or 
from  the  corporation. 

The  shareholders  are  persons  who  are  interested  in  the  operation 
of  the  corporate  property  and  franchises,  and  their  shares  actually 
represent  undivided  interests  in  the  corporate  enterprises.  The 
corporation  has  the  legal  title  to  all  the  properties  acquired  and 
appurtenant;  but  it  holds  them  for  the  pecuniary  benefit  of  those 
persons  who  hold  the  capital  stock.  They  appoint  the  persons  to 
manage  its  affairs,  they  have  the  right  to  share  in  surplus  earnings 
and,  after  dissolution,  they  have  the  right  to  have  the  assets  re- 
duced to  money  and  to  have  them  ratably  distributed.  Each  share 
represents  a  distinct  interest  in  the  whole  of  the  corporate  prop- 
erty.' 

In  the  active  affairs  of  the  corporation  the  stockholders 
occupy  a  position  of  minor  importance.  They  ow^n  the  stock 
of  the  corporation  and,  through  that  ownership,  the  corpora- 
tion itself  with  all  its  belongings.  Their  control  of  the  organiza- 
tion and  their  management  of  its  affairs  is,  however,  indirect 
and  somewhat  removed.  The  profits  of  the  business  belong  to 
them,  but  its  actual  management  and  the  general  control  of  the 


•  In  re  Bronson,  150  N.  Y.  i  (1896). 


131 


132  CORPORATE  LAW  [Bk.  I- 

corporation  are  in  the  hands  of  the  directors,  with  whom  the 
stockholders,  either  individually  or  collectively,  cannot  directly 
interfere. 

The  functions  of  stockholders  are  exceedingly  limited.  .The 
theory  of  a  corporation  is  that  stockholders  shall  have  all  the 
profits,  but  shall  turn  over  the  complete  management  of  the  enter- 
prise to  their  representatives  and  agents,  called  directors.  Accord- 
ingly there  is  little  for  the  stockholders  to  do  beyond  electing 
directors,  making  by-laws,  increasing  or  decreasing  the  capital 
stock,  authorizing  amendments  to  the  charter,  and  dissolving  the 
corporation.*  / 

§  150.    Functions  ,         .  „ . 

As  already  intimated,  the  functions  of  the  stockholders  are 
few  and  simple.  They  assemble  once  a  year  in  annual  meeting 
to  listen  to  reports,  elect  directors,  and  discuss  the  general 
affairs  of  the  company.  On  rare  occasions  they  are  assembled 
for  particular  action  in  special  meeting.  If  the  charter  is  to  be 
amended,  they  are  usually  required  to  act.  If  all  the  assets  of 
the  corporation  are  to  be  sold,  they  must  generally  be  called 
upon  to  sanction  the  proceeding.  In  some  states  their  consent 
is  required  to  validate  corporate  mortgages.  They  would  act 
on  any  proposed  liquidation  of  the  corporation.  By  charter 
provisions,  their  consent  may  be  necessary  to  other  proposed 
action.  One  other  most  important  function  pertains  to  the 
stockholders:  the  right  to  make,  amend,  and  repeal  the  by-laws. 

The  active  connection  of  the  stockholder  with  his  corpora- 
tion is,  under  normal  conditions,  limited  to  the  functions 
specified.  The  further  control  and  direction  of  the  corporate 
organization  and  its  property  and  business  are  left  entirely  to 
the  directors  he  has  elected. 

§  160.     Rights 

The  rights  of  stockholders  discussed  in  the  present  chapter 
are  those  general  rights  which  are  incident  to  the  ownership  of 

'3  Cook  on  Corp.,  }  708;  see  also  §  711. 


Ch.  17]  STOCKHOLDERS  133 

common  stock  in  a  stock  corporation.  The  holders  of  preferred 
stock  have  all  these  same  rights — in  addition  to  their  special 
rights — unless  denied,  varied,  or  restricted  by  the  terms  of 
issue. 

Every  stockholder  has  the  right  to  transfer  stock  freely,  to 
have  his  name  appear  as  that  of  a  stockholder  upon  the  stock 
books  of  the  company,  and,  when  his  stock  is  full-paid,  to  have 
a  stock  certificate.  In  addition,  the  ordinary  individual  rights 
of  a  holder  of  stock  are: 

I*.  To  be  notified  of  and  participate  in  all  stockholders' 
meetings  in  person  or  by  proxy,  and  usually,  for  each 
share  of  stock  standing  in  his  name  upon  the  books  of 
the  corporation,  to  cast  one  vote  at  any  election  of 
directors  or  upon  any  question  that  may  come  before 
such  meeting. 

2.  To  share,  in  proportion  to  the  amount  of  stock  owned, 

in  all  dividends  declared  on  the  common  stock,  and  to 
subscribe  in  like  proportion  for  any  increase  of  the 
capital  stock. 

3.  In  event  of  the  dissolution  of  the  corporation,  to  share 

in  proportion  to  the  amount  of  stock  owned  in  any 
assets  remaining  after  the  corporate  debts  and  obliga- 
tions have  been  paid. 

4.  To  inspect  the  corporate  books  and  accounts. 

These  rights  are  discussed  in  detail  in  the  sections  which 
follow. 

§  161.     (i)  Notice  of  Meetings  and  Voting 

As  a  matter  of  common  or  statutory  law  the  stockholder  is 
entitled  to  due  notice  of  all  stockholders'  meetings.  If  the  time 
of  the  annual  meeting  is  specified  in  the  by-laws,  this  in  itself 
is  presumed  to  be  notice  to  the  stockholder,  and  the  fact  that 
he  does  not  receive  a  personal  or  mail  notice  and  is  for  this 
reason  not  present,  does  not  affect  the  validity  of  such  meeting. 


134  CORPORATE  LAW  [Bk.  I- 

But  where,  as  in  New  York,  the  statute  requires  publication  of 
the  notice  of  the  annual  meeting,  or  where  the  by-laws  provide 
how  notice  shall  be  given,  the  statute  or  the  by-laws  must  be 
complied  with  unless  waived  by  all  of  the  stockholders. 

Unless  expressly  denied  in  some  way,  every  stockholder, 
whether  his  stock  be  common,  preferred,  or  special,  has  the 
right  to  participate  in  and  vote  at  all  meetings  of  stockholders. 
Usually  he  is  entitled  to  cast  one  vote  on  all  matters  passed 
upon  at  stockholders'  meetings  for  each  share  of  stock  standing 
in  his  name  upon  the  books  of  the  corporation — a  right  secured 
to  him  in  a  majority  of  the  states  by  express  statute  provision. 
In  other  states  the  right,  if  desired,  should  be  definitely  set 
forth  and  secured  by  proper  provision  in  the  charter  or  by-laws. 
If  this  is  not  done,  the  common  law  prevails,  under  which  every 
stockholder  is  entitled  to  one  vote  on  all  matters  passed  upon 
by  the  stockholders,  regardless  of  the  amount  of  stock  he  holds.^ 

If  the  statutes  make  no  provision  as  to  voting,  the  matter 
may  be  regulated  by  either  charter  or  by-laws.  In  some  few 
states,  as  in  Washington  and  Maine,  the  statutes  expressly 
authorize  such  regulation  by  the  by-laws.  In  others,  as  in 
Connecticut,  Delaware,  New  Jersey,  and  Nevada,  the  statutes 
provide  the  method  that  shall  be  followed  in  voting  unless 
otherwise  prescribed  by  charter  or  by-laws.  In  these  states  it 
is  possible  to  deprive  entirely  certain  classes  of  stock  of  the 
voting  power.  It  is  not  unusual  to  provide  that  preferred 
stock  shall  have  no  vote  where  the  holders  of  the  common  stock 
are  the  active  stockholders  and  the  preferred  stock  represents 
investments  by  outsiders.  In  California  the  statute  forbids  any 
such  denial  of  voting  power. 

The  statutes  usually  prescribe  that  voting  at  elections  of 
directors  shall  be  by  ballot.  Where  no  special  method  of  voting 
is  prescribed  by  statutes,  charter,  or  by-laws,  it  may  be  by  call 
of  roll,  by  ballot,  or  by  any  other  method  that  will  properly 
and  legally  indicate  the  sense  of  the  meeting.    If  all  are  agreed, 

»  Taylor  v.  Griswold,  14  N.  J.  L.  223  (1834). 


Ch.  i7l  STOCKHOLDERS  135 

it  is  always  permissible  to  instruct  the  secretary  to  cast  the 
single  ballot  of  the  meeting  for  the  election  of  specified  candi- 
dates for  directors,  or  for  or  against  any  other  measure  properly 
before  the  meeting. 

As  between  the  corporation  and  its  members,  the  right  to 
vote  and  usually  also  the  number  of  votes  a  stockholder  is 
entitled  to  cast  are  determined  by  the  stock  books  of  the  cor- 
poration.<  The  possession  or  non-possession  of  a  stock  certifi- 
cate is  immaterial,  as  the  right  to  vote  is  evidenced  positively 
by  the  record  of  the  stock  books. 

The  right  to  vote  by  proxy  is  generally  given  by  express 
provision  of  either  the  statutes  or  by-laws,  though  in  some 
states  the  right  is  secured  by  constitutional  provision.  It  did 
not  exist  at  common  law.s 

Trustees  may  vote  upon  the  stock  held  in  their  names  as 
trustees.  An  executor  or  administrator  may  vote  upon  the 
stock  belonging  to  the  estate  even  though  standing  in  the  name 
of  the  deceased  party.  In  the  absence  of  disagreement,  any 
partner  may  vote  stock  standing  in  the  partnership  name.  A 
corporation  holding  stock  of  another  corporation  may  vote  such 
stock  through  duly  authorized  agents.  A  receiver  usually  votes 
stock  in  his  possession.  When  stock  is  held  jointly  or  in  com- 
mon, as  in  the  case  of  a  partnership  or  where  there  are  two  or 
more  trustees  or  executors,  all  must  agree  on  the  vote  or  other- 
wise it  will  be  lost.  6 

§162.     (2)  Dividends  and  Participation  Rights  voiq  yrlJ 

Save  when  affected  by  the  issue  of  some  preferred  or  other 
special  stock,  each  stockholder  has  the  right  to  share  in  divi- 
dends with  the  other  stockholders  of  his  corporation  propor- 
tionately to  the  number  of  shares  of  stock  he  holds,  and  there 


*  Commonwealth  v.  Dalzell,  152  Pa.  St.  217  (1893);  State  v.  Ferris,  42  Conn.  560  (1875); 
In  re  Argus  Printing  Co.,  i  N.  D.  434  (1891). 

'Taylor  v.  Griswold,  14  N.  J.  L.  222  (1834);  Philips  v.  Wickham,  i  Paige  (N.  Y.)  590 
(1829);  Commonwealth  v.  Bringhurst,  103  Pa.  St.  134  (1883). 

•  Tunis  V.  Ilestonville.  etc.,  Co.,  149  Pa.  St.  70  (1892). 


136  CORPORATE  LAW  [Bk.  I- 

must  be  no  discrimination  of  any  kind  in  the  declaration  or  the 
payment  of  these  dividends. 

'Holders  of  preferred  stock,  unless  otherwise  expressly  pro- 
vided, are  entitled  in  any  year  to  payment  of  their  preferred 
dividends  before  any  dividends  are  paid  the  common  stock, 
and  thereafter,  as  soon  as  the  common  stock  has  received  an 
equal  dividend,  to  participate  equally  with  the  common  stock 
in  any  further  dividends  declared  in  that  year.^  Unless  other- 
wise expressly  provided,  dividends  on  preferred  stock  are  cumu- 
lative, and  current  dividends  on  preferred  stock  and  all  arrears 
must  be  paid  before  dividends  may  be  paid  on  the  common 
stock.  8 

If  the  capital  stock  of  a  corporation  is  increased,  each  stock- 
holder has  the  right  to  subscribe  for  the  new  stock  proportion- 
ately to  his  holding  of  the  old  outstanding  stock.  ^  Thus  if  he 
holds  10%  of  the  outstanding  stock  and  the  capital  stock  is 
increased,  he  has  the  privilege  of  subscribing  for  10%  of  the  new 
stock.  This  rule  applies  to  any  actual  increase  of  stock,  but 
not  to  a  sale  of  treasury  stock,  nor  usually  to  stock  which  is 
part  of  the  original  capitalization  but  which  has  not  yet  been 
issued.io  If,  however,  this  unissued  stock  has  been  held  for  a 
considerable  period  of  time  and  is  then  issued,  the  stockholders 
should  all  have  an  equal  opportunity  to  subscribe  therefor." 
Holders  of  preferred  stock  have  the  same  rights  of  subscription 
as  do  holders  of  common  stock,  unless  expressly  denied  them  by 
the  provisions  which  created  the  preferred  stock. 

The  right  of  subscription  is  sometimes  of  considerable  value, 
as  where  a  new  issue  of  stock  is  authorized  at  a  fixed  price  and 
this  price  advances  before  the  day  of  sale. 


'  Sternbergh  v.  Brock,  223  Pa.  St.  279  (1909);  Sterling  v.  H.  P.  Watson  Co.,  241  Pa.  St. 
los  (1913). 

'Fidelity  Trust  Co.  v.  Lehigh  Valley  R.  R.  Co.,  21s  Pa.  St.  610  (1006);  Boardman  v. 
Lake  Shore  Ry.  Co.,  84  N.  Y.  157  (1881). 

»  Way  V.  Am.  Grease  Co.,  60  N.  J.  Eq.  263  (1900);  Electric  Co.  v.  Edison,  etc.  Co..  200 
Pa.  St.  516  (1901);  Stokes  v.  Cont.  Trust  Co.,  186  N.  Y.  285  (1906). 

""Crosby  v.  Stratton,  68  Pac.  Rep.  130  (1902);  Archer  v.  Hesse.  164  App.  Div.  (N.  Y.) 
493.  497  (1914). 

"  Electric  Co.  v.  Edison  El.  Co.,  200  Pa.  St.  516  (1901). 


Ch.  17]  STOCKHOLDERS  137 

§  163.     (3)  Distribution  of  Assets  on  Dissolution 

Each  stockholder  is  entitled  to  share  equally  in  any  dis- 
tribution of  the  assets  of  the  corporation,  whether  on  final  dis- 
tribution or  on  some  partial  intermediate  distribution.  Under 
whatever  proceedings  a  corporation  is  dissolved,  the  general 
rule  holds  that  all  corporate  obligations  and  the  expenses  of  the 
proceedings  must  first  be  discharged,  and  that  any  remaining 
assets  must  be  distributed  among  the  stockholders,  the  same 
rules  applying  as  to  equality  of  payment,  of  time,  and  of  kind, 
as  in  the  case  of  dividends. 12 

In  the  absence  of  any  express  provision  to  the  contrary, 
common  and  preferred  stock  share  alike  in  the  distribution  of 
assets.13  If  by  its  terms  preferred  stock  takes  precedence,  it 
must  first  receive  any  assets  available  for  distribution  up  to  its 
full  face  value.  The  common  stock  then  receives  any  remain- 
ing assets  up  to  its  full  face  value.  If  any  balance  of  assets 
still  remains,  both  common  and  preferred  stock  participate 
therein  aUke,  unless  otherwise  expressly  provided. 

§  164.     (4)  Inspection  of  Books 

Under  the  common  law  every  stockholder  had  the  right  to 
inspect  the  books  and  accounts  of  the  corporation  in  person  or 
by  agent,  and  to  make  abstracts  or  copies  therefrom  without 
restriction,  save  that  the  examination  be  made  at  a  reasonable 
time  and  for  a  proper  purpose.  This  is  the  rule  in  states  where 
there  is  no  statutory  regulation.^* 

In  some  states  the  statutes  provide  that  a  stockholder  de- 
siring to  examine  the  books  of  account  or  the  records  of  his 
corporation  must,  if  refused,  secure  an  order  of  court  for  such 
examination,  which  will  be  granted  only  when  he  shows  some 
good  reason  therefor. is    This  reason  must  be  substantial  and 


"  2  Cook  on  Corp.,  S  641. 

>' Coltrane  v.  Building  Assn.,  no  Fed.  Rep.  281  (1901). 

"  Ranger  v.  Champion  Cotton  Press  Co.,  51  Fed.  61  (1892);  Huylar  v.  Cragin  Cattle  Co., 
40  N.  J.  Eq.  392  (188s);  Matter  of  Steinway,  IS9  N.  Y.  250  (1899);  State  v.  Jessup  &  Moore 
Paper  Co.,  88  Atl.  (Del.)  449  (1913);  State  v.  Insurance  Co.,  169  Mo.  App.  354  (1912). 

"  Varney  v.  Baker,  194  Mass.  239  (1907);  Kuhbach  v.  Irving,  etc.  Co.,  220  Pa.  St.  427 
(1908). 


^38  CORPORATE  LAW  [Bk.  I- 

must  be  for  the  specific  purpose  of  investigating  some  matter 
concerning  the  management  of  the  corporation  in  which  his 
rights  as  a  stockholder  are  or  may  be  affected  injuriously.ie 

This  restriction  of  the  right  is  not  unreasonable.  It  is  obvi- 
ous that  it  would  be  impracticable  in  a  large  modern  corpora- 
tion with  its  multitude  of  scattered  stockholders,  to  allow  these 
to  come  in  at  any  time  and  make  an  examination  of  the  books. 
The  interference  with  the  regular  business  would  in  itself  be 
intolerable,  but  beyond  this  the  right  might  be  so  used  in  the 
interest  of  business  competitors  as  to  render  it  destructive  of  the 
interest  of  the  stockholders  at  large. 

In  some  states  statutes  have  been  passed  which  enlarge  the 
stockholders'  usual  right  to  examine  the  corporate  records,  and 
in  a  few  states  the  right  has  been  considerably  extended.  These 
statutes  give  the  stockholders  the  right  to  inspect  the  corporate 
records  irrespective  of  the  purpose  for  which  the  inspection  is 
sought.  1^  In  some  states  this  right  extends  to  all  of  the  cor- 
porate records,  and  in  most  of  the  states  there  is  a  statutory 
right  to  inspect  the  stock  and  transfer  books. is  In  New  Jersey 
the  courts  hold  that  even  this  right  cannot  be  enforced  unless 
the  stockholder  can  show  some  reason  for  his  inspection  "ger- 
mane to  his  status  as  a  stockholder.""  In  many  of  the  states 
a  statutory  penalty  is  imposed  on  the  corporate  officers  who 
refuse  a  stockholder  the  right  of  inspection  prescribed  by  the 
statutes.  In  such  cases  the  stockholders'  rights  are  not  difficult 
of  enforcement.2o 

Where  the  right  to  examine  the  corporate  records  exists,  it 
includes  the  right  to  make  copies  and  abstracts.21  It  also  in- 
cludes the  right  to  be  accompanied  by  the  party's  attorney  or 
expert  accountant,  or  the  inspection  may  be  delegated  to  one 
or  both  of  these.22 

"Phoenix  Iron  Co.  v.  Commonwealth,  113  Pa.  St.  563  (1886). 

"  Poor  v.Yarnell,  153  Pac.  (Gal. )976(i9i5);  Baumrucker  v.  Jones,  172  111.  App.  188  (1912). 

>»  Lozier  v.  Saratoga,  etc.  Co.,  59  App.  Div.  (N.  Y.)  390  (1901);  State  v.  Middlesex 
BankinjS  Co.,  87  Conn.  483  (1913);  Wilkington  v.  Bradley,  iii  Me.  384  (1914). 

"State  V.  National  Biscuit  Co.,  S4  Atl.  (N.  J.)  241  (1903). 

2°  Lozier  v.  Saratoga,  etc.  Co.,  59  App.  Div.  (N.  Y.)  390  (1901). 

"  Cincinnati  Volksblatt  Co.  v.  Hoffmeister,  62  O.  St.  189  (1900). 

22  People  V.  Nassau  Ferry  Co.,  86  Hun  128  (1895);  State  v.  Insurance  Co.,  169  Mo.  App. 
3S4  (1912);  Varney  v.  Baker,  194  Mass.  239  (1907). 


/ 


Ch.  17]     *  STOCKHOLDERS  .  139 

,  Lists  of  stockholders  in  the  larger  corporations  have  an 
actual  money  value,  and  in  New  York  the  practice  of  acquiring 
a  share  of  stock  in  one  of  the  large  companies  for  the  sole  pur- 
pose of  using  the  right  thus  obtained  to  copy  the  list  of  stock- 
holders and  of  then  selling  the  list,  became  so  flagrant  that  in 
1916  the  legislature  amended  the  law  so  as  to  Hmit  the  right 
of  inspection  to  persons  who  have  been  stockholders  of  record 
for  six  months,  or  to  persons  holding  stock  equal  to  5%  of 
all  the  outstanding  shares.  The  statute  expressly  provides, 
however,  that  nothing  therein  shall  impair  the  right  of  the 
courts  to  compel  by  mandamus  the  production  of  the  stock 
book  for  the  examination  of  any  stockholder  upon  good  cause 
shown. 

§  165.    Special  Charter  Rights  // 

1©  In  many  states  special  provisions  for  the  regulation  of  the 
business  and  the  conduct  of  the  affairs  of  the  corporation  may 
be  inserted  in  the  corporate  charter.  Where  this  privilege 
exists,  rights  not  usually  belonging  to  the  stockholders  of  a 
corporation  may  be  thereby  secured.  Thus,  stock  may  be 
classified  so  as  to  give  the  minority  stockholders  unusual  voting 
powers;  minority  representation  may  be  insured  by  cumulative 
voting;  the  right  to  examine  books  may  be  defined  and  ex- 
tended; the  right  to  be  present  at  directors'  meetings  may  be 
given;  it  may  be  provided  that  profits  when  they  exist  shall 
be  declared  as  dividends  at  regular  intervals,  or  the  power  of 
the  directors  to  pay  salaries,  contract  debts,  sell  corporate 
property,  and  the  like,  may  be  restricted. 

Unfortunately,  those  who  incorporate  a  company  usually 
expect  to  be  majority  stockholders  and  to  control  the  corpora- 
tion, and  therefore  do  not  concern  themselves  to  protect  minority 
holders.  If  those  who  buy  stock  would  decline  to  invest  where 
minority  rights  are  not  protected,  there  would  soon  be  more 
consideration  for  the  smaller  stockholders.  '    ■■''''^  '' "'     ...*i     ' 

It  should  be  noted  that  special  provisions  ihcorporated  in 


I40 .  CORPORATE  LAW  [Bk.  1- 

the'charter  are  difficult  of  repeal  or  amendment.  For  this  reason 
only  those  which  are  expressly  desired  to  be  permanent  should 
be  made  the  subject  of  charter  provision.  Less  important  pro- 
visions are  better  included  in  the  by-laws,  where  they  may  be 
changed  when  necessary  with  less  formality. 

§  i66.    Statutory  Rights 

In  most  of  the  states  the  usual  common  law  rights  of  stock- 
holders— discussed  in  the  preceding  sections — have  been  re- 
enacted  in  the  statutes.  In  many  states  the  statutes  give  the 
stockholders  additional  rights,  some  of  which  have  already  been 
mentioned.  Thus  in  New  York,  Kansas,  North  Dakota,  and 
a  number  of  other  states,  stockholders  may  call  for  statements 
and  reports  from  the  corporate  officials.  In  California  and 
Washington  they  may  inspect'  mines  owned  by  the  corporation. 
In  Delaware  any  stockholder  may  demand  a  statement  of 
amounts  paid  on  capital  stock  and  the  amount  of  stock  issued. 
In  a  number  of  states  meetings  for  election  of  directors  may  be 
compelled  by  following  prescribed  procedure.  ' 

§  167.    Powers 

The  individual  stockholder,  no  matter  how  large  his  holding, 
has  no  power  as  a  stockholder  to  interfere  in  the  lawful  manage- 
ment of  the  company  or  its  business,23  If  the  directors  take, 
or  are  about  to  take,  any  illegal  or  wrongful  action,  he  may 
restrain  them  by  appeal  to  the  courts.  If,  however,  the  action 
taken  or  about  to  be  taken  is  in  itself  not  unlawful  but  merely 
objectionable  to  him,  his  only  recourse  is  to  induce,  if  he  can, 
a  majority  of  the  stockholders  to  act  with  him  in  holding  a  duly 
assembled  stockholders'  meeting,  when  the  by-laws  may  be 
amended  or  such  other  remedial  steps  be  taken  as  may  be 
possible. 

The  collective  powers  of  the  stockholders  apply  to  but  few 
matters  and  may  be  summarized  as  follows: 

■•  »  Detnarest  v.  Spiral,  etc.  Tube  Co.,  71  N.  J.  L.  14  (1904);  Continental  Securities  Co.  v. 
Belmont,  206  N.  Y.  7,  16  (191 2). 


Ch.  17]  STOCKHOLDERS  141 

1.  Amendment  of  charter. 

2.  Adoption,  repeal,  or  amendment  of  by-laws. 

3.  Election  of  directors. 

4.  Sale  of  entire  assets. 

5.  Dissolution  of  corporation. 

6.  Exercise  of  any  special  charter  powers. 

§  168.     (i)  To  Amend  Charter 

A  charter  is  a  contract  between  the  state  and  the  stock- 
holders of  the  particular  corporation,  and  the  assent  of  both 
the  state  and  these  stockholders  is  a  prerequisite  to  its  amend- 
ment. In  most  of  the  states  the  statutes  provide  that  the 
charter  may  be  added  to  or  amended,  usually  in  certain  pre- 
scribed details  or  matters,  at  a  duly  assembled  meeting,  by  the 
action  of  a  specified  proportion  of  the  stockholders  ranging 
upward  from  a  bare  majority  to  three-fourths  of  the  outstand- 
ing stock. 

§  169.     (2)  To  Adopt,  Repeal,  or  Amend  By-Laws 

The  adoption  or  amendment  of  by-laws  is  one  of  the  com- 
mon law  powers  of  the  stockholders.  If  no  provision  is  made 
otherwise,  the  power  to  adopt,  amend,  and  repeal  by-laws  rests 
with  the  stockholders  alone,24  who  must,  to  exercise  this  power, 
be  duly  assembled  in  a  meeting  at  which  such  action  can  be 
lawfully  taken.25  If  the  charter  or  by-laws  do  not  otherwise 
prescribe,  the  by-laws  may  be  adopted,  amended,  or  repealed 
at  any  regular  meeting  of  the  stockholders  or  at  any  special 
meeting  where  such  proposed  action  has  been  duly  announced. 
There  is  some  question  whether  by-laws  may  be  adopted  or 
amended  without  previous  notice  at  the  annual  meeting  held  in 
accordance  with  statutory  requirements,  unless  the  charter  or 
by-laws  expressly  so  provide.28 

If  the  power  to  adopt  by-laws  is  delegated  to  the  directors. 


*•  Angel  &  Ames  on  Corp.,  f  327. 

**  North,  etc.  Co.  v.  Bishop,  103  Wis.  492  (1899). 

"•  Bagley  v.  Reno,  etc.,  Co.,  201  Pa.  St.  78  (.1902). 


142  CORPORATE  LAW  [Bk.  I- 

this  does  not,  unless  expressly  so  stated,  confer  on  them  the 
exclusive  right  to  make  by-laws  nor  empower  them  to  repeal 
by-laws  enacted  by  the  stockholders.27 

§  170.     (3)  To  Elect  Directors 

The  election  of  directors  is  one  of  the  common  law  powers  of 
stockholders  which  has  been  re-enacted  in  the  statutes  of  most 
of  the  states.  In  all  corporations  for  profit  the  power  exists 
without  specific  statutory  authority.28 

In  the  absence  of  other  provision,  the  stockholders  have  the 
right  to  fill  vacancies  in  the  board  of  directors.  Ordinarily, 
however,  either  by  statute  or  by-law  provision  this  power  is 
given  to  the  board. 

§  171.     (4)  To  Sell  Entire  Assets 

A  solvent  corporation  can  sell  its  entire  assets  only  by  the 
unanimous  consent  of  all  its  stockholders.29  Where,  however, 
a  corporation  is  financially  involved  or  likely  to  become  so,  the 
sale  of  all  its  property  may  be  made  in  any  manner  that  will 
secure  a  fair  return,  by  authorization  of  a  majority  of  the 
stockholders. 30  Also,  if  the  statutes  or  charter  so  provide,  the 
entire  assets  of  a  corporation  may  be  sold  by  action  of  a  majority 
of  the  stockholders,  or  by  majority  action  of  the  directors,  the 
prescribed  formalities  being  duly  observed.^i 

§  172.     (5)  To  Dissolve  the  Corporation 

"It  is  an  unquestioned  rule  that  all  the  stockholders,  by 
unanimous  consent,  may  effect  a  dissolution  of  the  corporation 
by  the  surrender  of  the  corporate  franchises. "82     Where  the 


"  See  ii  231,  253,  291;  Stevens  v.  Davison,  18  Gratt.  (Va.)  819  (1868). 

«i?e  Union  Ins.  Co.,  22  Wend.  591  (1840). 

"Abbott  V.  American  Hard  Rubber  Co.,  33  Barb.  578  (1861);  People  v.  Ballard,  134 
N.  Y.  269  (1892);  Eldred  v.  American  Palace  Car  Co.,  96  Fed.  Rep.  59  (1899);  99  Fed.  Rep. 
168  (1900). 

'"Sewell  v.  East,  etc.  Co.,  so  N.  J.  Eq.  717  (1892);  Skinner  v.  Smith,  134  N.  Y.  240 
(1892);  Hayden  v.  Official  Hotel  Red-Book,  etc.  Co.,  42  Fed.  Rep.  875  (1890). 

"  Republican,  etc.  Mines  v.  Brown,  58  Fed.  Rep.  644  (1893);  Peabody  v.  Westerly 
Waterworks,  20  R.  I.  176  (1897). 

»  2  Cook  on  Corp.,  §  629. 


Ch.  17]  STOCKHOLDERS  143 

corporation  is  insolvent  or  is  in  danger  of  becoming  insolvent, 
and  is  unable  to  further  conduct  its  corporate  business,  a 
majority  of  the  stockholders  may  effect  its  dissolution.  This 
is  the  extent  of  the  power  of  the  stockholders  under  the  common 
law.33 

Statutory  provisions,  however,  exist  in  a  majority  of  the 
states  prescribing  procedure  whereby  dissolution  may  be  had 
by  action  of  a  stated  majority  of  the  stockholders. 

§  173.     (6)  Special  Powers 

In  many  states  special  powers  are  conferred  upon  the  stock- 
holders by  express  statutory  provision.  Thus  in  Kentucky, 
Maine,  and  some  other  states,  it  is  provided  that  corporations 
may  merge  or  consolidate  with  others  upon  the  consent  of  a 
prescribed  majority  of  the  outstanding  stock,  usually  with  a 
provision  for  the  appraisement  and  purchase  of  the  stock  of 
any  dissenting  stockholder.  In  New  York,  Pennsylvania,  and 
some  other  states  it  is  provided  that  any  mortgage  of  corporate 
property  must  be  authorized  by  a  vote  of  the  stockholders.  In 
several  states,  as  California  and  Montana,  directors  may  be  re- 
moved by  a  two-thirds  vote  of  the  entire  stock.  In  the  states 
where  special  provisions  may  be  inserted  in  the  charter,  as  in 
New  York,  Delaware,  and  South  Dakota,  it  is  possible  to  extend 
the  powers  of  stockholders  far  beyond  their  usual  scope. 

§  174.    Liabilities 

The  liabilities  of  stockholders  as  such  are  few — usually  only 
to  pay  the  full  par  value  of  the  stock  subscribed  for  or  purchased 
by  them.  If  subscriptions  are  not  paid  according  to  their  terms, 
or — when  subscriptions  are  unconditional — as  calls  are  made  by 
the  directors,  the  corporation  may  either  bring  suit  to  collect 
unpaid  amounts,  obtain  judgment  and  levy  on  the  stock  if 
necessary ,34  or,  where  the  statutes  give  such  power,  may  forfeit 

••Berry  v.  Broach,  6s  Miss.  450  (1888):  Price  v.  Holcomb,  89  Iowa  123  (1893). 
•*  Nashua  Bank  v.  Anglo-Am.  Co.,  189  U.  S.  221  (1903). 


144  CORPORATE  LAW  [Bk.  I- 

the  delinquent  stock.  If  the  corporation  does  neither,  the  lia- 
bility of  the  stockholder  on  his  unpaid  stock  still  remains  for 
the  benefit  of  creditors  of  the  corporation  in  case  of  its  in- 
solvency.55 

When  the  statutory  forfeiture  of  stock  for  unpaid  calls  is 
enforced  in  good  faith,  a  stockholder  who  is  thus  deprived  of 
his  stock  is  released  from  further  liability  to  the  corporation 
and  its  creditors.  When  stock  is  so  forfeited,  it  is  necessary  to 
observe  the  prescribed  statutory  formalities  carefully,  as  other- 
wise the  proceedings  may  be  set  aside  and  the  corporation  be 
liable  in  damages.^e 

As  a  rule,  corporate  creditors  must  first  proceed  against  the 
corporation  for  the  collection  of  their  claims.  If  they  secure 
judgment  against  the  corporation  and  are  unable  to  collect  from 
it,  they  may  then  proceed  against  any  stockholder  who  has  not 
paid  in  full  for  his  stock."  If,  however,  the  corporation  has 
been  dissolved  or  is  notoriously  insolvent,  creditors  may  some- 
times proceed  directly  against  the  stockholders  of  the  corpora- 
tion.38  If  the  corporation  goes  into  the  hands  of  an  assignee,  a 
receiver  or  a  trustee  in  bankruptcy,  it  is  the  duty  of  that  official 
to  collect  all  unpaid  subscriptions.s^ 

The  fact  that  other  stockholders  have  not  paid  their  sub- 
scriptions does  not  avail  a  stockholder  as  a  defense  against 
payment  of  his  own  subscription.  Nor  has  he  any  claim  against 
these  other  subscribers.  When,  however,  payment  of  his  sub- 
scription is  enforced  by  corporate  creditors,  the  conditions  are 
different.  A  corporate  creditor  need  not,  as  a  rule,  proceed 
against  or  join  all  the  stockholders  whose  subscriptions  are 
unpaid,  but  may  collect  from  any  one  or  more  of  them  up  to 
the  full  amount  due  on  their  stock  if  his  claim  amounts  to  so 
much.    In  such  case,  as  the  corporate  debts  are  a  joint  obliga- 


»  Scovill  V.  Thayer,  los  U.  S.  143. 156  (1881);. Hawkins  v.  Glenn,  131  U.  S.  319.  334  (1888). 

»  Lewey's  Island  R.  R.  Co.  v.  Bolton,  48  Me.  451  (i860). 

"  Wetherbee  v.  Baker,  3S  N.  J.  Eq.  501  (1882). 

»a  Terry  v.  Tubman,  92  U.  S.  156  (187s);  Terry  v.  Anderson.  95  U.  S.  628,  636  (1877.) 

»In  re  Crystal  Spring  Co.,  96  Fed.  945  (1899);  Scovill  v.  Thayer,  105  U.  S.  143  (1881). 


Ch.  17]  STOCKHOLDERS  145 

tion  to  be  borne  by  all  the  delinquent  stockholders  in  proportion 
to  the  amounts  due  on  their  stock,  any  subscribers  who  are 
compelled  to  pay  more  than  their  due  proportion  can  compel 
contribution  from  other  delinquent  stockholders  up  to  their  pro- 
portion of  the  debts  paid.*" 

§  175.    Liabilities  of  Purchasers  of  Stock 

The  stockholder  who  is  not  an  original  subscriber,  but  who 
purchases  outstanding  stock  in  good  faith  with  the  understand- 
ing or  express  statement  that  it  is  full-paid,  and  particularly 
when  the  certificates  are  so  marked,  does  not  incur  any  liability 
either  to  the  corporation  or  its  creditors  even  though  the  sub- 
scription price  or  the  par  value  of  such  stock  has  not  been  paid 
in  to  the  corporation.  In  any  such  case  the  unpaid  liability  on 
the  stock  either  remains  with  the  transferrer  or  is  lost." 

When,  however,  a  purchaser  takes  unpaid  stock  with  a 
knowledge  of  the  conditions,  the  liability  for  any  call  already 
made,  even  though  the  payment  date  of  such  call  has  not  yet 
arrived,  remains  with  the  transferrer,  but  the  transferee  is  liable 
for  any  subsequent  calls.<2 

§  176.    Statutory  Liabilities  of  Stockholders 

The  general  rule  is,  however,  modified  by  statute  in  many  of 
the  states.  Thus  in  Oregon  and  Tennessee  the  liability  on  un- 
paid stock  remains  with  the  transferrer,  while  in  Kentucky  it 
continues  with  the  transferrer  for  two  years  from  the  date  of 
transfer,  and  in  Maine  and  Mississippi  for  one  year.  In  Wis- 
consin the  liability  may  be  shifted  to  the  transferee  with  the 
consent  of  the  corporation,  but  the  liability  of  the  seller  con- 
tinues notwithstanding  for  six  months  after  the  transfer.  In 
Nebraska  the  liability  follows  the  unpaid  stock.  In  Illinois  both 
transferrer  and  transferee  are  liable. 


*"  4  Thompson  on  Corp.,  {  3816. 

"  Brant  v.  Ehlen,  S9  Md.  i  (1882);  Rood  v.  Whorton,  67  Ppd.  434  (1895). 

«  Webster  v.  Upton,  91  U.  S.  65  (1875). 


146  CORPORATE  LAW  [Bk.  I- 

The  common  law  liability  of  holders  of  unpaid  stock  for  any- 
unpaid  portion  of  its  par  value  is  confirmed  by  statute  in  most 
states  of  the  Union.  In  a  few  states  this  common  law  liability 
has  been  extended,  and  in  a  number  of  states  additional  Habili- 
ties  are  imposed.  These  subsequent  or  additional  liabilities  extend 
to  all  stockholders  whether  their  stock  is  full-paid  or  otherwise. 
This  liability  on  unpaid  stock  may,  by  agreement  of  the  cor- 
poration, be  terminated  as  between  the  corporation  and  its 
stockholders,  but  would  still  exist  as  between  these  stockhold- 
ers^3  and  creditors  of  the  corporation,  and  on  the  insolvency  of 
the  corporation  would  become  immediately  effective. ^4 

In  a  few  states  there  are  additional  liabilities.  Thus  in 
Minnesota  the  stockholder  is  liable,  in  case  the  corporation 
becomes  insolvent,  for  a  further  amount  equal  to  his  original 
subscription,  that  is,  equal  to  the  par  value  of  the  stock  he  holds. 
The  corporation  cannot  collect  this  additional  amount,  but  in 
case  of  its  insolvency  any  creditor  of  the  corporation  may  en- 
force payment.  This  double  liability  formerly  existed  in  several 
other  states,  but  is  now  found  in  Minnesota  alone.  In  Cali- 
fornia each  stockholder  is  liable  for  any  portion  of  his  subscrip- 
tion that  is  not  paid,  and  is  further  liable  for  such  proportionate 
part  of  the  corporate  indebtedness  incurred  during  the  period 
in  which  he  is  a  stockholder,  as  his  stock  bears  to  the  total 
capitalization  of  the  corporation. 


**  Goodnow  V.  Amer.  Writing  Paper  Co.,  66  Atl.  (N.  J.)  607  (1907);  Bostwick  v.  Young, 
118  App.  Div.  (N.  Y.)  490  (1907);  affd.,  194  N.  Y.  516  (1909). 

**  Merchants  Mutual  Adjusting  Agency  v.  Davidson,  23  Gal.  App.  274  (1913);  Southworth 
V.  Morgan,  205  N.  Y.  293  (1912);  Dickerman  v.  Northern  Trust  Co.,  176  U.  S.  181  (1900). 


CHAPTER  XVIII 
DIRECTORS 

§  177.    Powers  of  Directors 

The  board  of  directors  is  the  managing  body  of  the  corpora- 
tion. Unless  restricted  by  statute,  charter,  or  by-laws,  it  exer- 
cises the  active  controlling  power  in  all  corporate  business.  "The 
board  of  directors  and  not  the  stockholders,  nor  the  president, 
secretary,  treasurer,  or  other  agent,  is  the  original  and  supreme 
power  in  corporations  to  make  corporate  contracts."^  The 
directors  are  the  embodied  power  of  the  corporation,  so  con- 
stituted by  the  mere  fact  of  their  appointment.2  The  stock- 
holders can  neither  force  the  directors  to  act  nor  restrain  them 
from  acting — save  by  charter  or  by-law  provision — unless  the 
omission  in  the  one  case  or  the  act  in  the  other  is  so  glaringly 
unjust  or  injurious  to  the  interests  of  the  stockholders  as  to 
warrant  an  appeal  to  the  courts. 

The  powers  of  the  board  do  not,  however,  extend  beyond  the 
purposes  for  which  the  corporation  was  formed.  Thus  the  sale 
of  the  entire  assets,  the  dissolution  of  the  corporation,  or  a  radical 
change  of  its  business  are  not  within  the  unsupported  power  of 
the  board.  Also  the  statutes  in  the  different  states  restrict  in 
greater  or  less  degree  the  common  law  powers  of  the  board. 
Thus,  as  a  rule,  directors  are  not  allowed  to  issue  bonds  or  to 
mortgage  corporate  property  unless  expressly  authorized  thereto 
by  the  stockholders.  Also  the  absolute  authority  of  the  board 
may  always  be  limited  by  charter  or  by-law  provisions.  On  the 
other  hand,  the  powers  of  directors  are  sometimes  extended  by 


«  3  Cook  on  Corp.,  {|  709,  712. 

«  Landers  v.  Frank  St.  M.  E.  Church,  114  N.  Y.  626  {1889). 

147 


148  CORPORATE  LAW  [Bk.  I- 

charter  or  by-law  provisions,  or  by  the  statutes,  in  the  latter 
case  mainly  as  to  adoption  of  by-laws. 

§  178.    The  Power  of  the  Directors  Collective,  Not  Individual 

The  authority  of  the  directors  may  be  exercised  only  as  a 
board  in  duly  assembled  meeting  with  a  quorum  present.^  A 
single  director,  as  such,  has  absolutely  no  authority  over  the 
corporate  affairs.*  He  may  be  appointed  by  the  board  to  man- 
age some  feature  of  the  corporate  business,  or  as  managing 
director  may  practically  control  the  corporate  affairs,  but  in  any 
such  case  his  powers  are  only  those  which  are  delegated  to  him 
by  the  board  and  are  limited  strictly  by  the  terms  of  his  appoint- 
ment, s  As  a  knowledge  of  the  corporate  affairs  is  essential  to 
the  proper  discharge  of  his  duties,  he  has  a  right  to  inspect  the 
records  and  the  property  of  the  corporation  and  to  familiarize 
himself  with  its  operations. e  He  is  also  entitled  to  attend  any 
meeting  of  the  standing  committees, 7  to  be  notified  of  all  special 
meetings  of  the  board,  to  attend  all  board  meetings,  and  to  be 
heard,  if  he  so  desires,  on  all  matters  coming  before  any  such 
meeting.  8  If  he  discovers  anything  wrong  in  the  conduct  of  the 
corporate  affairs,  he  has  no  individual  power  to  right  it,  but  must 
present  the  matter  to  the  board  for  its  action. 

§  179.    Directors  Trustees  for  the  Stockholders 

Directors  of  a  corporation  are  virtually  trustees  for  the  body 
of  stockholders,  and  must  exercise  the  same  care  and  diligence 
in  the  conduct  of  the  corporate  affairs  as  prudent  business  men 
would  exercise  in  the  conduct  of  their  own  affairs.  ^  As  trustees, 
they  must  have  no  interest  adverse  to  the  interest  of  the  com- 


'  North  Hudson,  etc.  Assn.  v.  Childs,  82  Wis.  460  (1892);  Ames  v.  Goldfield  Merger 
Mines  Co.,  227  Fed.  292,  301  (1915). 

*  Alabama  Nat.  Bank  v.  O'Neil,  128  Ala.  192  (1900);  Gaynor  v.  R.  R.,  189  Pa.  St.  5  (1899). 
'  3  Clark  &  Marshall  on  Corp.,  }  690. 

•  People  V.  Throop,  12  Wend.  (N.  Y.)  183  (1834);  Rosenfield  v.  Einstein,"46  N.  J.  L.  479, 
484  (1884). 

'  Western  Ry.  v.  Rushout,  5  De  G.  &  Sm.  290  (1852). 

«  Metropolitan,  etc.  Co.  v.  Domestic,  etc.  Co.,  44  N.  J.  Eq.  568  (1888);  Curtin  v.  Salmon, 
etc.  Co.,  130  Cal.  34s  (1900);  Broiightor  v.  Jones,  120  Mich.  462  (1899). 

•3  Cook  on  Corp.,  {  648;  Elfiott  v.  Baker,  194  Mass.  518  (1907);  Gen.  Rubber  Co.  v. 
Benedict,  ais  N.  Y.  18  (191S). 


Ch.  i81  DIRECTORS  149 

pany.     Too  often  directors  are  not  as  scrupulous  as  they  should 
be  in  this  particular. 

§  180.    Appointment  and  Removal  of  Officers  and  Agents 

The  authority  of  the  board  to  appoint  and  remove  officers 
and  agents  of  the  corporation  is  not  a  common  law  power,  but 
must  be  given  it  by  statute,  charter  or  by-law  provision.  Unless 
this  is  done,  the  power  belongs  to  and  may  be  reserved  by  the 
stockholders.  The  subject  is  treated  more  fully  in  the  following 
chapter, 

§  181.    Appointment  of  Standing  Committees 

Standing  committees  are  those  permanent  committees  of  the 
board  to  which  some  measure  of  its  discretionary  power  has  been 
delegated.  The  board  has  general  power  to  appoint  standing 
committees.  Their  purpose  is  twofold :  (i)  to  secure  the  prompt, 
decisive  action  of  a  small,  easily  assembled  body,  and  (2)  to 
obviate  the  necessity  for  frequent  meetings  of  the  board. 

As  the  discretionary  powers  of  the  board  itself  are  delegated 
to  standing  committees,  they  must  be  composed  of  members  of 
the  board.  Their  powers  are  exercised  during  the  interim  be- 
tween the  board  meetings;  and  within  the  limits  of  their  author- 
ity they  act  with  the  same  binding  force  and  effect  as  the  board 
itself  and  their  contracts  are  not  subject  to  revision  by  the 
board.i" 

When  authorized  thereto  by  the  charter  or  by-laws  of  the 
corporation,  the  power  of  the  board  to  delegate  its  authority  to 
properly  constituted  standing  committees  is  well  established. 
How  much  power  should  be  so  delegated  is  to  be  determined  by 
the  nature  and  conditions  of  the  company's  business. 

It  is  but  rarely  that  more  than  two  standing  committees  are 
deemed  necessary.  If  but  one  committee  exists,  it  is  usually 
termed  the  "executive  committee,"  and  its  powers  are  ordinarily 
those  of  the  board.     If  two  committees  are  appointed,  the  second 

*•  Corpus  Juris,  II  1863,  1865;  Hayes  v.  Canada,  etc.,  Co.,  181  Fed.  Rep.  289  (1910). 


I50  CORPORATE  LAW  IBk.  I- 

is  usually  designated  the  "finance  committee,"  and  to  this  com- 
mittee is  given  direct  supervision  of  the  corporate  finances  and 
accounts;  all  general  matters  remaining  in  charge  of  the  execu- 
tive committee.  The  matter  is,  however,  one  to  be  regulated  by 
the  charter  or  by-laws,  and  variations  of  the  usual  arrangements 
are  frequent. 

When  standing  committees  are  appointed  with  the  usual 
powers,  they  are  the  real  managing  bodies  of  the  corporation,  the 
board  merely  receiving  their  reports  and  supervising  their  opera- 
tions. In  a  small  corporation  or  any  corporation  with  a  compact, 
easily  assembled  board,  they  are  as  a  rule  an  unnecessary  and 
even  undesirable  complication.  They  are  advantageous  only 
when  the  board  is  so  large  or  so  scattered  as  to  be  difficult  of 
assembHng,  or  when  for  other  reasons  the  business  of  the  corpora- 
tion cannot  be  properly  transacted  by  the  board  as  a  whole. 
Not  infrequently  the  standing  committee  is  used  as  a  device  by 
which  a  few  men  practically  manage  the  affairs  of  the  corpora- 
tion, the  board  being  superseded  by  the  standing  committee. 

The  membership  of  standing  committees  is  seldom  less  than 
three,  nor,  save  in  very  large  corporations,  more  than  five.  To 
increase  the  number  renders  the  standing  committee  unwieldy 
and  defeats  the  purpose  of  its  creation. 

§  182.    Adoption  of  By-Laws 

Originally  the  stockholders  were  supposed  to  express  their 
wishes  as  to  the  management  of  the  corporation  through  the  by- 
laws, and  the  directors  to  exercise  their  powers  in  subordination 
thereto."  Of  late  years,  however,  in  many  states  the  statutes 
confer  upon  the  directors  more  or  less  extended  power  to  adopt 
by-laws.  In  some  of  these  states  the  by-laws  adopted  by  the 
directors -must  be  either  in  harmony  with  the  by-laws  passed  by 
the  stockholders,  or  subject  to  their  revision.  In  Illinois  the 
board  is  given  the  sole  and  entire  right  to  adopt  by-laws.    Also 


"  North  Milwavikee,  etc.,  Co.  v.  Bishop,  103  Wis.  492  (1899);  Morton,  etc.,  Co.  v.  Wysong, 
/.I  Ind.  4  (1875). 


Ch.  i8]  DIRECTORS  15 1 

in  some  other  states  they  are  given  power  to  make  by-laws  for 
their  ow^n  government.  When  the  stockholders  have  by  by-law 
provision  delegated  the  power  of  making  by-laws  to  the  directors, 
it  has  been  held  that  the  directors  are  not  thereby  authorized  to 
repeal  by-laws  passed  by  the  stockholders.12  Unless  directors 
are  given  independent  power  to  adopt  by-laws  by  statute  or 
charter  provisions,  their  by-laws  may  be  repealed  or  amended  at 
any  duly  assembled  stockholders'  meeting. 

§  183.    Common  Law  Liability  of  Directors 

The  liabiHties  of  directors  fall  naturally  under  two  heads — 
common  law  liabilities  and  Habilities  imposed  by  statute.  Under 
the  common  law  the  directors  are  personally  liable  for  loss  or 
damage  resulting  from  ultra  vires  actsj^s  for  any  unlawful 
corporate  act  committed  with  their  connivance,  assent,  or  knowl- 
edge; for  issuance  of  unpaid  or  partly  paid  stock  as  full-paid; 
for  paying  dividends,  either  negligently  or  wilfully,  that  impair 
the  capital  stock ;  and  for  any  other  gross  mismanagement.  As 
trustees  for  the  company,  they  are  bound  to  give  its  affairs  all 
requisite  care  and  attention.  If  they  do  not,  they  are  responsible 
for  any  resulting  loss  or  damage. 1*  They  are  not,  however, 
responsible  for  the  results  of  errors  of  judgment  in  their  manage- 
ment of  the  ordinary  business  affairs  of  the  corporation.is 

§  184.    Statutory  Liabilities  of  Directors 

In  almost  every  state  liabilities  have  been  imposed  upon 
directors  by  statute.  Thus  in  New  York — a  typical  state — 
directors  may  be  held  personally  liable  as  follows : 


"Stevens  V.  Davison,  18  Gratt.  (Va.)  8i<)  (t868). 

'•  National  Cash  Reg.  Co.  v.  Leland,  94  Fed.  502  (1899);  McKinnon  v.  Morse,  177  Fed, 
576  (1910);  Hill  V.  Murphy,  212  Mass.  i,  2,  (1912). 

"  3  Cook  on  Corp.,  J  703;  Cassidy  v.  Uhlmann,  170  N.  Y.  505  (1902);  Hayes  v.  Pierson, 
6s  N.  J.  Eq.  353  (1903);  Elliott  v.  Baker,  194  Mass.  518  (1907);  Childs  v.  White,  158  App.  Div. 
(N.  Y.)  I  (1913). 

'»  Chick  V.  Fuller,  114  Fed.  22  (1902);  United  Zinc  Cos.  v.  Harwood,  216  Mass.  474,  476 
(1914);  Holmes  v,  St.  Joseph  Lead  Co.,  168  App.  Div.  (N.  Y.)  688  (191s). 


152  CORPORATE  LAW  [Bk.  I- 

1.  For  declaring  dividends  except  from  surplus  profits,  or 

for  dividing,  withdrawing,  or  paying  out  any  part  of 
the  capital  except  that  authorized  by  law. 

2.  For  making  a  loan  of  corporate  money  to  any  stockholder, 

or  for  discounting  from  corporate  funds  any  note  or 
evidence  of  debt  for  any  stockholder,  or  for  receiving 
the  same  for  any  instalment  due  on  stock. 

3.  For  making  any  certificate  or  report  or  public  notice  that 

is  false  in  any  material  respect. 

4.  For  making  transfers  of  property  to  officers  or  stockhold- 

ers when  the  company  is  insolvent  or  threatened  with 
insolvency,  for  the  purpose  of  preferring  or  defrauding 
creditors. 

5.  In  case  of  dissolution,  as  trustees  for  all  corporate  prop- 

erty that  may  come  into  their  hands. 

In  the  majority  of  the  states  directors  guilty  of  most  of  the 
enimierated  offenses  are  not  only  personally  liable,  but  are  also 
criminally  hable  under  the  laws  against  fraud,  larceny,  and 
embezzlement. 

When  any  action  is  taken  by  the  board  in  violation  of  law  or 
which  might  involve  its  members  in  a  liability,  any  dissenting 
director  may  always  relieve  himself  from  responsibility  by  proper 
procedure.  In  some  states  this  procedure  is  prescribed  by 
statute.  Usually  it  involves  the  entry  of  his  dissent  or  protest 
on  the  minutes  of  the  particular  meeting  or,  if  such  entry  is 
refused,  pubHcation  of  the  protest. 

It  may  be  said  generally  that  the  law  as  to  the  liabilities  and 
obligations  of  directors  is  much  more  satisfactory  in  theory  than 
in  practice,  and  that  the  best  possible  method  of  avoiding  loss 
through  wrongful  or  ill-judged  acts  of  the  directors  is  to  confine 
the  directorships  only  to  men  of  known  integrity  and  character. 

§  185.    Resignation  of  Directors 

A  director  is  under  no  obhgation  to  continue  in  the  service 
of  his  corporation  longer  than  he  desires.     Even  though  the 


Ch.  i8]  DIRECTORS  I53 

statutes  or  by-laws  provide  that  he  shall  continue  in  office  until 
the  end  of  his  term,  he  may  resign  at  any  time  and  thereby  ter- 
minate his  official  position.ie 

The  effect  of  a  resignation  is  governed  by  its  terms.  It  may 
be  tentative,  requiring  acceptance  by  the  board  before  it  is 
effective,  or  peremptory  and  effective  as  soon  as  delivered  to  the 
proper  representative  of  the  corporation.^^ 

The  resignation  should,  for  purposes  of  record  and  proof,  be 
in  writing,  but  an  oral  resignation  properly  presented  to  the 
board  of  directors  and  recorded  in  the  minutes  as  so  presented,  is 
sufficient.  It  is  obvious,  however,  that  an  oral  resignation  is 
objectionable  on  account  of  its  difficulty  of  proof.  A  peremptory 
resignation  may  be  made  effective  at  a  future  date.  A  tentative 
resignation  may  fix  a  future  date  on  which  it  will  be  effective  if 
accepted. 

A  peremptory  resignation  cannot  be  withdrawn  after  its 
formal  presentation  to  the  board,  save  with  the  consent  of  the 
board.  A  tentative  resignation  may  be  withdrawn  at  any  time 
before  its  acceptance. i^ 

§  186.    Removal  of  Directors 

The  directors  have  no  power  to  suspend  or  remove  a  fellow 
member  of  the  board.  The  stockholders  have  a  common  law 
power  to  remove  directors  for  adequate  cause,  but  such  removals 
are  not  frequent.  The  cause  must  be  good  and  capable  of  proof, 
charges  must  be  preferred,  a  meeting  must  be  called,  and  the 
accused  be  given  a  hearing.  The  whole  procedure  is  trouble- 
some, and  it  is  usually  preferable  to  await  the  expiration  of  an 
offending  director's  term  rather  than  to  attempt  his  forcible 
removal  sooner. 

In  some  states,  however,  the  statutes  extend  this  common  law 
power  of  removal,  and  wherever  special  provisions  are  permitted 


"3  Clark  &  Marshall  on  Corp.,  {  667,  and  cases  cited;  Briggs  v.  Spaulding,  141  U.  S. 
132  (1891);  Will  of  McNaughton,  138  Wis.  179,  208  (1909). 
"  Manhattan  Co.  v.  Kaldenberg,  i6s  N.  Y.  i  (1900).' 
"'  See  Book  IV,  Ch.  XVIII,  "Resignations"  (forms). 


154  CORPORATE  LAW  [Bk.  I- 

in  the  charter  the  same  end  may  be  attained  by  proper  charter 
provision.  When  thus  given  by  the  statutes  or  charter,  the 
power  of  removal  is  usually  summary,  i.e.,  an  objectionable 
director  may  be  removed  by  prescribed  procedure — usually  by 
a  two-thirds  vote  of  the  stock,  but  in  a  few  states  by  a  bare 
majority — at  once  and  with  or  without  cause.  Under  these 
circumstances  the  removal  of  directors  is  more  frequent. 

When  the  office  of  director  has  been  usurped  or  is  unlawfully 
held,  and  is  claimed  by  a  party  who  is  not  in  possession,  a  writ 
of  quo  warranto  will  lie  or  an  equitable  action  for  possession  may 
be  instituted.! 9 

§  187.    Vacancies  on  the  Board  . 

The  stockholders  alone  have  power  to  fill  vacancies  on  the 
board,  unless  otherwise  expressly  provided  by  statute,  charter, 
or  by-laws.  Such  vacancies  must  therefore  await  the  election 
of  directors  at  the  next  annual  meeting,  or  be  filled  by  special 
election,  unless  the  power  of  filling  vacancies  has  been  conferred 
upon  the  board.20  It  is  advisable  that  the  directors  have  this 
power,  and  in  practice  it  is  almost  invariably  given  them. 

Vacancies  on  the  board  may  be  caused  by  the  death,  removal, 
resignation,  or  disability  of  a  director,  or  the  failure  of  a  director- 
elect  to  accept  his  office. 21  The  continued  absence  of  a  director 
from  meetings  is  not  itself  sufficient  to  vacate  his  position.  If 
it  is  desired  that  such  continued  absence  shall  have  this  effect, 
the  by-laws  should  so  provide,  specifying  the  exact  number  of 
consecutive  absences  from  regular  meetings  or  from  regular  and 
special  meetings  necessary  to  create  a  vacancy. 

A  board  of  directors  may  legally  continue  to  act  in  spite  of 
vacancies,  provided  enough  remain  to  make  up  a  quorum  of  the 
whole  board.  Less  than  a  quorum  of  the  board  cannot  fill 
vacancies  unless  expressly  so  empowered  by  charter  or  by-laws. 


"  Powers  V.  Blue,  etc.,  Assn.,  86  Fed.  70s  (1898);  People  v.  Powell,  201  N.  Y.  194  (1911). 
^  Inre  Griffing  Iron  Co.,  63  N.  J.  L.  168,  357  (1899);  2  Thompson  on  Corp.,  J  1083. 
"  Whittaker  v.  Amwell  Nat.  Bank,  52  N.  J.  Eq.  400  (1894);  United  Growers  Co.  v.  Eisner, 
22  App.  Div.  (N.  Y.)  I  (1897). 


Ch.  1 8]  DIRECTORS  155 

§  188.    Directors  Holding  Over 

"If  the  directors  shall  not  be  elected  on  the  day  designated  in 
the  by-laws,  or  by  law,  the  corporation  shall  not  for  that  reason 
be  dissolved;  but  every  director  shall  continue  to  hold  his  office 
and  discharge  his  duties  until  his  successor  has  been  elected.  "22 
This  statement  of  the  law  taken  from  the  New  York  statutes  is 
also  a  statement  of  the  common  law,  existing  in  practically 
every  state. 23  A  similar  provision  also  usually  appears  in  the 
by-laws. 

The  powers  of  directors  who  continue  in  office  because  of  a 
failure  to  elect  their  successors  are  tlie  same  in  every  respect  as 
before  their  term  of  office  expired.  They  are  directors  both  de 
jure  (by  right)  and  de  facto  (in  fact),  and  their  acts  are  valid.24 

The  smaller  corporations  relying  upon  this  condition  some- 
times omit  the  annual  meeting  with  its  election  of  directors  for 
years,  thereby  avoiding  the  formalities  of  the  annual  meeting. 
In  such  case  the  old  board  holds  over  indefinitely  and,  duly 
empowered  thereto  by  charter  or  by-laws,  fills  by  vote  of  its  own 
members  any  vacancies  that  may  occur.  So  long  as  the  stock- 
holders do  not  protest,  the  practice  is  not  legally  objectionable. 
In  New  York  the  omission  of  the  election  of  directors  for  eight 
years  has  been  upheld.25 

§  189.    Directors  Dealing  with  Corporation 

The  subject  of  directors'  deahngs  with  their  corporations  is 
too  extensive  for  full  treatment  here.  A  director  occupies  a 
fiduciary  relation  to  his  corporation  and  should  as  far  as  possible 
avoid  any  position  in  which  his  personal  interest  is  adverse  to 
that  of  the  corporation.  He  may,  however,  speaking  generally, 
make  any  contract  with  his  corporation  that  is  fair  and  to  its 
interest.     His  contract  is  therefore  not  void  but  merely  voidable, 


«  Gen.  Corp.  Law,  N.  Y..  }  28. 

»  State  V.  Bonnell,  35  Ohio  St.  10  (1878);  Appleton  v.  Am.  Malting  Co.,  65  N.  J.  Eq.  375 
(1903). 

2*  3  Cook  on  Corp.,  i  713;  Kent  Co..  etc..  Society  v.  Houseman,  81  Mich.  609  (1890) 
"  Geneva  Mineral  Springs  v.  Coursey,  45  App.  Div.  (N.  Y.)  268,  275  (1899). 


1 56  CORPORATE  LAW  [Bk.  I- 

and  if  no  stockholder  objects  will  stand.^s  Also  cases  have  arisen 
where  a  contract  between  a  director  and  his  corporation  has  been 
ratified  by  a  majority  of  stockholders  at  a  duly  called  meeting, 
and  the  courts  have  sustained  the  contract.2''  Also,  if  all  the 
stock  is  owned  by  the  directors  and  there  are  no  creditors,  a 
director  may  contract  with  his  corporation  at  pleasure.28 

In  all  cases  where  a  director  is  personally  interested  in  any 
particular  contract  or  other  matter  to  be  acted  upon  by  the 
board,  he  should  withdraw  from  the  room  while  the  vote  is  being 
taken  and  his  absence  should  be  noted  on  the  minutes.  To-be 
vaUd  the  action  must  be  taken  by  a  legal  quorum  exclusive  of 
the  interested  party.29  ,  .,-.r'n<»  'tn  p, 

The  United  States  Steel  Corporation,  in  its  by-laws  provides 
for  such  a  situation  as  follows: 

Contracts.  Inasmuch  as  the  Directors  of  this  Company  are 
men  of  large  and  diversified  business  interests,  and  are  likely  to  be 
connected  with  other  corporations  with  which  from  time  to  time 
this  Company  must  have  business  dealings,  no  contract  or  other 
transaction  between  this  Company  and  any  other  corporation  shall 
be  affected  by  the  fact  that  directors  of  this  Company  are  interested 
in,  or  are  directors  or  officers  of,  such  other  corporation,  if,  at  the 
meeting  of  the  board,  or  of  the  committee  of  this  Company,  mak- 
ing, authorizing  or  confirming  such  contract  or  transaction,  there 
shall  be  present  a  quorum  of  directors  not  so  interested;  and  any 
director  individually  may  be  a  party  to,  or  may  be  interested  in, 
any  contract  or  transaction  of  this  Company,  provided  that  such 
contract  or  transaction  shall  be  approved  or  be  ratified  by  the 
affirmative  vote  of  at  least  ten  directors  not  so  interested. 


^Fort  Payne  Rolling  Mill  v.  Hill,  174  Mass.  224  (1899);  Welch  v.  Bank,  122  N.  Y.  177 
(1890);  Cont.  Ins.  Co.  v.  N.  Y.,  etc.,  R.  R.  Co.,  187  N.  Y.  225  (1907). 

"  Nye  V.  Storer,  16S  Mass.  S3  (1897);  Gamble  v.  Queens  Co.  Water  Co.,  123  N.  Y.  91 
(1890). 

28  McCracken  v.  Robison,  57  Fed.  37s  (1893);  Barr  v.  R.  R.  Co.,  125  N.  Y.  263  (1891). 

"  Curtin  V.  Salmon,  etc.,  Co.,  130  Cal.  345  (1900);  Steele  v.  Gold,  etc.,  Co.,  95  Pac.  (Colo.) 
349  (1908);  Schaffhauser  v.  Brewing  Co.,  218  Pa.  St.  298  (1907). 


CHAPTER  XIX 

OFFICERS 
§  190.    General 

The  term  "officers"  is  here  applied  to  those  permanent  agents 
of  the  corporation  appointed  or  elected — usually  by  the  board  of 
directors — as  the  direct  representatives  of  the  board  and  of  the 
corporation.  The  directors  themselves  are  at  times,  and  with 
legal  correctness,  styled  "officers,"  but  to  avoid  confusion  the 
term  is  as  a  rule  employed  in  the  present  volume  to  designate 
those  officials  subordinate  to  the  board.i 

The  necessary  officers  of  a  corporation,  sometimes  termed  the 
"executive  officers,"  are  the  president,  secretary,  and  treasurer. 
One  or  more  vice-presidents  are  usual.  In  addition  to  these, 
other  officers  or  agents  are  frequently  appointed,  as  managing 
directors,  general  managers  or  superintendents,  counsel,  auditors, 
and  special  agents  for  particular  purposes. 

§  191.    Appointment  of  Officers 

The  stockholders  have  the  original  right  to  elect  or  appoint 
officers  of  their  corporation,  and  in  the  absence  of  preventing 
statutes  this  power  may  be  reserved  to  them.  In  practice,  how- 
ever, by  express  provision  of  the  statutes,  charter,  or  by-laws 
the  power  of  appointing  officers  is  almost  invariably  vested  in 
the  board  of  directors. 

The  election  of  one  person  to  two  corporate  offices  is  common, 
and  is  usually  authorized  by  charter  or  by-law  provision.  If 
otherwise,  the  board  still  has  power  to  combine  any  two  or  more 
official  positions  in  one  person  if  the  duties  of  the  combined 
positions  do  not  conflict.* 


«  See  Ch.  XXXIII,  "By-Laws— Officers." 

'  People  V.  Green,  58  N.  Y.  295-304  (1874);  3  Cook  on  Corp.,  i  712. 

157 


158  CORPORATE  LAW      .  [Bk.  I- 

The  term  for  which  corporate  officials  are  elected  is  usually 
prescribed  by  proper  charter  or  by-law  provision,  and  seldom 
exceeds  one  year.  As  a  matter  of  business  policy  such  term 
should  not  be  longer  than  that  of  the  directors  by  whom  the 
officials  are  elected.  That  is,  if  the  directors  are  elected  annually, 
the  officers  also  should  be  elected  annually  so  that  each  new 
board  may  appoint  its  own  agents. 

The  appointment  of  managers,  experts,  or  other  specially 
skilled  employees  is,  however,  of  a  different  nature.  These  are 
not  so  directly  agents  of  the  board,  and  contracts  for  their  serv- 
ices extending  over  a  term  of  years  are  frequently  advantageous 
or  even  necessary  to  the  corporation.  Such  contracts  are  entirely 
within  the  power  of  the  board  without  special  charter  or  by-law 
authorization. 

Unless  they  resign  or  are  removed  in  some  manner,  the  cor- 
porate officials  hold  over  after  the  expiration  of  their  elective 
term,  until  they  are  relieved  by  properly  elected  or  appointed 
successors. 3  This  is  frequently  a  statute,  charter,  or  by-law 
provision,  but,  if  otherwise,  is  a  matter  of  common  law.  These 
officials  have  every  power  that  they  possessed  before  the  expira- 
tion of  their  elective  terms. 

As  the  board  elects  and  appoints  officers,  it  has  also  the  power 
to  fill  vacancies  among  them  without  specific  authorization. 

§  192.     Qualifications  of  Officers 

The  officers  are  the  agents  of  the  board  of  directors  and  of  the 
corporation.  Hence  anyone  who  may  act  as  an  agent  is  capable 
of  acting  as  a  corporate  official,  and  in  the  absence  of  prohibition, 
a  married  woman,  a  minor,  an  alien,  or  one  of  its  own  directors 
may  be  legally  elected  as  an  officer  of  the  corporation. 

Membership  in  the  board  is,  as  a  rule,  a  necessary  qualifica- 
tion for  the  president  and  vice-president  of  a  corporation.  They 
are  almost  invariably  the  presiding  officers  of  the  board,  and  when 


•  Mining  Co.  v.  Abraham,  26  Ore.  282  (1894);  Agricultural  Soc.  v.  Houseman,  81  Mich. 
609  (1890);  Quitman  Oil  Co.  v.  Peacock,  81  S.  E.  (Ga.)  908  (1914). 


Ch.  19]  OFFICERS  1 59 

this  is  the  case  the  election  of  a  president  or  vice-president  not  a 
member  of  that  body  might  lead  to  difficult  situations. 

§  193.    Powers  and  Duties  of  Officers 

The  mere  fact  of  election  to  office  does  not  necessarily  in  itself 
confer  any  power  or  duties  upon  the  officials  of  a  corporation.^ 
Custom  or  usage  may  have  attached  certain  powers  and  duties 
to  certain  official  positions,  but  the  corporation  may  disregard 
this  and  vary  the  powers  and  duties  of  the  different  officers  as 
seems  to  it  best. 

In  general  it  may  be  said  of  corporate  officials  that,  as  agents 
of  the  corporation,  they  are  governed  by  the  general  law  of 
agency.  Accordingly  a  corporate  official  has  only  those  powers 
which  are  conferred  upon  him  or  are  incidental  to  the  exercise  of 
these  powers. 

The  different  sources  from  which  the  powers  of  corporate 
officials  are  derived  are,  given  in  rank  of  their  authority,  (i)  the 
statutes  of  the  state,  (2)  the  charter,  (3)  the  by-laws,  (4)  resolu- 
tions of  directors,  and  (5)  usage. 

Statutory  provisions  affecting  corporate  officials  are  few. 
The  charter  likewise  but  seldom  contains  provisions  affecting 
the  officers  of  the  corporation,  though  occasionally  such  pro- 
visions are  inserted  therein  for  the  sake  of  permanence.  The 
by-laws,  however,  usually  prescribe  the  official  powers  and  duties 
with  fulness;  and  the  directors,  subject  to  the  provisions  of  the 
higher  authorities  referred  to,  confer  such  other  proper  official 
powers  and  prescribe  such  other  official  duties  as  they  see  fit. 

Beyond  all  these,  it  will  usually  be  found  that  the  officers 
transact  certain  routine  business^  and  perform  certain  duties  as 
a  matter  of  custom,  and  their  acts  are  valid  and  binding  upon 
the  corporation,  even  though  not  specifically  authorized. « 


«R.  R.  Co.  V.  Bayne.  11  Hun  (N.  Y.)  166;  afifd.,  75  N.  Y.  i  (1877);  Cushman  v.  Cleveland, 
etc.,  Co.,  84  N.  E.  (Ind.)  759  (1908);  Emmet  v.  Northern  Bank,  173  App.  Div.  (N.  Y.)  840 
(1916):  Marqusee  v.  Ins.  Co.,  211  Fed.  903  (1914). 

'  Fitzgerald,  etc.,  Co.  v.  Fitzgerald,  137  U.  S.  98  (1890). 

•  Ins.  Co.  V.  McCain,  96  U.  S.  84  (1877);  Story  on  Agency,  {S  126,  127. 


l6o  CORPORATE  LAW  [Bk.  I- 

Also  it  may  be  stated  generally  that,  whenever  the  directors 
permit  an  officer  to  exercise  apparent  authority  in  the  corporate 
affairs  or  transactions,  the  corporation  is  bound  thereby  as  to 
third  persons  as  fully  as  if  such  officer  had  been  duly  authorized.' 

Beyond  this,  corporate  officers  not  infrequently  act  clearly 
without  the  bounds'of  their  authority,  relying  upon  ratification 
of  their  acts  by  the  board  of  directors  later.  If  so  ratified,  the 
corporation  is  bound  and  the  officials  are  absolved  from  all 
responsibility  for  their  ultra  vires  acts.^  If,  however,  the  official 
action  is  not  ratified,  the  corporation  is  not  bound  and  the  officers 
are  personally  liable  for  their  acts.^ 

The  validity  of  an  officer's  acts  depends  entirely  upon  his 
authority  and  not  on  the  place  in  which  the  authority  is  exer- 
cised, i"  Therefore,  when  in  the  proper  discharge  of  his  duties, 
his  acts  are  as  effective  in  one  place  as  another  and  equally 
binding  upon  the  corporation. 

§  194.    Delegation  of  Officers'  Authority 

The  board  may  temporarily  delegate  the  powers  of  an  official 
to  another  person,  provided  such  delegation  is  reasonable  and 
only  for  such  length  of  time  as  may  be  actually  necessary  to 
conserve  the  interests  of  the  corporation.  An  officer  cannot 
delegate  his  powers  to  another  officer  in  any  material  matter, 
even  temporarily,  unless  specially  authorized  thereto  by  the  by- 
laws or  by  action  of  the  board.  ^ 

§  195.    Liabilities  of  Officers 

An  officer  contracting  for  his  corporation  within  the  limits 
of  his  authority  is  merely  a  corporate  agent,  and  if  not  guilty  of 


'  New  York  &  New  Haven  R.  R.  Co.  v.  Schuyler.  34  N.  Y.  30  (1865);  3  Clark  &  Marshall 
on  Corp.,  {  708;  Louchheim  v.  Bldg.  Assn.,  211  Pa.  St.  499  (190s);  Rankin  v.  Tygard,  198  Fed. 
795  (1912). 

8  Rolling  Mill  V.  R.  R.,  120  U.  S.  256  (1886);  Nims  v.  Boys'  School,  160  Mass.  177(1893); 
Topolewski  v.  Plankinton  Packing  Co.,  143  Wis.  52  (1910). 

»  Malone  v.  Pierce',  231  Pa.  St.  534  (1911);  Falls  City  Lumber  Co.  v.  Watkins,  53  Ore.  212 
(1909). 

'»  Hastings  v.  Ins.  Co.,  138  N.  Y.  473  (1893). 

"  Caldwell  V.  Life  Assn..  53  App.  Div.  (N.  Y.)  24s  {1900).  As  to  when  corporation  will  be 
bound  see  Emerson  v.  Hat  Co.,  12  Mass.  237  (1815);  also  Luttrell  v.  Martin,  112  N.  C.  593 
(1893). 


Ch.  igj  OFFICERS  l6l 

fraud  or  deceit,  does  not  bind  himself  and  cannot  be  held  per- 
sonally liable  in  any  way.  If,  however,  he  exceeds  his  authority 
he  renders  himself  personally  liable,i2  unless  the  corporation 
later  ratifies  the  unauthorized  action,!^  in  which  case  he  is 
released. 

'  Officers  are  bound  to  use  ordinary  care  and  diligence  in  the 
conduct  of  the  corporate  business  and  are  therefore  liable  for 
any  losses  caused  by  their  neglect,  mismanagement,  or  wrong- 
doing in  the  discharge  of  their  official  duties,!^  though  not  for  an 
error  of  judgment.is  }  Y*w.n  ' 

An  officer  is  also  personally  liable  for  any  wrong  he  does  on 
behalf  of  his  corporation,  such  as  sending  out  false  and  deceptive 
reports,  statements,  prospectus,  etc.,  even  though  the  corpora- 
tion is  also  liable.  16 

In  many  states  statutes  exist  prescribing  penalties  for  various 
misdeeds  of  corporate  officials.  Thus  in  New  York  neglect  to 
make  proper  entries  in  the  stock  book,  or  to  exhibit  this  book 
on  request  to  those  entitled  to  its  inspection,  involves  a  penalty 
of  $50  and  of  resulting  damages;  rendering  a  false  report  in- 
volves Uability  for  all  resulting  damages;  loaning  corporate  funds 
to  a  stockholder  or  allowing  him  to  withdraw  his  investment  in 
any  way  renders  officers  and  directors  personally  Hable  for  all 
debts  of  the  corporation  until  the  amount  is  returned;  while  the 
penalty  for  falsifying  accounts  or  erasing  or  destroying  the  cor- 
porate records  is  the  same  as  that  for  forgery, 

§  196.    De  Facto  Officers 

A  de  facto  officer  is  one  actually  in  possession  of  an  office  and 
exercising  its  powers  and  duties  by  virtue  of  some  other  authority 
or  right  than  that  of  a  regular,  unquestioned  election  or  appoint- 


"  See  citations  in  footnote  9. 

"  See  citations  in  footnote  8. 

"3  Cook  on  Corp.,  (  702,  and  cases  there  cited;  McEwen  v.  Kelly,  140  Ga.  720  (1913); 
United  Zinc  Cos.  v.  Harwood,  216  Mass.  474  (1914);  Childs  v.  White,  158  App.  Div.  (N.  Y.) 
I  (1913). 

"  Briggs  V.  Spaulding,  141  U.  S.  132  (1890);  People  v.  Equit.,  etc..  Society,  124  App.  Div. 
(N.  Y.)  714  (1908). 

»•  Cowley  V.  Smyth,  46  N.  J.  L.  380  (1884);  Morgan  v.  Skiddy,  62  N.  Y.  319  (1875). 


l62  CORPORATE  LAW  [Bk.  I- 

ment.  He  must  be  "distinguished  on  the  one  hand  from  a  mere 
usurper  of  an  office,  and  on  the  other  hand  from  an  officer  de 
jure,"^''  i.e.,  one  holding  his  position  by  legal  right.  It  not  in- 
frequently happens  that  the  results  of  an  election  are  disputed 
or  that  an  election  is  not  held.  In  the  first  case  if  the  officers 
claiming  election  enter  upon  their  official  duties,  or  in  the  second 
case  if  the  old  officers  continue  in  office,  the  acting  officials  are 
de  facto  officers,  and,  until  ousted  or  superseded,  their  official 
acts  are  legal  and  binding  upon  the  corporation. 

Speaking  generally  it  may  be  said  that  anyone  connected 
with  a  corporation  who  is  publicly  allowed  to  act  as  its  officer  or 
agent  is  a  de  facto  officer.  Persons  dealing  with  the  corporation 
cannot  usually  investigate  and  ascertain  whether  those  who 
purport  to  represent  it  are  legally  appointed.  The  law  therefore 
holds  that  the  acts  of  these  de  facto  officers  are  binding  on  the 
company  even  though  they  have  no  legal  right  to  the  position 
they  pretend  to  hold. 

§  197.    Removal  of  Officers 

When  an  officer  is  elected  for  a  definite  term  and  accepts  the 
of&ce,  a  contract  has  been  made  for  that  term,  and  unless  power 
has  been  given  the  board  by  express  provision  of  statutes,  charter, 
or  by-laws  to  remove  the  corporate  officers  at  pleasure,  the  in- 
cumbent can  be  legally  removed  only  for  cause.is  If  a  removal  is 
to  be  made,  the  cause  must  be  such  as  will  justify  breaking  the 
contract  with  the  offending  official,  charges  must  be  brought 
against  him,  and  he  must  be  allowed  an  opportunity  to  defend 
himself. 19  If  removed  without  cause,  his  ofl&dal  status  ceases 
but  the  corporation  is  liable  to  him  for  breach  of  contract.20 

In  some  few  states  the  statutes  give  the  directors  power  to 
remove  officers  at  pleasure.     Elsewhere  it  may  be  given  them 


"Waterman  v.  Chicago,  etc.,  R.  R.  Co.,  139  HI.  658-665  (1892);  Merchants'  Bank  v. 
Citizens'  Gas  Light  Co.,  159.  Mass.  505  (1893)- 

'8  State  V.  Kuehn,  34  Wis.  229  (1874)- 

i«  State  V.  Adams,  44  Mo.  570,  585  (i869);State  v.  Kuehn,  34  Wis.  299  (1874)- 

^"In  re  Griffing  Iron  Co.,  63  N.  J.  L.  168  (1899);  Brindley  v.  Walker,  70  Atl.  Rep.  fPa.) 
794  (1908). 


Ch.  19]  OFFICERS  163 

by  charter  or  by-law  provision.21  Such  provisions  are  usually 
desirable,  as  the  board  is  responsible  for  the  proper  conduct  of 
the  corporate  business  and  should  have  power  to  remove  an 
objectionable  official  without  the  necessity  of  a  formal  trial. 
When  by-laws  are  adopted  giving  the  directors  power  to  remove 
officers  without  cause,  they  do  not  authorize  the  removal  of 
officers  already  elected,  but  are  effective  as  to  officers  elected 
thereafter. 

§  198.    Resignation  of  an  Officer 

Under  the  usual  conditions  of  election,  a  corporate  officer  may 
resign  at  will,22  unless  he  has  entered  into  some  distinct  agree- 
ment to  serve  the  corporation  for  a  fixed  period.  His  resignation 
should  as  a  rule  be  in  writing,  be  phrased  to  meet  the  exact  end 
in  view,  and  be  deHvered  to  the  secretary  ;23  though  an  oral 
resignation  in  open  meeting  is  sufficient,  especially  if  followed  by 
acceptance  by  the  board.2*  It  has  been  held  that  all  the  cor- 
porate officers  cannot  resign  at  once  for  the  purpose  of  throwing 
the  corporation  into  the  hands  of  a  receiver,25  or  to  free  them- 
selves from  their  obligations  in  regard  to  the  custody  of  the  cor- 
porate property  .26 


2'  State  V.  Adams,  44  Mo.  S70,  585  (1869);  Darrah  v.  Ice  &  Storage  Co.,  so  W.  Va.  417 
(1901);  Douglass  V.  Merchants'  Ins.  Co.,  118  N.  Y.  484  (1890). 

22  Yorkville  Bank  v.  Zeltner  B.  Co.,  80  App.  Div.  (N.  Y.)  578  (1903);  Van  Amburgh  v. 
Baker,  81  N.  Y.  46  (1880).     See  Book  IV,  Ch.  XVIII,  "Resignations"  (forms). 

'•3  Manhattan  Co.  v.  Kaldenberg,  165  N.  Y.  i  (1900);  Noble  v.  Euler,  20  App.  Div.  (N.  Y.) 
548  (1897). 

"  Briggs  V.  Spaulding,  141  U.  S.  132-152  (1891);  Fearing  v.  Glenn,  73  Fed,  116  (1896). 

"Zeltner  v.  Brewing  Co.,  174  N.  Y.  247  (1903). 

»•  Yorkville  Bank  v.  Zeltner  B.  Co..  80  App.  Div.  (N.  Y.)  578  (1903). 


,;V7 


iv'jtc^iaii 


tKj'l 


Part  V— The  Charter 


CHAPTER  XX 
CHARTER— GENERAL  CONSIDERATIONS 

§  199.    Nature  of  Charter 

The  foundation  of  the  corporation  is  a  formal  written  grant 
or  authorization  from  the  state.  This  instrument,  originally 
known  as  the  "charter,"  is  now  usually  designated  by  the  statute 
laws  of  the  various  states  as  the  "certificate  of  incorporation" 
or  the  "articles  of  association."!  From  a  legal  standpoint  there 
is  no  distinction  between  these  different  names.  As  a  matter  of 
convenience  the  term  "charter"  is  generally  employed  in  the 
present  volume.  The  charter  may  be  granted  by  a  particular 
state,  or  by  the  general  government  as  in  the  case  of  national 
banks  and  certain  other  corporate  organizations.  It  is  a  recog- 
nized principle  that  all  statutory  laws  of  the»  state  of  incorpora- 
tion governing  or  regulating  corporations  become  a  part  of  the 
charter.2 

Formerly  every  charter  was  created,  or  authorized,  by  a 
separate  legislative  act.  Charters  termed  "special  charters"  are 
still  granted  in  some  states  by  act  of  legislature  for  special  cor- 
porations, but  the  greater  number  of  corporations  are  organized 
under  state  laws  of  general  application-^ 

All  corporations  have  certain  common  law  powers,  such  as 
the  right  to  sue  and  be  sued  under  the  corporate  name,  the  right 


»  Book  IV,  Ch.  I,  "Charter  Forms." 

'EUeritian  v.  Railway  Co.,  49  N.  J.  Eq.  217  (1891);  Bixler  v.  Summerfield,  195  111.  147 
(1902):  Westport  Stone  Co.  v.  Thomas,  17s  Ind.  319  (1910). 
•  See  i  20s.  , 


i66  •  CORPORATE  LAW  [Bk.  I- 

to  contract  and  to  use  the  corporate  seal.  In  addition  they  have 
any  general  powers  granted  by  the  statutes  and  the  special  rights 
granted  by  their  respective  charters,  such  as  the  use  of  the 
particular  name,  the  right  to  carry  on  the  special  business  and 
to  have  a  certain  capital  stock.  They  also  have  such  incidental 
powers  as  are  necessary  to  render  these  express  powers  effective. 
If  any  further  corporate  powers  allowable  under  the  laws  of  the 
state  of  incorporation  are  desired,  they  must  be  secured  by  proper 
amendment  of  the  charter.  Their  exercise  otherwise  is  ultra 
vires,  i.e.,  beyond  the  powers  of  the  company. 

As  the  charter  is  usually  a  very  formal  instrument,  and  the 
procedure  for  its  amendment  is  also  formal  and  usually  trouble- 
some, it  is  important  that  all  desired  purposes  and  powers  should 
be  stated  with  clearness  and  fulness  in  the  original  charter 
application. 

The  powers  and  privileges  conferred  upon  a  corporation  by 
its  charter  are  only  such  as  are  allowable  under  the  laws  of  the 
state  of  incorporation.  Ordinarily  any  provisions  of  a  different 
tenor  would  be  refused  or  stricken  out  of  the  charter  application 
by  the  state  officials.  Occasionally  it  happens,  however,  through 
official  ignorance,  inadvertence,  or  indifference,  that  powers  and 
privileges  illegal  or  not  permissible  are  passed  and  apparently 
granted  by  the  charter  of  a  corporation.  Such  appearance  is 
deceptive.  The  corporation  is  empowered  by  its  charter  just 
so  far  as  that  instrument  is  in  accord  with  the  law  of  the  state 
and  no  further.  The  charter  is  not  and  cannot  be  superior  to 
the  law,  and  is  absolutely  ineffective  just  so  far  as  it  goes  beyond.* 

It  must  be  noted  that  the  ordinary  business  corporation  does 
not.  in  any  but  a  technical  sense  of  the  word  receive  a  franchise, 
as  the  granting  of  the  charter  does  not  give  it  any  powers  that 
will  not  be  freely  given  to  any  other  incorporation  upon  like 
application.  5 


*  People  V.  Chicago  Gas  Trust  Co.,  130  111.  268  (1889). 
'  2  Morawetz  on  Corp.,  §  923. 


Ch.  20]  CHARTER— GENERAL  CONSIDERATIONS  167 

§  200.    Classification 

Charters  are  divided  into  two  important  classes  by  the  gen- 
eral division  of  corporations  into  stock  and  non-stock  or  menfiber- 
ship  corporations.  Charters  for  membership  corporations  are 
not  treated  specifically  in  the  present  volume. 

Beyond  this  general  division,  stock  corporations  and  the 
charters  creating  them  may  be  divided  into  three  important 
classes  as  follows: 

1.  Business  corporations,  organized  to  conduct  an  ordinary 

mining,  mercantile,  manufacturing,  or  other  private 
business. 

2.  Public  utility  corporations,  organized  to  undertake  some 

public  function,  such  as  the  supply  of  heat,  light, 
power,  or  water,  or  the  construction  or  operation  of  a 
railway,  a  telephone  or  telegraph  system. 

3.  Financial    corporations,    as    banks,    trust    companies, 

building  associations,  and  insuraijce  companies. 

The  corporations  of  each  of  these  classes  are  created  by  char- 
ters differing  from  those  of  the  other  classes  in  form  and  terms, 
though  all  conform  to  the  general  principles  governing  charters. 
The  characteristic  features  of  each  of  these  classes  of  corporations 
are  given  in  the  following  sections 

§  201.     (i)  Business  Corporations 

This  term  is  used  to  designate  corporations  organized  to 
conduct  those  various  forms  of  private  business  not  subject 
to  special  regulations  and  restrictions  in  the  interest  of  the 
public.  All  corporations  for  mining,  manufacturing,  and  mer- 
cantile pursuits  are  included  under  this  head. 

Business  corporations  are,  as  a  rule,  chartered  in  each  state 
under  general,  uniform  laws  and  forms,  have  no  special  privi- 
leges, and  when  incorporated  are  allowed  to  pursue  their  cor- 
porate ends  almost  as  freely  and  as  simply  as  would  a  private 
individual  or  firm  under  the  same  circumstances.    The  majority 


l68  CORPORATE  LAW  [Bk.  I- 

of  existing  corporations  belong  to  this  class  and  the  great  mass 
of  corporate  law  and  decisions  applies  to  them  primarily.  For 
the  other  classes  of  stock  corporations  there  are  special  laws, 
special  limitations,  and  in  some  cases  special  privileges. 

§  202.     (2)  Public  Utility  Corporations 

Pubhc  utility  or  public  service  corporations  are  those  organ- 
ized for  the  purpose  of  securing  and  operating  under  some 
franchise  of  a  public  nature,  which  confers  upon  such  corpora- 
tions rights  or  privileges  which  other  citizens  and  private  cor- 
porations do  not  enjoy.  Usually  these  franchises  carry  with 
them  certain  rights  of  way,  or  condemnation  powers  to  secure 
such  rights  granted  by  the  state  under  its  power  of  eminent 
domain. 

An  ordinary  private  corporation  enjoys  no  exclusive  franchise, 
and  any  other  body  of  citizens  may  incorporate  for  the  same 
purposes.  A  company  organized  to  operate  a  public  utility 
must,  however,  have  special  rights  and  powers  affecting  the 
public  welfare  or  convenience,  and  usually  another  similar  cor- 
poration would  not  be  granted  these  identical  rights  and  powers 
while  the  former  corporation  was  in  active  existence.  For 
instance,  a  gas  company  must  have  the  right  to  tear  up  streets 
in  order  to  lay  and  repair  its  pipes.  The  ordinary  citizen  or 
corporation  has  no  such  right.  If  such  right  were  granted  to  one 
company,  the  same  right  in  the  same  territory  would  not  properly 
be  granted  to  another  company.  Should  such  double  concession 
be  made,  it  would  be  but  a  short  time  until,  in  obedience  to  well- 
known  economic  laws,  the  two  competing  companies  would 
combine. 

This  peculiarity  is  true  of  all  classes  of  public  utility  corpora- 
tions. They  enjoy  franchises  that  cannot  be  granted  indis- 
criminately and  that  tend  inevitably  to  monopoly.  They  enjoy 
these  special  privileges  for  the  purpose  of  supplying  certain  public 
needs  that  must  be  supplied  uniformly.  They  cannot  be  given 
the  liberty  to  make  prices  and  conditions  that  obtain  in  the  con- 


Ch.  20]  CHARTER— GENERAL  CONSIDERATIONS  169 

duct  of  a  private  corporation.  Hence,  the  laws  under  which  they 
receive  charters  should  guard  against  the  indiscriminate  bestowal 
of  such  rights  and  should  carefully  regulate  charges  and  methods. 
In  many  states  the  charters  of  public  utility  corporations  are 
granted  only  by  special  acts  of  legislation;  in  others,  commissions 
pass  upon  such  applications  and  decide  whether  the  pubhc  wel- 
fare requires  the  issuance  of  the  desired  charter;  while  in  other 
states  such  corporations  are  chartered  under  the  provisions  of 
general  laws. 

§  203.     (3)  Financial  Corporations 

Experience  has  shown  that  it  is  unsafe  to  allow  irresponsible 
parties  to  incorporate  and  conduct  banks,  trust  companies, 
savings  institutions,  and  similar  associations  dealing  with  the 
funds  of  others.  Hence  institutions  of  this  sort  are  now  so 
hedged  about  with  restrictions  and  limitations  that,  in  a  measure 
at  least,  their  conduct  is  confined  to  reputable  and  responsible 
people.  Their  safety  is  also  partially  assured  by  stringent  rules 
as  to  the  payment  of  stock  subscriptions  in  cash  before  business 
is  commenced,  and  as  to  the  liabihty  of  their  stockholders  there- 
after. In  national  banks  and  in  many  state  banks  a  stock- 
holder's liability  is  equal  to  the  face  value  of  his  stock,  thus 
nominally  placing  $200  behind  each  $100  of  stock  as  security 
for  the  deposits  and  other  liabilities  of  such  institutions.  In 
many  cases  this  extra  $100  is  paid  in  and  used  as  surplus. 

Usually  charter  applications  for  financial  corporations  must 
be  approved  by  some  department  or  official  of  the  state;  and 
after  incorporation  their  affairs  are  subject  to  the  inspection  and 
supervision  of  the  state  officials,  and  their  officers  are  required 
to  make  regular  reports  of  their  business  and  financial  condition. 
National  banks  are  under  the  jurisdiction  of  the  United  States 
laws  and  are  not  subject  to  this  supervision  and  regulation  from 
the  authorities  of  the  state  in  which  they  operate. 

Speaking  generally,  both  public  utility  corporations  and 
financial  institutions  chartered  by  the  state  are  subject  to  the 


170  CORPORATE  LAW  [Bk.  I- 

usual  statute  law  regulating  stock  corporations,  and  in  addition 
to  such  special  legislation  as  may  affect  them.  If  doing  business 
in  other  states,  they  would  be  governed  by  the  local  regulations 
affecting  such  foreign  corporations. 

§  204.    Charter  Details 

When  a  corporation  is  to  be  organized,  all  the  important 
features  which  are  pecuHar  to  the  new  corporation  and  which  are 
not  secured  to  it  by  the  common  law  or  are  necessarily  incident 
to  incorporation,  should  appear  in  its  charter.  These  are  usually 
the  name,  purposes,  duration,  location,  capitalization  and  the 
details  thereof;  also  in  some  states  the  number  of  directors  and 
the  names  of  those  who  are  to  act  for  the  first  year,  and  any 
desired  special  provisions  that  can  be  made  a  permanent  part  of 
the  corporate  organization  under  the  laws  of  the  state  of  incor- 
poration. Temporary  or  less  important  details  may  be  left  for 
by-law  or  other  regulation,  but  all  matters  of  permanence  or 
importance  should  appear  in  the  charter  as  far  as  possible.  The 
statutes  usually  require  the  main  features  outlined  above  to 
appear  in  the  charter.  ^ 

In  New  York,  New  Jersey,  and  some  other  states,  special 
provisions  may  be  inserted  in  the  charter  for  the  regulation  and 
conduct  of  the  corporate  business  and  affairs  and  for  any  proper 
limitations  on  the  powers  of  its  officials.  This  leaves  wide  scope 
for  the  insertion  of  such  provisions  and  many  varying  arrange- 
ments result  from  this  freedom. 

§  205.    Application  for  Charter 

Special  charters  are  prohibited  by  constitutional  provision  in 
a  number  of  states.  Where  not  prohibited  they  are  secured 
by  application  to  the  legislature.  In  such  case  the  charter  ap- 
plication is  put  in  the  form  of  an  act  declaring  that  certain  named 
parties  and  their  successors  are  a  body  corporate  for  the  purposes 
enumerated.     This  act,  if  passed  by  the  legislature,  becomes 


«  See  Book  IV,  Ch.  I,  "Charter  Forms." 


Ch.  20]  CHARTER— GENERAL  CONSIDERATIONS  17 1 

the  charter  of  the  company  and  is  its  sole  authority  for  existence 
and  operation. 

The  granting  of  special  charters  is  a  source  of  grave  abuses, 
and  in  many  states,  as  already  said,  is  prohibited  by  constitu- 
tional provisions.  In  other  states,  however,  as  in  New  York, 
such  charters  are  still  granted,  and  charters  may  be  secured 
either  under  the  general  corporation  laws  or,  where  sufficient 
influence  exists,  by  direct  appeal  to  the  legislature. 
1  In  all  the  states  general  laws  have  been  passed  prescribing 
the  method  whereby  charters  may  be  secured.  These  laws  are 
modified  by  special  additional  requirements  in  the  case  of 
financial  and  public  utility  corporations.  Under  the  provisions 
of  such  general  laws,  when  due  and  proper  application  is  made 
with  payment  of  the  proper  fees,  the  secretary  of  state  must 
issue  a  charter  in  accordance  with  the  terms  of  the  application, 
or  if  actual  issuance  of  the  charter  is  not  required,  the  official 
acceptance  and  filing  of  the  application,  ipso  facto,  authorizes  the 
parties  to  organize  as  a  corporation. 

This  is  the  usual  procedure  under  which  the  great  majority 
of  modern  business  corporations  come  into  existence.  It  is  a 
matter  of  right,  not  of  favor,  and  is  available  equally  for  all 
qualified  persons  who  choose  to  comply  with  the  necessary 
formalities  and  pay  the  required  fees. 


CHAPTER  XXI 
CHARTER— INCORPORATORS 

§  206.    Who  May  Incorporate 

Corporations  are  creatures  of  the  law.  They  derive  their 
right  to  existence  either  from  direct  legislative  enactment  or 
from  the  general  laws  under  which  they  are  formed.  Therefore, 
only  those  may  incorporate  who  are  expressly  authorized  thereto 
by  these  special  acts  or  imder  these  general  laws.  In  each  state 
the  statutes  must  be  consulted  in  order  to  ascertain  definitely 
just  who  may  participate  in  any  proposed  incorporation. 

Usually  the  statutes  authorizing  incorporations  employ  the 
term  "persons"  or  "natural  persons"  in  prescribing  who  may 
incorporate.  This  wording  excludes  a  firm,  a  corporation,  or 
anyone  acting  in  a  representative  capacity.  Any  of  these  might 
hold  stock  in  the  corporation  when  organized,  but  could  not 
legally  act  as  an  incorporator.! 

As  the  charter  is  in  effect  a  contract,  a  person  unable  to  con- 
tract cannot  properly  act  as  an  incorporator.  This  is  a  matter 
of  common  law  and  excludes  minors,  persons  of  unsound  mind, 
and  others  similarly  incompetent  to  contract.  Under  the  old 
common  law  it  would  also  exclude  married  women,  but  this 
disability  has  been  generally  removed  and  married  women  fre- 
quently act  as  incorporators. 

In  some  states  one  or  more  of  the  incorporators  must  be 
citizens  of  the  state  of  incorporation.  Unless  this  is  expressly 
prescribed,  any  person  otherwise  competent  can  act,  whether  a 
citizen  of  the  state  or  not.  Incorporators  need  not  even  be  cit- 
izens of  the  United  States  unless  expressly  required  by  the  stat- 


1  Schwab  V.  Potter,  194  N.  Y.  409,  416  (1909);  Converse  v.  Emerson,  Talcott  &  Co.,  148 
111.  App.  604  (1909). 

172 


Ch.  2i]  CHARTER— INCORPORATORS  173 

utes.  In  New  York,  at  least  one  of  the  incorporators  must  be  a 
resident  of  the  state,  and  two-thirds  of  the  total  number  must 
be  citizens  of  the  United  States.  In  New  Jersey  none  of  the 
incorporators  need  be  citizens  either  of  the  state  or  of  the 
United  States. 

It  must  be  borne  in  mind  that  each  state  has  the  entire 
right  to  impose  any  qualifications  on  incorporators  that  its  legis- 
lators deem  desirable,  and  that  there  is  no  appeal  from  such 
statutory  requirements.  Usually,  however,  the  matter  is  not  of 
great  importance,  since,  if  any  of  the  proposed  incorporators 
are  barred  by  statute  requirements,  a  substitute  may  be  ap- 
pointed who  is  qualified,  and  who  will  act  up  to  such  point  as  is 
necessary  or  desirable  and  then  transfer  his  subscription  and  all 
his  rights  to  the  party  for  whom  he  has  been  acting.  This 
utilization  of  "dummy"  incorporators  for  the  preliminary 
organization,  is  a  common  procedure.^  . , 

:  KJli 

§  207.    Number  of  Incorporators  .noi/nr/aoa  io  notUm  r. 

In  every  state  the  minimum  number  of  incorporators  is 
prescribed  by  statute.  In  most  states  this  minimum  is  three, 
though  in  a  few  states  five  are  required.  No  maximum  number 
is  designated  in  any  state,  this  feature  being  a  matter  of  no  im- 
portance from  the  standpoint  of  the  state. 

As  a  general  rule  it  is  advisable  to  incorporate  with  the  min- 
imum number  of  incorporators  permitted  by  the  statutes. 
Usually  each  incorporator  must  sign  and  acknowledge  the  charter 
application,  and  must  either  sanction  or  participate  in  the  first 
meeting,  and  these  proceedings  are  much  facilitated  by  a  small 
number  of  incorporators.  At  times  different  interests  must  be 
represented  in  an  incorporation  and  the  subsequent  organiza- 
tion, and  a  considerable  number  of  incorporators  is  therefore 
unavoidable;  but  without  some  such  reason  the  minimum 
number  is  to  be  preferred. 

'See  I  210.  dt0l;i>- 


174  CORPORATE  LAW  [Bk.  I- 

§  208.    Functions  of  Incorporators  u;  ,.1..//  taVi  ni     .rr»ju 

The  incorporators  furnish  the  nucleus  about  which  the  hew 
corporation  is  formed,  and  are  the  active  agents  in  bringing  it 
into  existence.  They  are  essential  participants  in  the  formalities 
incident  to  the  creation  of  the  corporation.  They  must  usually 
sign  and  acknowledge  the  charter  and  are  generally  required  to 
be  subscribers  to  the  stock  of  the  corporation.  They  call  and 
conduct  the  first  meeting.  The  organization  of  the  corporation 
is  usually  entirely  in  their  hands,  though  in  case  they  are  not  the 
real  parties  in  interest,  i.e.,  are  "dummy"  incorporators  acting 
for  others,  the  organization  and  first  proceedings  will  be  pre- 
scribed for  them  in  advance. 

It  will  be  seen  that  the  only  necessary  function  of  the  incor- 
porators is  to  figure  in  certain  formalities  incident  to  the  forma- 
tion of  the  new  corporation.  They  may  be  the  real  parties  in 
interest  who  will  remain  with  and  own  stock  in  the  new  corpora- 
tion, or  they  may  be  "dummy"  incorporators,  called  in  merely  as 
a  matter  of  convenience  or  for  more  cogent  reasons,  without 
interest  in  the  corporation  beyond  their  perfunctory  subscription 
for  one  or  more  qualifying  shares — an  interest  that  is  usually 
assigned  to  the  real  parties  in  interest  so  soon  as  the  corporation 
is  once  organized  and  ready  to  begin  its  operations, 

§  209.    Incorporators  as  Stockholders 

It  is  usual  for  incorporators  to  be  subscribers  for  one  or  more 
shares  of  stock  in  the  proposed  corporation.  In  most  of  the 
states,  such  subscription  is  either  required,  or  it  is  assumed  that 
such  subscription  will  be  made.  If  not  either  directly  or  infer- 
entially  required  by  the  statutes,  such  subscription  is  not 
essential. 

When  an  incorporation  is  effected  with  incorporators  who  do 
not  desire,  or  are  not  desired,  to  remain  as  permanent  stock- 
holders, it  is  usual,  after  the  organization  has  been  completed, 
for  the  incorporators  to  assign  their  subscription  rights  or  their 
stock  to  those  parties  who  are  to  be  the  real  owners  of  the  cor- 


Ch.  2i]  CHARTER— INCORPORATORS  17 5 

poration.  These  latter  assume  the  obligations  of  the  incorpora- 
tors on  the  assigned  subscriptions  of  stock,  and  if  the  transaction 
is  acquiesced  in  by  the  corporation,  it  is  then  legally  complete 
and  the  original  incorporators  are  in  most  states  discharged  from 
any  subscription  obligations  either  to  the  corporation  or  to  cor- 
porate creditors.* 

§  210.    Dummy  Incorporators  i,,>i  i.-jd^u^iiwij  mua,/ 10 

As  has  been  stated,  any  competent  person  may  join  in  an 
incorporation  without  any  material  or  permanent  interest  in  the 
matter,  and  such  non-interested  or  "dummy"  incorporators  are 
frequently  employed.  Sometimes  this  is  done  where  the  real 
parties  in  interest  do  not  deem  it  advisable  to  appear  as  incor- 
porators; sometimes  of  necessity  because  of  the  absence  of  the 
principals;  and  sometimes  purely  as  a  matter  of  convenience, 
the  real  parties  concerned  being  disinclined  or  too  busy  to  under- 
take themselves  the  technical  duties  of  incorporators. 

In  such  cases  the  dummy  incorporators  execute  the  charter 
and  organize  the  corporation,  usually  subscribing  for  the  smallest 
number  of  shares  that  will  satisfy  the  statute  requirements,  and 
carrying  the  organization  to  such  point  as  the  real  parties  in 
interest  or  their  attorneys  indicate.  The  "dummies"  then 
assign  their  subscription  rights  or  stock,  resign  any  official  posi- 
tions they  may  hold  in  the  new  corporation,  and  step  out. 

Such  an  incorporation,  if  properly  conducted,  is  entirely 
legal,  and  the  method  is  that  pursued  in  the  formation  of  almost 
all  the  larger  corporations  and  combinations.  The  proceedings 
are,  as  a  matter  of  course,  supervised  and  ordinarily  conducted  by 
the  attorneys  of  the  parties  really  interested,  these  attorneys 
dictating  all  that  is  done  and  seeing  that  the  interests  of  their 
clients  are  properly  conserved.  The  proceeding  is  carried  as 
far  as  the  conditions  render  advisable  before  the  dummy  incor- 
porators make  way  for  their  principals.     Usually  they  fully 


'  I  Cook  on  Corp.,  §  255,  and  cases  cited. 


176  CORPORATE  LAW  'Bk.  I-, 

complete  the  organization  of  the  corporation,  electing  themselves 
directors  and  officials,  or  perhaps  electing  to  the  official  positions 
the  parties  who  are  to  be  permanent  incumbents.  Meanwhile; 
they  usually  take  action  of  the  greatest  moment  to  the  future 
of  the  new  organization. 

The  organization  of  the  United  States  Steel  Corporation  was 
effected  in  this  way.  Three  incorporators  were  provided,  each 
of  whom  subscribed  for  ten  shares  of  stock  out  of  a  total  capitali-^ 
zation  of  but  $3,000.  As  soon  as  the  organization  of  the  new 
corporation  was  completed,  the  incorporators  were  retired,  the: 
real  parties  in  interest  came  in,  and  the  capitalization  was  in- 
creased to  $1,100,000,000. 

In  such  cases  the  incorporators  are  usually  the  junior  counsel, 
and  clerks  in  the  offices  of  the  attorneys  having  the  incorpora-, 
tion  in  charge.     As  stated,  if  the  incorporators  are  properly 
quaUfied  and  the  proceedings  are  conducted  in  accordance  with, 
the  statutory  requirements,  there  is  no  question  as  to  the  legality, 
of  the  use  of  dummy  incorporators,  even  where  properties  of  large 
value  are  taken  over  for  the  corporation  by  these  irresponsible 
parties. 


CHAPTER  XXII 
CHARTER— THE  CORPORATE  NAME 

§211.    Selection  of  Name  '^''•'  '^^^' 

,,  The  selection  of  the  corporate  name  is  frequentty  a  matter 
of  considerable  importance,  though  usually  governed  by  business 
considerations  rather  than  legal  rules.  As  a  matter  of  both 
taste  and  business,  a  name  should  be  selected  that  is  distinctive, 
not  too  long,  and,  if  possible,  expressive  of  the  business  to  be 
done  by  the  corporation.  The  selected  name  shou  d  not  be 
fraudulent  or  misleading,  nor  should  it  infringe  on  the  rights 
of  others.! 

In  the  incorporation  of  a  partnership,  the  general  usage  is 
to  retain  the  partnership  name  with  only  such  changes  as  will 
indicate  the  corporate  organization.2 

In  most  states  great  latitude  is  allowed  in  the  selection 
of  the  corporate  name,  the  prohibition  against  conflicting 
names  being  practically  the  only  restriction.  If  not  required 
by  statute,  the  use  of  the  prefix  "The"  is  to  be  avoided  as 
unnecessarily  lengthening  the  name  and  producing  a  peculiarly 
awkward  effect  in  legal  instruments  when  the  name  is  used 
following  the  word  "said,"  as  is  frequently  the  case. 

Hackneyed  names  such  as  "Standard,"  "Union,"  "National," 
etc.,  as  well  as  much-used  geographical  names,  are  to  be  avoided, 
both  as  a  matter  of  taste  and  business.  No  trade-name  rights 
can  ordinarily  be  secured  in  such  well-worn  designations,  though 
in  some  cases  the  first  user  of  a  geographical  name  will  be  protected 
in  the  right  where  it  has  been  used  over  a  period  of  years. » 


'  I  Machen  on  Corp.,  J  450;  Von  Thodorvich  v.  Beneficial  Assn.,  154  Fed.  911  (1907). 

'  Columbia  Mill  Co.  v.  Alcorn,  150  U.  S.  460  (1893);  Coming  Glass  Works  v.  Coming  Cut 
Glass  Works,  197  N.  Y.  173  (1900). 

'  Kayser  &  Co.  v.  Italian  Silk  Underwear  Co.,  160  App.  Div.  (N.  Y.)  607  (1914);  British- 
American  Tobacco  Co.  v.  British- American  Cigar  Stores  Co.,  211  Fed.  933  (1914). 

177 


178  CORPORATE  LAW  [Bk.  I- 

§  212.    How  Secured 

The  name  of  the  proposed  corporation  must  be  set  forth 
specifically  in  its  charter  application.  This  name,  so  soon  as 
the  application  is  allowed,  becomes  the  name  and  property  of 
the  new  corporation.  In  the  state  of  incorporation  the  right 
to  such  name  is  exclusive. 

If  the  desired  name  were  the  same  as  that  of  some  other 
domestic  corporation  or  foreign  corporation  licensed  to  do 
business  within  the  state,  or  so  nearly  the  same  as  to  cause 
confusion,  that  fact  alone  would  be  ground  for  the  rejection 
of  the  charter  application. 

But  few  statutory  restrictions  exist  in  regard  to  the  cor- 
porate name.  The  prohibition  against  the  adoption  of  a  name 
similar  to  that  of  a  corporation  already  doing  business  under  the 
state  laws  is  the  most  important.  In  some  states  the  prefix 
"The"  must  be  used  to  introduce  the  corporate  appellation; 
in  some  states  "Corporation,"  "Company,"  "Association," 
or  some  other  word  expressing  the  idea  of  corporate  association 
must  be  used  in  the  corporate  name.  In  some  few  states  the 
word  "Incorporated"  or  "Limited"  must  follow  the  corporate 
designation. 4  In  New  York  every  corporation  must  use  such 
word  or  words,  abbreviations,  affix,  or  prefix  as  will  distinguish 
it  from  a  natural  person,  firm,  or  copartnership.  In  191 2  a 
lower  court  refused  to  allow  an  existing  corporation  to  change 
its  name  to  one  ending  in  "Company."  Since  then  the  state 
authorities  refuse  to  charter  any  corporations  with  a  name 
terminating  in  "Company,"  unless  followed  by  "Inc." 

In  most  of  the  states  insurance  and  moneyed  corporations, 
and  in  many  states  co-operative  corporations,  must  be  organized 
under  special  statutes,  and  in  these  states  the  statutes  usually 
provide  that  the  corporation  not  organized  under  the  special 
laws  shall  not  use  the  words  "Trust,"  "Bank,"  "Insurance," 
"Co-operative,"  and  like  words  in  their  corporate  titles. 


*  I  Machen  on  Corp.,  S  449,  and  notes. 


Ch.  22]  CHARTER— CORPORATE  NAME  1 79 

The  state  authorities  would  have  no  right  to  refuse  a,  charter 
application  on  the  ground  that  some  foreign  corporation  not 
licensed  by  the  state  is  using  the  selected  name.  In  such  event 
the  charter  application,  if  no  other  objection  existed,  must  be 
allowed,  leaving  the  right  to  use  the  name  to  be  settled  between 
the  two  corporations. 

§  213.    Right  to  Corporate  Name 

One  important  object  of  incorporation  is  to  secure  per- 
manence, and  the  corporate  name  is  an  almost  essential  element 
of  this  desired  commercial  continuity.  Once  established,  the 
name  is  the  embodiment  of  the  good-will  of  the  enterprise 
and  has  a  value  in  accordance.  If  the  corporation  is  properly 
managed  and  is  successful,  this  value  is  frequently  very  con- 
siderable. In  some  instances  it  is  the  chief  asset  of  a  prosperous 
business. 

The  corporation's  right  to  its  name  is  the  same  as  to  any 
other  trade-mark  or  trade-name  possessed  by  it,  and  is  generally 
more  easily  established.  If  the  name  is  used  by  other  parties 
without  authority,  such  use  may  be  stopped  by  injunction,  and 
if  damage  can  be  shown,  an  action  will  lie  against  the  offending 
parties.  3  The  same  rule  applies  whether  the  infringement  is 
by  another  corporation  or  by  the  adoption  of  a  trade-name  by 
an  individual  or  partnership.  ^  A  corporation  cannot  take  the 
name  of  an  existing  copartnership,  where  this  would  result  in 
injury  to  the  partnership.  If  it  does  take  such  a  name  it  may  be 
enjoined.  7 

As  has  been  stated, '  there  is  usually  no  statute  restriction 
against  the  adoption  of  the  name  of  a  foreign  corporation 
by  a  domestic  corporation  if  such  foreign  corporation  has  not 
been  licensed  to  operate  in  the  state.  The  allowance  of  such 
name  would  not,  however,  give  the  new  corporation  an  un- 


'  Higgins  Co.  v.  Higgino  Soap  Co.,  144  N.  Y.  462  (i8ps);  Coming  Giass  Works  v.  Coming 
Cut  Glass  Co.,  197  N.  Y.  173  (1910);  Salvation  Amiy  v.  Am.  Salvation  Araiy,  13s  A.  D.  (N.  Y.) 
268  (1909). 

•  German-Amer.  Button  Co.  v.  Heymsfeld.  170  App.  Div.  (N.  Y.)  416  (i9is)i        .. 

»  Pettes  V.  Am.  W.  C.  Co.,  89  A.  D.  (N.  Y.)  34S  (1903).  'in*  J  *' 


i8o  CORPORATE  LAW  [Bk.  I- 

questioned  right  to  its  use.  If  the  older  corporation  could  show 
that  it  had  a  trade  right  in  the  name,  and  that  the  use  of  the 
name  by  the  new  corporation  would.be  injurious  to  this  right, 
and  would  permit  it  to  compete  unfairly,  the  new  corporation 
might  be  enjoined  from  the  use  of  such  name,  and,  if  the  injunc- 
tion should  be  sustained,  would  be  compelled  either  to  secure 
a  new  name  by  due  and  formal  procedure  or  to  discontinue 
its  operations. 8 

In  New  York  a  foreign  corporation  will  be  refused  ad- 
mittance to  the  state  on  the  ground  that  another  corporation  is 
doing  business  under  the  same  or  a  similar  name ;  but  in  North 
Carolina,  under  a  ruling  of  the  Attorney-General,  foreign  cor- 
porations will  not  be  excluded  from  the  state  because  another 
corporation  is  already  doing  business  under  the  same  name.^ 

Where  confusion  in  delivery  of  mail  results  from  similarity 
of  corporate  names,  the  courts  favor  the  corporation  that  first 
lawfully  used  the  name.i* 

§  214.    Changing  the  Corporate  Name 

Occasionally  it  becomes  necessary  or  expedient  to  change 
the  corporate  name.  It  may  be  that  the  use  of  the  name  first 
adopted  is  prevented  by  injunction,  or  new  interests  may  have 
come  in,  that  as  a  matter  of  business  poHcy  must  be  represented 
in  the  corporate  name,  or  possibly  the  corporation  has  been 
unsuccessful  or  has  achieved  a  bad  reputation,  and  the  adoption 
of  a  new  name  is  thought  desirable.  In  any  such  case  the  name 
may  usually  be  changed  but  only  with  the  permission  and  sanc- 
tion of  the  state.  In  many  states  the  change  of  name  must  be 
secured  by  an  amendment  to  the  charter,  which  is  a  more  or  less 
troublesome  operation  according  to  the  statutory  requirements 
of  the  particular  state.     Other  more  or  less  troublesome  pro- 


« Benevolent  Order  of  Elks  v.  Improved  Benevolent  Order,  etc.,  205  N.  Y.  459  (1912); 
Hoevel  Sandblast  Machine  Co.  v.  Hoevel  S.  M.  Co.  of  N.  Y.,  Inc.,  167  App.  Div.  (N.  Y.)  548 
(1915). 

»  Atty.-Gen.'s  opinion.  Biennial  Report,  1913-14,  p.  92. 

"  Central  Trust  Co.  v.  Central  Trust  Co.  of  Ill.,.i49  Fed.  789  (1906). 


Ch.  22]  CHARTER— CORPORATE  NAME  l8i 

ceedings  obtain  in  different  states,  as  in  New  York  where  formerly 
the  only  method  of  changing  the  corporate  name  was  by  formal 
court  proceedings. 

The  formalities  incident  to  a  change  of  corporate  name 
are  so  great  that  in  some  cases  it  is  simpler  and  no  more  ex- 
pensive to  organize  a  new  corporation  and  transfer  to  it  the 
assets  of  the  existing  corporation,  than  to  take  the  time  and 
trouble  incident  to  a  change  of  name  by  the  regular  procedure. 
In  such  a  case,  from  the  legal  standpoint  the  old  company 
has  ceased  to  exist  and  a  new  company  has  come  into  existence. 
A  mere  change  of  name,  on  the  other  hand,  does  not  affect  the 
identity  of  the  corporation.!! 


"  Allen  V.  M.  E.  Church,  127  Iowa  96  (1905);  N.  B.  Lumber  Co.  v.  Sims  &  White,  iS7 
Ala.  S9S  (1908);  Carton  v.  City  Savings  Bank,  82  Neb.  582  (1908). 


q^ii/H  ai,\i 


CHAPTER  XXIII 
CHARTER— THE  CORPORATE  PURPOSES 

§  215.    General 

An  individual  or  firm  may  do  anything  or  engage  in  any 
form  of  business  not  prohibited  by  the  laws.  A  corporation, 
on  the  contrary,  may  do  only  those  things  and  engage  in  those 
businesses  permitted  it  by  the  law  and  set  forth  in  its  charter. 
This  renders  it  important  that  the  charter  should  clearly  and 
fully  empower  the  corporation  to  do  all  those  permissible  things 
that  may  be  necessary  in  its  operations. 

Usually  the  general  corporation  laws  in  each  state  specify 
the  purposes  for  which  corporations  may  be  organized.  In 
some  states  these  purposes  are  limited  to  certain  classes  of 
pursuits,  and  corporations  cannot  be  formed  for  purposes  not 
specifically  included.  Mining  and  manufacturing  corporations 
are  authorized  in  all  states.  In  most  states  the  laws  specify 
mercantile  and  trading  corporations  as  well.  Some  states  go 
still  further  and  broadly  authorize  the  formation  of  corporations 
for  "any  lawful  business,"  "any  lawful  industry  or  pursuit," 
or  for  "pecuniary  profit." 

Under  these  latter  clauses  it  would  be  difficult  to  discover 
any  legitimate  calling  or  pursuit  that  could  not  be  undertaken 
by  a  corporation.  The  tendency  of  the  present  day  is  towards 
liberality  in  this  respect  and  the  few  limitations  that  do  exist 
are  gradually  being  removed. 

§  216.    Single  Purpose 

Formerly  the  rule  was  to  organize  corporations  for  a  single 
purpose,  as  to  mine  for  copper,  to  manufacture  shoes,  or  to 
conduct  a  trading  business  in  some  specified  line.    The  authori- 

183 


Ch.  23]  CHARTER— CORPORATE  PURPOSES  1 83 

zation  for  this  one  purpose  would,  as  a  matter  of  course,  carry 
the  right  with  it  to  do  all  things  necessary  or  proper  to  effect 
that  purpose,  but  nothing  further.  If  another  line  of  business 
were  to  be  taken  up,  a  new  corporation  must  be  organized, 
as  the  powers  of  the  old  corporation  could  not  be  extended  to 
cover  the  new  pursuit.  That  is,  if  the  members  of  the  copper 
mining  company  wished  to  mine  for  the  precious  metals  also, 
they  could  not  secure  specific  authorization  thereto  for  the  old 
company,  but  must  organize  a  new  company  for  the  purpose. 

This  rule  is  now  almost  abrogated.  In  a  few  states  it  is 
still  the  law  and  a  corporation  will  not  be  chartered  for  more 
than  one  purpose,  but  generally  a  corporation  will  be  em- 
powered for  as  many  legitimate  purposes  as  may  be  included 
in  the  charter  application.  In  some  few  cases,  however,  it 
is  still  advantageous  to  confine  the  corporate  activities  to  one 
specific  purpose.  For  instance,  if  a  partnership  is  incorporated, 
it  may  be  advisable  to  restrict  it  to  the  purposes  of  the  business 
already  under  way.  This  would  prevent  any  subsequent  diver- 
sion of  the  corporate  activity  and  resources  into  other  and 
possibly  dangerous  channels.  The  corporation  could  conduct 
the  one  business  and  that  alone.  It  would  have  no  power  to 
venture  into  new  and  untried  fields. 

§  217.    Comprehensive  Purposes 

At  the  present  time  the  tendency  in  corporate  organization 
is  towards  comprehensive  purposes — purposes  that  will  permit 
the  corporation  to  undertake  and  operate  any  line  of  business, 
in  any  part  of  the  world,  and  under  any  conditions.  It  is  the 
natural  desire  to  secure  all  powers  and  privileges  that  may  be 
had — not  that  they  are  all  needed  or  are  to  be  exercised,  but 
unforeseen  opportunities  may  occur  when  these  powers  will  be 
required.  Incorporators  are  pleased  with  these  extensive  arrays 
of  possible  activities,  investors  and  interested  parties  generally 
expect  them,  and  as  their  inclusion  is  a  matter  of  little  difficulty, 
nearly  all  modem  charters  enumerate  almost  every  conceivable 


1 84  '  '    '  CORPORATE  LAW      H   !•/  !    '  [Bk.  I- 

branch  of  business  and  every  kind  of  enterprise  allowable  under 
the  statutes. 

In  some  cases  this  has  been  carried  to  an  absurd  extreme, 
but  in  general  the  practice  has  its  advantages.  There  is  no 
good  reason  why  corporations  should  not  have  the  same  free 
range  of  business  activities  possessed  by  the  individual  or  firm, 
and  the  effort  of  the  present  day  is  to  approximate  as  nearly 
as  may  be  to  this  ideal.  '^  iitb-K]^.  oiuooz  )(m  DJuoo  -prtJ 

It  is  to  be  noted,  however,  that  this  end  could  be  attained 
with  equal  efficiency  and  with  much  less  trouble  and  verbosity 
by  a  few  general  statements  of  comprehensive  scope.  In  most 
cases  all  the  purposes  of  the  most  elaborately  extended  charter 
could  be  obtained  in  their  full  force  and  efficiency  by  a  few  well- 
turned  phrases. 

-  odi  offilnoD  ol  sue  •.  liiig  fci 

§218.    Illegal  Purposes 

No  state  allows  the  organization  of  a  corporation  for  illegal 
or  immoral  purposes.  Where  state  officers  inadvertently  or  by 
intent  allow  charters  for  such  purposes,  the  authorization  of  these 
charters  is  void  and  ineffective  and  will  not  protect  the  stock- 
holders from  any  penalties  and  liabilities  that  would  be  visited 
upon  the  members  of  a  partnership  engaged  in  similar  under-' 
takings. 

This  would  apply  to  any  business,  occupation,  or  organiza- 
tion in  direct  violation  of  the  laws  of  the  state  of  incorporation, 
such  as  lotteries,  gambling,  and  combinations  in  restraint  of 
trade. 1 

Apart  from  these  manifestly  illegal  or  immoral  undertakings, 
any  business  purposes  not  allowed  to  corporations  under  the 
laws  of  the  state  are  illegal.  A  charter  for  any  such  purpose, 
even  if  allowed  by  the  state  officials,  would  be  ineffective  and 
the  stockholders  would  be  held  as  partners  in  case  of  the  in- 
solvency of  the  enterprise.    This  does  not  often  happen  at  the 


»  Peabody  v.  Gas  Triist  Co.,  130  111.  268  (1889);  McGrew  v.  City  Produce  Exchange,  85 
Tenn.  573  (1886). 


th.  23]  CHARTER—CORPORATE  PURPOSES  185 

present  day,  as  most  of  the  states  allow  incorporation  for  all 
proper  purposes  and  the  possibility  exists  only  in  those  states 
where  corporate  purposes  are  still  restricted.^ 

Also  it  is  to  be  noted  that  if  some  of  the  purposes  are  legiti- 
mate and  proper  and  some  unauthorized,  the  charter  is  good  as 
to  the  legitimate  portions  but  is  held  non-effective  and  non- 
existent in  those  portions  unauthorized  or  in  conflict  with  the 
laws.  The  laws  cannot  be  added  to  or  be  overridden  by  a 
charter  provision.s 

§  219.    Things  "Ultra  Vires" 

Things  otherwise  legal,  but  not  specified  or  implied,  among 
the  charter  powers  of  the  corporation,  are  beyond  its  powers, 
or  ultra  vires.  Contracts  made  in  pursuance  of  such  unauthor- 
ized ends  cannot  be  enforced  against  others,  although  the 
corporation  itself  is  usually  bound.  Directors  and  officers 
may  make  themselves  personally  liable  either  to  the  corpora- 
tion, to  its  stockholders,*  or  to  third  persons,  for  involving  the 
corporation  in  such  transactions,  s 

Both  creditors  and  stockholders  have  the  right  to  object 
to  any  action  of  the  corporation  exceeding  its  legal  powers. 
If,  however,  the  stockholders  assent  and  there  are  no  creditors, 
there  is  no  one  to  object  to  the  exercise  of  powers  not  authorized 
by  its  charter,  and  the  corporate  powers  may  be  exceeded  without 
danger  to  the  officers  and  directors. 

Owing  to  the  broad  powers  that  are  now  usually  granted, 
the  doctrine  of  ultra  vires  has  much  less  importance  than  for- 
merly.    A  modem  work  on  corporations  says : 

The  old  theory  of  a  corporation  was  that  it  coxild  not  legally 
do  anything  in  excess  of  its  express  or  implied  powers.     But  the 


»  Amer.  Trust  Co.  v.  R.  R.  Co.,  157  111.  641  (1895);  Oregon  R.  R.  Co.  v.  Oregonian  Ry. 
Co.,  130  U.  S.  I  (1888);  Johnson  v.  Northern  Trust  Co.,  265  111.  263  (1914). 

'  Peabody  v.  Gas  Trust  Co.,  130  111.  268  (1889);  Straacke  v.  Routledge,  17s  S.  W.  (Tex.) 
444  (1915). 

•Greenfield  Savings  Bank  v.  Abercrombie,  211  Mass.  232  (1912);  McKinnon  v.  Morse 
et  al.,  177  Fed.  576  (1910). 

'  3  Clark  &  Marshall  on  Corp.,  i  744d.  See,  however,  Linkhauf  v.  Lombard,  137  N.  Y. 
417  (1893). 


1 86  CORPORATE  LAW  [Bk.  I- 

modern  view  is  that  a  private  corporation  may,  if  all  its  stock- 
holders assent  and  if  creditors  are  paid.  Public  policy  does  not 
require  business  corporations  to  confine  themselves  strictly 
within  the  limits  of  the  words  of  their  charters.' 

In  case  the  corporation  does  exceed  its  powers  and  anything 
goes  wrong,  the  directors  and  officers  might  be  held  personally- 
responsible.  When  they  do  business  beyond  the  corporate 
powers,  they  take  an  uncalled-for  risk. 


■  I  Cook  on  Corp.,  !  3.     See  also  64  L.  R.  A.,  366  el  seq.,  onimplied  powers  of  corporations. 


CHAPTER  XXIV 
CHARTER— STOCK;  LOCATION  AND  DURATION 

§  220.    General  Provisions  as  to  Stock 

In  most  states  the  capital  stock  of  a  corporation  and  the 
divisions  and  general  features  of  this  capital  stock  must  be 
stated  in,  and  are  fixed  by,  the  charter.  In  a  few  states,  stock 
with  preference  or  other  special  features  may  be  issued  after 
the  allowance  of  the  charter,  by  specified  action  of  the  stock- 
holders, but  as  a  general  rule  everything  relating  to  the  stock 
is  fixed  once  for  all  by  the  charter  and  may  be  changed  there- 
after only  by  an  amendment  of  that  instrument. 

Usually  the  charter  states  the  full  amoimt  of  the  capital- 
stock,  its  division  into  common  and  preferred  stock  if  such 
division  exists,  the  number  of  shares  into  which  it  is  divided, 
and  the  par  value  of  each  share.  The  par  value  is  usually  the 
same  for  all  the  shares,  though  not  necessarily  so,  unless  re- 
quired by  statute  as  in  Cajifomia.  The  par  value  of  the  common 
stock  might  be  fixed  at  $io  per  share,  while  the  par  value  of  the 
preferred  stock  were  fixed  at  $ioo.  Generally  such  variations 
of  the  par  value  are  not  advisable. 

§  221.    Classifications  of  Stock 

Any  classifications  of  the  stock  should  be  very  clearly  set 
out  in  the  charter.  These  classifications  are  varied  and  numer- 
ous. The  most  usual  is  that  of  common  and  preferred  stock. 
This  preferred  stock  may  be  divided  into  different  classes  as  to 
precedence  in  dividends,  or  as  to  amount  of  dividend,  or  as  to 
participation  in  assets,  or  as  to  redemption  features,  or  as  to 
participation  in  dividends  beyond  preferred  dividends,  or  as  to 
voting  or  other  powers. 

187 


l88  CORPORATE  LAW  [Bk.  I- 

The  common  stock  is  sometimes  classified  in  regard  to 
voting  powers,  each  portion  or  class  having  the  right  to  elect 
a  certain  number  of  directors,  or  at  times  one  portion  of  the 
common  stock  may  be  given  the  sole  right  to  vote  upon  certain 
kinds  of  questions  or  under  certain  contingencies. 

Such  charter  classifications  are  not  allowable  in  all  of  the 
states,  but  the  same  result  may  be  attained  in  many  cases  by 
suitable  by-law  enactments  unanimously  adopted  at  the  first 
meeting  of  stockholders.  As  stated  by  Judge  Folger  of  the  New 
York  Court  of  Appeals: 

We  know  nothing  in  the  constitution  or  the  law  that  inhibits  a 

corporation  from  beginning  its  corporate  action  by  classifying  the    .dj 

shares  in  its  capital  stock,  with  peculiar  privileges  to  one  share  over    ,  ^^j 

another,  and  thus  offering  its  stock  to  the  public  for  subscriptions, 

thereto.^ 

in  \6  yjno  loJts 

§222.    Common  Stock  /jlnmM 

'  -^"    ■'■"]-• 
Usually    the    charter    provisions    affecting    common    stock 

are  few  and  simple.  For  example,  if  a  corporation  is  to  be 
capitalized  at  $100,000,  with  shares  of  the  par  value  of  $100, 
without  preferred  stock  or  classifications  of  the  common  stock, 
the  charter  would  merely  state  that  the  capital  stock  is  to  be 
$100,000  divided  into  1,000  shares  of  the  par  value  of  $100 
each.  Nothing  more  would  be  necessary.  The  fact  that  it 
was  all  common  stock,  that  this  was  unclassified,  and  that 
there  was  no  preferred  stock  or  restrictions  of  any  kind  on  the 
common  stock,  would  be  understood  without  specific  statement. 
If  there  are  to  be  any  classifications  of  the  common  stock 
or  any  restrictions  upon  it  in  any  way,  these  must  be  stated  in 
the  charter  specifically  and  in  detail.  The  mere  fact  that  com- 
mon stock  is  usually  unrestricted  renders  it  the  more  necessary 
to  be  clear  and  explicit  if  restrictions  are  to  be  created.  . .     ... 


•  Kent  V.  Quicksilver  Mining  Co.,  78  N.  Y.  159,  178  (1879);  also  Burke  v.  Gas  and  El.  Co., 
123  Pac.  (Kans.)  8S7  (1912);  Page  v.  Whittenton  Mfg.  Co.,  97  N-  E.  (Mass.)  1006  (1912)- 


Ch.  24]  CHARTER— STOCK  189 

§  223.    Preferred  Stock 

Preferred  stock,  by  its  mere  existence,  indicates  the  fact  that 
it  has  features  not  possessed  by  other  stock  of  the  corporation, 
but  the  differences  and  preferences  which  distinguish  it  should 
be  stated  as  clearly  as  possible  in  the  creating  clause,  and  so 
concisely,  if  it  may  be  done,  that  the  entire  clause  may  be  printed 
on  the  face  of  the  preferred  stock  certificates. 

It  should  be  borne  in  mind  that  unless  otherwise  provided 
by  the  charter,  preferred  stock  has  all  the  rights  of  common 
stock  in  addition  to  its  preference;  that  is,  it  would  vote,  par- 
ticipate in  any  dividends  in  excess  of  its  preferential  dividend, 
participate  in  any  distribution  of  assets  on  the  dissolution 
of  the  corporation,  and  generally  be  on  exactly  the  same  plane 
as  common  stock  except  as  to  the  indicated  preference  in  divi- 
dends. If  any  of  these  rights  are  to  be  denied  it,  such  denial 
must  be  clearly  expressed.  If  it  is  to  have  any  rights  other  than 
its  preference  dividends,  these  rights  must  also  be  clearly  indi- 
cated. Nothing  should  be  left  to  implication,  or  be  taken  for 
granted.2 

Location  and  Duration        ,',      ,^ 

§  224.    Domestic  and  Foreign  Corporations 

rt  Yhe  natural  locality  in  which  to  incorporate  a  company  is 
m  the  state  where  it  is  proposed  to  do  business  and  where  its 
plant  or  place  of  business  is  to  be  situated. 

In  its  own  state — the  state  in  which  it  is  incorporated — 
a  corporation  is  a  "domestic  corporation."  Elsewhere  it  is 
designated  a  "foreign  corporation."  In  its  own  state  it  usually 
enjoys  rights  and  privileges  not  accorded  a  foreign  corporation; 
hence,  unless  there  is  some  strong  reason  to  the  contrary,  it 
should  always  be  incorporated  in  the  state  in  which  the  larger 
part  of  its  business  is  to  be  done. 


9  See  Ch.  XI,  "Preferred  Stock.' 


19©  CORPORATE  LAW  [Bk.  I- 

§  225.    Selection  of  State 

The  usual  inducements  for  foreign  incorporation  are  the 
smaller  fees  and  taxes  of  the  selected  state.s  ' 

Unless  there  is  a  material  difference  in  favor  of  foreign 
incorporation,  it  should  be  avoided.  Corporations  organized 
outside  the  state  are  always  liable  to  adverse  discrimination, 
and  in  many  states  are  at  a  positive  disadvantage  in  event  of 
litigation.* 

§  226.    Principal  Office 

Usually  the  location  of  the  office  in  which  the  corporation 
is  to  have  its  headquarters  must  be  designated  in  the  charter 
application.  In  New  Jersey  and  most  of  the  other  states,  this 
principal  office  must  be  located  definitely.  In  New  York  the 
borough  and  county  in  which  the  principal  office  may  be  found 
must  be  given,  but  neither  then  nor  later  is  any  more  definite 
address  required.  This  renders  it  impossible  to  secure  the 
local  address  of  a  corporation  from  its  charter — a  seemingly 
serious  omission.  The  weight  of  authority  is  that  the  location 
of  the  principal  place  of  business  stated  in  the  charter  is  con- 
clusive for  the  purposes  of  taxation, s  jurisdiction  of  federal 
courts,^  and  other  purposes.' 

It  is  a  general  principle  of  law  that  stockholders'  meetings 
must  be  held  within  the  state  of  incorporation,  and  the  principal 
office  in  that  state  is  usually  designated  by  the  by-laws  as  the 
place  where  such  meetings  are  to  be  held.  One  or  two  states, 
by  statute  provision,  permit  stockholders'  meetings  to  be  held 
outside  the  state,  but  the  practice  though  convenient  in  some 
cases  is,  generally  speaking,  objectionable. » 

Meetings  of  both  stockholders  and  directors  are  usually 


•  See  Ch.  VIII,  "Cost  of  Incorporation." 

•  See  Ch.  VII,  "Where  to  Incorporate." 

•Union  Steamboat  Co.  v.  City  of  Buffalo,  82  N.  Y.  351    (1880);  Loyd's  Executorial 
Trustees.  V.  City  of  Lynchburg,  113  Va.  627  (1912). 

•  Lemon  v.  Imperial  Window  Glass  Co.,  199  Fed.  927  (1912). 
'  In  re  Federal  Contracting  Co.,  212  Fed.  688  (1914). 

''See  §§  394.  412,  420. 


Ch.  24]  CHARTER— LOCATION  AND  DURATION  I91 

held  in  the  principal  office  in  the  state  of  incorporation.  To 
allow  meetings  of  either  stockholders  or  directors  to  be  called 
elsewhere,  unless  in  places  formally  designated  by  the  by-laws 
or  agreed  to  by  all  parties  in  interest,  gives  opportunity  for 
grave  abuses.  The  by-laws  should  designate  the  principal 
office  and,  unless  there  is  good  reason  for  doing  otherwise, 
prescribe  that  all  corporate  meetings  be  held  therein. 

The  principal  office  in  the  state  of  incorporation  is-  usually 
designated  by  the  statutes  as  the  place  where  legal  process 
may  be  served  on  the  corporation. 

§  227.    Duration 

In  some  states  corporate  existence  is  limited  to  a  fixed 
period,  as  twenty  or  fifty  years.  In  most  of  the  states,  how- 
ever, the  duration  of  a  corporation  may  be  made  nominally 
perpetual.  This  unrestricted  duration  is  advantageous  and 
is  in  line  with  the  greater  HberaHty  manifested  towards  cor- 
porations in  later  years.  No  serious  objection  can  be  urged 
against  it,  the  reincorporations  necessary  in  the  short  period 
states  are  avoided,  and  the  general  stability  of  the  corporation 
is  improved. 

Where  corporate  existence  is  limited  by  statute,  the  extreme 
statutory  period  is  usually  selected  with  the  expectation  of  a 
reincorporation  at  its  end.  At  times  limited  periods  are 
preferred  for  the  corporate  existence  in  order  definitely  to 
limit  the  period  of  the  association  undertaking.  In  such  case, 
at  the  end  of  the  selected  term  the  corporation  expires  by  limita- 
tion, its  assets  are  distributed,  and  the  corporate  venture  is 
terminated.  Usually  such  distribution  is  made  under  some 
prearranged  plan  in  order  to  avoid  the  losses  and  injury  to  good- 
will of  a  forced  liquidation. 


-^.tll.UJ  !-      i  ■(  J  • 


CHAPTER  XXV 

CHARTER— THE  BOARD  OF  DIRECTORS 

§  228.     Qualifications 

At  common  law  it  was  not  required  that  directors  should 
be  stockholders.  In  most  states  this  has  been  modified  by 
statute  provisions  requiring  that  directors  hold  one  or  more 
shares  of  stock.  Such  provisions  do  not  apply — unless  ex- 
pressly so  stated — to  directors  named  in  or  appointed  by  the 
charter.  In  New  York  the  statute  requiring  directors  to  be 
stockholders  may  be  waived  by  proper  charter  or  by-law  pro- 
vision, and  persons  not  stockholders  may  then  be  selected  as 
directors  of  the  corporation. 

In  general  it  is  very  advisable  that  directors  should  be 
stockholders  of  the  corporation  in  which  they  act,  and  the 
liberality  of  the  laws  in  permitting  persons  who  are  not  stock- 
holders, or  who  hold  but  one  or  two  shares,  to  act  as  directors, 
is  not  in  the  best  interests  of  stockholders.  Occasionally  the 
privilege  may  be  advantageous,  but  as  a  general  rule  the  man- 
agement of  a  business  enterprise  cannot  safely  be  placed  in  the 
hands  of  those  having  no  material  interest  in  its  success,  and 
the  incorporation  of  an  enterprise  does  not  exempt  it  from  this 
rule. 

In  most  states  the  statutes  require  that  one  or  more  of  the 
directors  be  residents  of  the  state  of  incorporation.  In  such 
cases,  where  the  parties  really  interested  reside  in  other  states 
than  the  one  selected  for  incorporation,  resident  directors  must 
be  secured.  In  some  states,  as  New  Jersey,  Maine,  and  South 
Dakota,  this  has  led  to  the  organization  of  concerns  whose  sole 
business  is  supplying  of  resident  directors  and  the  representation 
of  outside  corporations  organized  within  the  state.     At  times 

IQ2 


Ch.  25]  CHARTER— BOARD  OF  DIRECTORS  193 

this  has  the  very  unexpected  result  of  giving  some  dummy 
director  the  deciding  vote  as  between  two  equally  divided 
factions  of  the  board.  A  recent  statute  in  New  York  makes  the 
added  requirement  that  at  least  one  of  the  directors  shall  be  a 
citizen  of  the  United  States. 

Unless  debarred  by  some  statutory  prohibition,  anyone 
capable  of  acting  as  an  agent  of  a  corporation  may  act  as  a 
director.  A  trustee,  or  an  executor  of  an  estate  consisting  in 
part  of  stock,  would  be  ehgible  as  a  director.  Under  the  modern 
statutes  removing  their  disabilities,  married  women  may  act  as 
directors.  Unless  expressly  prohibited  by  statute,  aliens  may 
act  as  directors.! 

§  229.    Number 

Some  limitation  upon  the  number  of  directors  is  usually 
imposed  by  the  statutes.  The  exact  nimiber  within  these  limits 
is,  in  most  states,  fixed  by  the  charter.  In  practically  all  the 
states  a  minimum  number  of  directors  is  fixed  by  the  statutes, 
though  in  many  no  maximum  number  is  prescribed.  3  i/a 

In  general  the  membership  of  the  board  should  be  fixed' 
at  the  lowest  number  that  will  permit  due  representation  of 
the  various  interests  involved  and  provide  for  the  proper  trans- 
action of  business.  In  small  or  close  corporations  it  is  usual 
to  select  the  minimum  number  of  directors  permitted  by  the 
statutes.  In  the  larger  corporations  more  directors  are  usually 
necessary  in  order  that  all  the  interested  parties  may  be  repre- 
sented, or  in  order  that  all  the  parties  really  concerned  in  the 
management  of  the  corporation  may  participate  in  the  delibera- 
tions and  actions  of  the  board.  Frequently  the  board  is  increased 
far  beyond  the  needs  of  management  in  order  to  secure  names 
that  will  attract  investors  and  add  to  the  financial  stability  of 
the  corporation  or  benefit  it  in  other  ways. 

If  the  number  of  directors  is  made  too  large  it  is  difficult 
to  secure  a  quorum,  meetings  are  apt  to  become  infrequent  and 

1  See  I  378. 


194  CORPORATE  LAW  [Bk.  I- 

perfunctory,  the  members  of  the  board  do  not  keep  in  touch 
with  its  business,  and  some  further  device  must  be  resorted  to 
for  the  real  conduct  of  the  business.  Under  such  circum- 
stances the  management  is  sometimes  left  in  an  irregular  way 
to  the  ofl&cers  and  a  few  actively  interested  directors;  usually, 
however,  the  difficulty  is  met  by  the  appointment  of  an  executive 
committee,  to  which  is  sometimes  added  a  finance  committee 
and  upon  occasion  other  special  committees.  These  committees 
then  exercise  the  powers  of  management  that  usually  pertain 
to  the  board.2 

For  the  business  operations  of  an  ordinary  corporation  a 
board  of  five  or  seven  members  actually  in  control — three  or 
four,  respectively,  forming  a  quorum — is  far  better  than  a 
larger  board  in  nominal  control  but  with  special  committees 
doing  the  real  work.3 

§  230.    Authority 

The  stockholders  are  the  owners  of  the  corporate  property, 
but  the  direct,  active,  and  immediate  control  rests  with  the 
board  of  directors.  The  authority  of  the  board  exists  under  the 
common  law,  extends  to  all  subjects  connected  with  the  manage- 
ment of  the  corporate  affairs,  and,  unless  in  some  way  restricted, 
is  practically  supreme.  Its  actions  in  the  conduct  of  the  cor- 
porate business  cannot  be  questioned  or  interfered  with  by  the 
stockholders  unless  in  case  of  gross  mismanagement  or  actual 
fraud. 

The  property  of  a  corporation  is  not  subject  to  the  control  of 
individual  members,  whether  acting  separately  or  jointly.  They 
can  neither  encumber  nor  transfer  that  property,  nor  authorize 
others  to  do  so.  The  corporation — the  artificial  being  created — 
holds  the  property,  and  alone  can  mortgage  or  transfer  it,  and  the 
corporation  acts  only  through  its  officers,  subject  to  the  conditions 
prescribed  by  law.* 


'See  {  233;  also  Ch.  XXXII,  "By-Laws — Standing  Committees." 

»  See  I  278. 

♦Justice  Field  in  Humphreys  v.  McKissock,  140  U.  S.  304.  312  (1890). 


Ch.  25]  CHARTER— BOARD  OF  DIRECTORS  JQS 

So  far  as  the  corporate  management  is  concerned,  the  stock- 
holder's position  is  but  little  more  than  that  of  an  interested 
spectator.  5 

If  such  unrestrained  power  in  the  hands  of  the  board  is 
considered  undesirable,  it  may  usually  be  restricted  by  charter 
provision  or  by-law  regulations.  In  a  few  states  certain  re- 
strictions— and  in  some  cases  extensions — of  the  power  of 
directors  are  found  in  the  statutes. 

Where  special  charter  provisions  are  permissible,  any  desired 
restrictions  upon  the  power  of  the  board  should  be  incorporated 
in  the  charter.  If  this  is  not  possible  they  may  usually  be 
embodied  in  the  by-laws,  where  they  are  equally  effective  but 
lack  stability,  as  by-laws  are  easily  changed. 

By  either  of  these  methods  the  power  of  the  board  to  incur 
obligations  may  be  limited;  their  power  to  sell  the  assets  of  the 
corporation  may  be  restricted;  it  may  be  required  that  two- 
thirds  or  other  proportion  of  the  entire  number  must  concur 
in  all  expenditures  above  a  certain  amount;  the  payment  of 
excessive  salaries  may  be  prohibited;  expenditures  within  a 
certain  period  may  be  limited;  and  many  other  restrictions, 
depending  upon  the  particular  conditions,  may  be  imposed. « 

§  231.    Power  to  Pass  By-Laws 

The  board  of  directors  has  no  power  to  pass  by-laws  or 
to  amend  existing  by-laws,  unless  expressly  authorized  thereto 
by  the  statute  law  of  the  state,  the  charter  of  the  corporation, 
or  its  by-laws.  Where  special  provisions  cannot  be  included 
in  the  charter,  the  only  other  legal  method  of  giving  the  directors 
power  to  amend  the  by-laws  is  by  express  by-law  provision. 

It  may  be  advisable  that  the  board  shall  have  power  to 
pass  additional  by-laws  to  meet  new  situations  and  emergencies 
as  they  arise,  and  where  this  is  so  the  desired  power  may  be 


'  2  Cook  on  Corp.,  {{  709,  712;  3  Clark  &  Marshall  on  Corp.,  {  691a;  Sellers  v.  Greer, 
172  111.  549  (1898);  Ellerman  v.  Ry  Co.,  49  N.  J.  Eq.  217  (1891);  Humphreys  v.  McKissock, 
140  U.  S.  304  (1890);  Denver  Engineering  Works  v.  Elkins,  179  Fed.  922  (1909). 

•  See  Ch.  XXVI,  "Charter— Special  Provisions." 


196  CORPORATE  LAW  [Bk.  I- 

given  them  by  an  authorization  to  supplement  the  by-laws 
adopted  by  the  stockholders.  This  is  as  far  as  is  prudent.  To 
place  unrestricted  power  to  make  and  amend  the  by-laws  in 
the  hands  of  the  board  would  seem  a  dangerous  and  unnec- 
essary removal  of  one  of  the  most  important  safeguards  of  the 
corporate  form. 

In  the  smaller  corporations  where  a  stockholders'  meeting 
may  be  readily  called  in  case  of  an  emergency,  there  would 
seem  to  be  no  real  object  or  advantage  in  giving  the  board  any 
power  whatsoever  over  the  by-laws.  In  the  larger  corporations 
that  power  should  only  be  granted  with  caution  as  one  that  is 
of  but  occasional  utiHty  and  that  may  be  used  to  the  disadvantage 
of  the  general  corporate  interests.^ 

§  232.    Classification 

The  classification  of  directors  in  such  manner  that  but  a 
portion  of  the  board  is  elected  at  any  one  annual  meeting,  is  at 
times  a  convenient  and  advantageous  arrangement.  Its  object 
is  to  prevent  the  sudden  alterations  of  membership  and  policy 
which  are  always  possible  where  the  entire  board  is  elected 
at  one  time,  and  also  to  render  the  selection  of  desirable  members 
more  probable  by  lessening  the  number  to  be  elected  at  any 
particular  time. 

It  is  to  be  noted  that  the  classification  of  directors  is  but 
seldom  necessary  where  cumulative  voting  prevails,  as  the 
sudden  change  of  the  entire  board  that  might  otherwise  result 
from  a  passing  of  the  control  of  the  stock  of  a  corporation 
is  then  hardly  possible.  In  the  smaller  corporations  classifi- 
cation of  directors  is  but  rarely  desirable  and  is  not  often  found. 

The  most  common  classification  of  directors  is  the  division 
of  the  board  into  three  classes  equal  in  munber,  each  class  holding 
for  three  years,  and  one  class  being  elected  each  year.  Under 
this  plan  three  years  are  required  lor  a  complete  change  of  the 
personnel  of  the  board. 

'See  H  253.  29i- 


Cb.  25]  CHARTER— BOARD  OF  DIRECTORS  197. 

Classification  of  directors  is  attainable  in  almost  every 
state.  Where  permissible,  such  classification  should  be  pro- 
vided for  in  the  charter.  Where  special  provisions  are  not 
allowed  in  the  charter,  it  may  usually  be  secured  by  by-law 
provision.  Unless  actually  prohibited  by  the  statutes  or  pre- 
cluded by  implication,  such  classification  may  be  secured  by 
either  charter  or  by-law  provision. 

It  is  unusual  to  provide  for  more  than  three  classes  of  di- 
rectors, and  such  classified  board  should  preferably  consist  of 
some  number  that  will  permit  three  equal  divisions,  as  three, 
nine,  or  fifteen.  The  classes  might  be  made  unequal,  that  is, 
if  the  board  consisted  of  eleven  members,  three  might  be  elected 
one  year,  four  the  next  year,  and  four  the  third.  Such  arrange- 
ment is,  however,  not  common. 

Upon  the  organization  of  a  corporation  with  a  classified 
board  the  whole  number  of  directors  are  usually  elected  at 
once,  the  term  or  class  of  each  director  being  decided  by  some 
agreed  method.  For  instance,  in  a  board  of  nine  members, 
divided  into  three  equal  classes,  the  three  directors  receiving  the 
highest  number  of  votes  might  constitute  the  longest  term  class, 
the  three  receiving  the  next  highest  number  of  votes  the  class 
for  the  intermediate  term,  and  so  on.s 

It  is  to  be  noted  that  the  stability  of  management  sought 
by  classification  of  directors  may  be  secured — and  at  times 
even  more  efiiciently  and  conveniently — by  the  creation  of  a 
voting  trust.  9 

§  233.    Standing  Committees 

The  board  of  directors  is  the  managing  body  of  a  corporation 
and  supposed  to  be  in  direct  charge  of  its  affairs.  When  the 
board  is  of  moderate  size  this  direct  supervision  is  usually 
exercised,  but  when  the  directors  are  numerous  it  is  not  always 


g  Caa    I    282 

•See  Ch.  LVI.  "Voting  Trusts." 


igS  CORPORATE  LAW  [Bk.  !- 

practicable,  and  standing  committees  are  then  usually  em- 
ploy ed.i" 

These  committees  are  appointed  or  elected  in  such  manner 
as  may  be  prescribed  by  charter  or  by-laws;  they  must  be  com- 
posed of  members  of  the  board  of  directors,  and,  subject  to  the 
provisions  by  which  they  are  created  and  empowered,  usually 
exercise  all  the  powers  of  the  board  in  their  respective  fields. 

Any  necessary  number  of  these  committees  may  be  ap- 
pointed, but  they  are  usually  limited  to  two — the  executive 
committee  and  the  finance  committee — the  first-named  com- 
mittee exercising  its  powers  over  the  general  affairs  of  the 
corporation,  while  the  powers  of  the  last-named  committee 
are  usually  confined  to  matters  relating  to  finance. 


"  See  Ch.  XXXII,  "By-Laws— Standing  Committees.' 


CHAPTER  XXVI 

CHARTER— SPECIAL  PROVISIONS 

§  234.    General 

The  ordinary  corporation  charter  is  constructed  on  a  simple 
pattern  and  does  not  permit  cumulative  voting,  classification  of 
directors,  limitations  on  salaries,  power  to  hold  stock  of  other 
corporations,  and  other  privileges  that  are  generally  designated 
as  special  provisions. 

The  first  general  laws  relating  to  incorporations  were  harsh. 
Only  one  purpose  was  allowed,  the  privileges  granted  were 
few,  and  all  corporations  were  to  be  organized  and  operated 
on  exactly  the  same  lines.  Only  one  mold  was  provided,  and 
if  this  did  not  fit  the  needs  of  any  particular  corporation,  relief 
could  be  had  only  by  recourse  to  a  special  charter  or  enabling  act. 
'if  These  narrow  and  unnecessary  limitations  were  slowly  and 
grudgingly  relaxed,  but  no  marked  advance  was  made  until 
New  Jersey  recognized  the  necessity  of  greater  freedom  and 
flexibility,  and  also  perceived  the  very  material  advantages  that 
might  accrue  to  the  state  itself  from  more  liberal  corporate 
legislation.  Her  legislators  then  proceeded  to  remodel  the  bare 
laws  existing  at  that  time,  so  as  to  allow  a  plurality  of  purpose, 
all  proper  special  powers,  and  a  freedom  and  convenience  not 
theretofore  enjoyed  by  corporations  formed  under  general  laws. 
To  this  politic  concession  to  the  reasonable  business  demands  of 
the  times  is  principally  due  the  repute — and  resulting  revenue — 
which  New  Jersey  enjoyed  and  still  enjoys  as  a  state  for  incor- 
poration. 

§  235.    Special  Charter  Provisions 

The  greater  scope  and  freedom  of  action  of  New  Jersey 
corporations  under  the  new  law  was  mainly  due  to  its  express 

199 


200  CORPORATE  LAW  [Bk.  I- 

recognition  of  special  charter  provisions.  The  right  to  include 
such  provisions  in  the  charter  is  conferred  by  the  following 
clause  from  the  statute: 

The  certificate  of  incorporation  may  also  contain  any  provision 
which  the  incorporators  may  choose  to  insert,  for  the  regulation  of 
the  business  and  for  the  conduct  of  the  affairs  of  the  corporation, 
and  any  provision  creating,  defining,  limiting  and  regulating  the  . 
powers  of  the  corporation,  the  directors  and  the  stockholders,  or 
any  class  or  classes  of  stockholders;  provided  such  provision  be  not 
inconsistent  with  this  act.^ 

This  enables  the  incorporators  to  secure,  through  charters 
granted  under  the  general  laws,  powers,  privileges,  and  regu- 
lations formerly  possible  only  under  special  charters.  This 
statute  has  been  followed  in  Delaware,  to  a  certain  extent  in 
New  York,  and,  with  more  or  less  variation,  in  a  number  of 
other  states. 

New  Jersey  lost  most  of  its  popularity  as  a  state  for  incorpor- 
ation when  its  legislature  made  the  laws  relating  to  corporations 
harsh  and  forbidding.  All  these  repressive  measures  have  now 
been  repealed,  and  the  only  cause  that  hinders  the  patronage  of 
outside  incorporators  is  the  fact  that  the  fees  and  taxes  of 
Maine  and  Delaware  are  much  more  reasonable. 

In  those  states  in  which  special  charter  provisions  are  not 
allowed,  many  of  the  desired  powers,  restrictions,  or  regulations 
may  be  obtained  through  by-law  provisions.  In  some  matters 
and  under  some  circumstances  this  may  be  done  efifectively, 
but  usually  the  by-laws  may  be  amended  or  repealed  with 
comparative  ease,  and  their  provisions  do  not  always  have  the 
necessary  permanence. 

Where  the  statutes  do  not  permit  special  charter  provisions, 
and  desired  provisions  cannot  be  properly  or  permanently 
included  in  the  by-laws,  the  only  recourse  is  to  incorporate  in 
some  more  Uberal  state  where  such  provisions  are  permitted. 


'  Laws  of  1896  (N.  J.),  Ch.  185.  5  8,  p.  280,  as  amended  by  Laws  of  1898,  Ch.  172,  p.  408 


Ch.  26]  CHARTER— SPECIAL  PROVISIONS  201 

The  corporation  would  thereafter  operate  in  its  own  state  as  a 
foreign  corporation.  Outside  incorporation  for  such  a  purpose 
would  be  justified  only  where  the  special  provisions  obtained  were 
of  considerable  importance. 

§  236.    Usual  Objects  of  Special  Provisions 

Many  of  the  corporate  features  already  discussed,  such 
as  cumulative  voting,  classification  of  directors,  and  limita- 
tions of  the  directors'  power  of  incurring  obligations,  are  fre- 
.quently  best  secured  by  special  charter  provisions.  In  addition 
to  these  are  many  other  provisions  designed  to  meet  the  varying 
requirements  of  particular  incorporations,  such  as  limitations 
on  the  voting  power,  limitations  on  salaries,  and  provisions 
authorizing  a  reserve  fund  or  the  accumulation  of  operating 
capital,  etc. 

In  the  different  states  the  variation  of  the  statute  laws 
as  to  special  charter  provisions  is  wide.  Thus  in  some  states 
such  provisions  are  not  provided  for  and  are  therefore  not 
permissible  at  all;  while  in  other  states  almost  any  desired 
provision  is  permitted  in  the  charter.  In  New  Jersey  by 
charter  provision  the  directors  may  be  empowered  to  alter, 
amend,  or  repeal  by-laws,  while  in  New  York  the  exact  power 
of  the  board  as  to  by-laws  is  laid  down  in  the  statute  law,  and 
cannot  be  denied  or  modified  in  any  way  by  charter  pro- 
visions. Again,  in  New  Jersey  the  directors  may  be  empowered 
by  tne  charter  to  mortgage  any  or  all  of  the  corporate  property 
without  consulting  the  stockholders;  but  in  New  York  the  cor- 
porate property  may  be  mortgaged  only  with  the  consent  of 
two-thirds  of  the  stockholders  of  the  corporation,  and  any 
charter  provision  to  the  contrary  would  be  absolutely  non- 
effective. The  New  Jersey  courts  have  held  that  a  provision 
in  the  charter  of  a  corporation  that  any  resolution  in  writing 
signed  by  all  of  the  members  of  the  board  of  directors  should  have 
the  same  effect  as  if  passed  at  a  duly  called  meeting,  is  void, 
because  inconsistent  with  the  provisions  of  the  General  Corpora- 


202  CORPORATE  LAW  [Bk.  I- 

tion  Law.'  On  account  of  this  wide  difference  it  is  necessary 
to  consult  the  statutes  of  the  particular  state  when  any  special 
provisions  are  under  consideration. 

§  237.    Cumulative  Voting 

Cumulative  voting  is  one  of  the  most  common  and  one 
of  the  most  important  of  special  charter  provisions.  Its  usual 
purpose  is  the  protection  of  minority  interests  by  securing  to  these 
interests  representation  on  the  board  of  directors. 

As  its  name  indicates,  cumulative  voting  is  a  system  or 
method  of  cumulating  or  concentrating  votes.  Under  it  the 
owner  of  stock  is,  for  each  share  of  stock  he  owns,  entitled 
to  as  many  votes  for  directors  as  there  are  directors  to  be  elected, 
and  at  any  election  of  directors  he  may  cast  these  votes  pro 
rata  among  all  the  directors  to  be  elected,  or  all  for  one  director, 
or  may  distribute  them  among  two  or  more  as  he  sees  fit.  That 
is,  if  the  total  number  of  directors  to  be  elected  is  seven,  the 
owner  of  one  share  of  stock  might  cast  one  vote  for  each  of  the 
seven  directors,  or  might  cast  seven  votes  for  one  director,  or 
cast  four  votes  for  one  director  and  three  for  another,  or  apportion 
his  seven  votes  in  any  other  way  he  chose  among  the  candidates. 

Under  this  arrangement  it  is  obvious  that  even  a  small 
minority,  by  combining  on  one  candidate,  may  secure  repre- 
sentation on  the  board.  At  times  this  representation  becomes 
of  much  importance.  If  the  minority  are  not  represented, 
they  are  debarred  from  information  of  what  the  majority 
propose  to  do  or  are  doing.  Under  such  conditions  action  may 
be  taken  which  cannot  be  undone,  but  which  the  minority  might 
have  prevented  by  injunction  or  other  means  had  they  been 
informed  in  time.  Also  the  mere  presence  of  a  capable  minority 
representative  on  the  board  prevents  many  abuses  of  power 
that  might  otherwise  occur.  For  this  and  other  reasons, 
cumulative  voting  is,  from  the  minority  standpoint,  always  a 


J.-.*  Audenried  v.  East  Coast  MiUinct  Co.,  68  N.  J.  Eq.  450  (igod.'l. 


Ch.  26]  CHARTER— SPECIAL  PROVISIONS  203 

wise  provision  and  occasionally  becomes  a  matter  of  the  most 
vital  importance. 

'<  Cumulative  voting  may,  in  many  states,  be  secured  by 
proper  provision  in  the  charter,  and  in  Colorado  the  charter 
must  provide  whether  or  not  cumulative  voting  shall  be  allowed. 
In  Pennsylvania,  South  Dakota,  West  Virginia,  and  a  number 
of  other  states  it  is  mandatory  without  reference  to  any  charter 
provisions.  In  Nevada  it  is  mandatory  unless  the  charter 
provides  otherwise.  In  a  few  states  it  is  doubtful  whether 
the  provision  would  be  allowed  in  the  charter  or  would  be 
effective  if  included. 3 

§  238.    Classification  of  Stock 

Where  special  charter  provisions  are  allowed,  classification 
of  stock  is  common.  Stock  may  be  classified  in  many  ways. 
The  most  usual  of  these  are:  the  division  of  the  capitalization 
into  common  and  preferred  stock ;  division  of  the  preferred  stock 
into  classes,  as  first,  second,  etc.;  and  division  of  the  common 
stock  into  classes,  each  class  electing  a  due  proportion  of  the 
directors.* 

''  The  division  into  common  and  preferred  stock  and  the 
indicated  division  of  preferred  stock  may  be  secured  by  charter 
provision  in  nearly  every  state,  together  with  such  other  proper 
classifications  of  the  preferred  stock  as  may  be  desired. 

The  division  of  the  common  stock  into  voting  classes,  and 
the  many  other  classifications  occasionally  employed,  may 
usually  be  secured  by  special  charter  provision  where  such  pro- 
visions are  allowed,  s 

Where  permitted  by  the  statutes,  the  classification  of  stock 
may  be,  and  occasionally  is,  carried  into  wide  variations.  Some- 
times a  portion  of  the  stock  will  be  denied  the  voting  right 
entirely,  or  will  be  prohibited  from  voting  on  particular  ques- 


'  See  JS33. 

« See  Ch.  X,  "Stock. 

»See  i  221. 


204  CORPORATE  LAW  [Bk.  I- 

tions.  Certain  stock  may  be  debarred  from  participation  in 
dividends  for  a  stated  period.  In  New  York  a  peculiar  partly 
paid  stock  may  constitute  a  part  of  the  issue,  drawing  dividends 
only  upon  the  amount  actually  paid  in  upon  it.  -i{{ 

These  unusual  arrangements  are  desirable  only  under  excep- 
tional circumstances.  Generally  they  are  to  be  avoided  as  being 
complicated,  unnecessary,  and  at  times  of  uncertain  result,    lo 

§  239.    Corporate  Stockholding 

At  common  law  a  corporation  cannot  hold  stock  in  another 
corporation.  Though  the  law  was  not  formulated  with  any  such 
intent,  its  practical  effect  was  to  render  the  formation  of  trusts 
and  combinations  extremely  difficult,  and  in  many  cases  im- 
possible. 

New  Jersey  was  the  first  state  to  modify  the  law  in  this 
direction  and  to  grant  to  corporations  unlimited  power  to 
hold  and  vote  stock  in  other  corporations.  Delaware  and  other 
states  followed  the  earlier  statutes  of  New  Jersey,  a.nd  in  a 
number  of  these  states,  under  existing  statutes,  corporations 
have  the  unlimited  power  first  granted  in  New  Jersey.  Other 
states  have  granted  the  power  within  certain  limits.  New  York 
has  followed  New  Jersey  to  the  extent  of  allowing  this  right 
where  provision  is  made  therefor  in  the  charter,  or  where  the 
corporation  whose  stock  is  purchased  is  of  a  similar  nature,  and 
one  with  which  the  purchasing  corporation  would  be  authorized 
to  consolidate. 

The  right  is,  at  times,  a  very  valuable  one,  and  in  those 
states  where  allowed,  a  provision  authorizing  the  holding  of 
corporate  securities  by  the  corporation  is  usually  included  in 
the  charter.  6 

§  240.     Limitations  on  Indebtedness 

In  a  large  proportion  of  the  cases  where  corporations  are 
wrecked,  the  result  is  brought  about  by  the  directors'  abuse  of 


•  See  Ch.  LVII,  "Holding  Companies." 


Ch.  26]  CHARTER— SPECIAL  PROVISIONS  205 

the  power  to  incur  debt.  In  those  states  where  the  power  of  the 
directors  in  this  respect  may  be  limited  by  charter  provision, 
such  restriction  is  on  occasion  very  desirable.  Limitations 
on  indebtedness  vary  with  the  conditions.  Under  some  circum- 
stances it  may  be  desirable  to  fix  an  absolute  limit  beyond  which 
the  directors  have  no  power  to  obligate  the  corporation.  Or 
it  may  be  provided  that  if  the  directors  exceed  a  certain  sum,  they 
shall  be  held  personally  liable  for  such  excess;  or  that  they  shall 
not  enter  into  any  single  contract  involving  obligations  over  a 
certain  amount;  or  that  obligations  beyond  a  certain  amount 
shall  be  incurred  only  with  the  affirmative  vote  of  two-thirds  or 
other  proportion  of  the  whole  board,  or  shall  be  undertaken 
only  after  authorization  thereto  by  due  resolution  of  the  stock- 
holders. 

Whatever  the  plan  adopted,  it  should  be  carefully  con- 
sidered and  adapted  to  the  special  situation,  and  the  limitations 
should  not  be  so  low  as  to  amount,  nor  so  narrow  in  application, 
as  to  interfere  with  the  ordinary  operations  of  the  business. 
The  abuse,  not  the  use,  of  the  debt-incurring  power  is  to  be 
prevented.'' 

It  is  also  to  be  noted  that  conditions  may  arise  under  which 
the  directors  are  powerless  to  prevent  corporate  indebtedness 
in  excess  of  charter  or  by-law  limitations.  Thus  the  corporate 
revenues  may  be  unexpectedly  curtailed,  but  nevertheless  with  a 
fine  disregard  of  prohibitory  provisions,  taxes,  rents,  official 
salaries,  and  other  contract  obligations  continue  to  roll  up  a 
constantly  increasing  load  of  corporate  debt.  In  such  cases  the 
directors  cannot  be  held  accountable,  though  the  limitation  has 
been  exceeded.  8  ,    , 

n-'.\\    ijM  i;rff    Y«)!i' 

§  241.    Limitations  on  Salaries 

The  diversion  of  profits  by  excessive  salaries  is  a  not  un- 
common method  of  draining  a  corporate  treasury  and  thereby 


'See  I  316.  • 

*Jn  re  Putnam,  193  Fed.  464  (1911). 


206  ,  CORPORATE  LAW  [Bk.  I- 

preventing  the  payment  of  proper  dividends.  If  not  properly 
guarded  against  at  the  time  of  the  organization  of  the  cor- 
poration, such  practice  may  be  extremely  difficult  to  correct  or 
prevent  later.  9 

Charter  provisions  imposing  limitations  on  salaries  should 
not  be  made  too  narrow  or  too  inflexible.  Good  management 
is  an  absolutely  indispensable  element  of  success,  and  fair 
salaries,  with  even  more  liberal  compensation  when  demanded 
by  the  welfare  of  the  company  or  justified  by  the  excellence 
of  the  management,  should  not  be  rendered  impossible  by  too 
narrow  restrictions. 

Flexibility  of  restriction  in  the  matter  of  salaries  may  be 
provided  for  in  various  ways.  The  charter  provision  may 
merely  require  that  salaries  be  fixed,  and  varied  thereafter  if 
need  be,  by  a  two-thirds  vote  of  the  entire  board.  Occasionally 
the  concurrence  of  the  entire  board  may  be  required.  Or  the 
salaries  of  officers  may  be  determined  each  year  at  the  stock- 
holders' annual  meeting  by  a  stated  majority  of  the  entire 
outstanding  stock.  In  such  case  the  required  majority  may  be 
fixed  so  high  as  to  require  the  concurrence  of  any  desired  part  of 
the  minority  interests.  Or  it  may  be  provided  that  no  official 
salary  shall  be  increased  over  a  stated  figure,  until  a  dividend  of, 
say,  6%  has  been  paid  upon  the  outstanding  stock  for  two 
or  more  years.  Or  any  salary  payments  over  a  certain  minimum 
might  be  made  absolutely  dependent  each  year  upon  the  pay- 
ment of  a  certain  dividend  for  the  previous  year. 

It  is  to  be  noted  that  where  the  ease  of  alteration  is  not 
objectionable,  provisions  limiting  indebtedness  and  salaries  are 
usually  included  in  the  by-laws  instead  of  the  charter.  Here 
they  may  be  modified  as  the  circumstances  demand,  whereas 
in  the  charter  they  may  be  altered  only  by  formal  amendment 
of  that  instrument.     But  to  protect  the  minority  effectually, 


•Raynolds  v.  Diamond  Mills  Paper  Co.,  69  N.  J.  Eq.  299  (1905);  Jaccbson  v.  Brooklyn 
Lumber  Co.,  184  N.  Y.  152  (1906);  Davids  v.  Davids,  135  App.  Div.  (N.  Y.)  206  (1909); 
Carr  v.  Kimball,  153  App.  Div.  (N.  Y.)  825  (1912). 


Ch.  26]  CHARTER— SPECIAL  PROVISIONS  207 

such  limitations  must  under  ordinary  circumstances  be  inserted 
in  the  charter, 

§  242.    Sundry  Provisions 

Many  other  provisions  will  on  occasion  be  incorporated  in 
the  charter.  This  is  especially  so  in  the  incorporation  of  a 
partnership  or  the  reorganization  or  consolidation  of  corpora- 
tions, when  special  provisions  are  often  necessary  to  insure 
the  varying  interests,  or  to  carry  out  agreements  entered  into 
as  a  prerequisite  to  the  proposed  arrangement. 

It  is  essential  that  such  provisions  shall  not  go  counter 
to  any  law  regulating  corporations,  and  important  that  they 
be  not  such  as  to  involve  the  corporation  in  any  subsequent 
deadlock  or  entanglement.  The  death  of  parties,  sale  of  stock 
to  strangers,  change  of  industrial  conditions  and  other  mutations 
may  make  apparently  desirable  arrangements  exactly  the 
reverse.  It  is  not  always  possible  to  amend  a  charter,  and 
if  there  is  any  doubt  as  to  the  expediency  or  effect  of  any  par- 
ticular provision,  it  should  be  brought  into  the  by-laws  rather 
than  the  charter.  Then  if  found  undesirable,  it  may  usually  be 
amended  or  altered  by  a  mere  majority  vote  of  the  stockholders* 


Imi 


yfii  bri4i  baijJJiuui 'jii  iiiw  ak;  ;Wiji  aiiif  ob 


T'^'. 


CHAPTER  XXVII 

CHARTER— EXECUTION   AND    FILING; 

AMENDMENT  -j 

§  243.    General 

In  most  states  a  form  of  charter  application  is  prepared  by 
the  state  authorities  and  will  be  furnished  by  them  on  applica- 
tion. Where  this  is  not  done  the  forms  are  usually  prepared  by 
law  stationers  and  kept  on  sale.  Care  should  be  exercised  in  the 
use  of  these  prepared  forms,  as  they  sometimes  contain  undesir- 
able features  which  must  be  eliminated  before  the  form  is  used. 
In  some  states  most  of  the  published  forms — and  notably  those 
for  New  Jersey  and  Delaware — include  the  objectionable  pro- 
visions of  the  trust  charters  whereby  the  minimum  of  power 
is  left  with  the  stockholders  and  the  rights  of  the  minority  are 
reduced  to  their  lowest  terms.  Such  features,  while  possibly 
adapted  to  trust  management,  are  not  usually  desirable  for  an 
ordinary  corporation. 

If  any  of  these  prepared  forms  have  received  the  sanction 
or  approval  of  the  state  authorities,  such  forms  should  either 
be  used  or  be  closely  followed.  To  depart  materially  therefrom 
is  to  invite  objection,  which  may  at  times  be  captious  and  in  any 
case  will  cause  delay  and  trouble.  The  authorities  cannot  be 
deemed  unreasonable  in  their  preference  for  forms  which  have 
been  passed  upon,  with  which  they  are  familiar,  and  which  when 
used  enable  them  the  more  readily  to  determine  the  legality  and 
correctness  of  an  application. 

In  addition  to  the  usual  provisions  of  the  charter,  any 
special  provisions  desirable  for  the  particular  corporation  and 
permissible  under  the  laws  of  its  state  will  be  included  and  the 

208 


Ch,  27]  CHARTER— EXECUTION  AND  FILING  209 

charter  application  is  then  ready  for  the  final  formalities.     These 
consist  of  its  signing,  acknowledgment,  and  filing. 

These  final  formalities  are  in  a  general  way  similar  in  almost 
all  the  states,  but  as  the  matter  is  one  of  statutory  regulation,  the 
laws  of  the  particular  state  must  be  consulted  for  the  details  of 
procedure. 

§  244.     Signing  and  Acknowledgment 

Each  of  the  incorporators  must  sign  and  acknowledge 
the'  charter  application.  If  there  are  but  three  incorporators 
and  they  come  together  for  the  signing  and  acknowledgment 
of  the  instrument,  the  formality  is  a  simple  one.  The  three 
acknowledgments  are  taken  at  the  one  time  and  one  notarial 
certificate  serves  for  all.  If  the  notarial  officer  who  acts  in  the 
matter  calls  on  the  incorporators  at  their  offices  or  residences 
and  takes  their  several  acknowledgments,  the  one  notarial 
certificate  will  still  serve.  If,  however,  the  incorporators  are 
numerous,  live  in  other  states,  or  for  any  other  reason  cannot  be 
easily  reached  or  assembled,  separate  notarial  certificates  may 
be  necessary  for  each  acknowledgment.  A  party  to  the  charter 
cannot  act  as  notary  therein.  1 

These  acknowledgments  may  usually  be  taken  by  a  notary 
public,  commissioner  of  deeds,  justice  of  the  peace,  or  other 
officer  authorized  to  take  acknowledgments  to  deeds.  If  taken  in 
another  state,  a  certificate  may  be  necessary  as  to  the  due 
appointment  and  authority  of  the  officer  by  whom  the  acknowl- 
edgment is  taken.  The  statutes  are  in  most  cases  explicit  as 
to  the  details  of  acknowledgment,  and  as  the  whole  matter  is 
one  of  statutory  regulation,  these  must  be  closely  followed. 

In  some  states,  in  addition  to  the  usual  execution  by  the 
incorporators  it  is  necessary  to  secure  the  approval  of  the  pro- 
posed incorporation  by  some  designated  court,  or  by  a  judge 
of  such  court,  as  one  of  the  preliminaries  to  filing. 
'Mv  'Jii'ibi>tti 

*  People,  etc.  v.  Commissioners,  105  App.  Div.  (N.  Y.)  273  (1905). 


«IO  CORPORATE  LAW  [Bk.  I- 

§  245.    Filing 

The  technical  details  of  filing  the  charter  application  vary 
to  some  extent  in  the  different  states.  In  some  the  application 
is  sent  direct  to  the  secretary  of  state,  accompanied  by  the 
prescribed  fees.  In  others,  the  application  must  be  sent  direct 
to  the  secretary  of  state,  but  the  filing  fees  are  paid  the  state 
treasurer,  who  before  the  charter  will  be  filed  must  certify  to 
the  secretary  that  this  has  been  done.  Again  in  some  states 
the  charter  must  be  filed  with  the  clerk  of  the  county  court 
in  the  home  county  of  the  corporation,  before  filing  with  the 
secretary  of  state;  elsewhere  the  charter  must  be  filed  with 
the  clerk  of  the  county  court  after  its  filing  with  the  state 
secretary. 

The  treatment  accorded  the  charter  applications  by  the 
filing  officials  also  varies  in  the  different  states.  In  some  these 
officials  consider  that  the  insertion  of  unauthorized  or  im- 
proper powers  gives  no  legal  authority,  and  that  they  are  not 
called  upon  to  decide  the  legal  effect  of  the  verbiage  employed, 
and,  in  accordance  with  these  views,  they  accept  any  powers  or 
purposes  not  openly  in  conflict  with,  or  glaringly  outside  the 
intent  of,  the  law.  In  other  states,  on  the  contrary,  the  author- 
ities scrutinize  the  application  in  detail,  and,  if  its  purposes  and 
powers  seem  to  exceed  the  statutory  limits,  dechne  to  file  the 
appUcation.  In  such  case  the  application  is  returned  with  an 
explanation  or  statement  of  the  reasons  for  its  refusal. 

At  times  the  state  authorities  clearly  exceed  their  authority 
in  passing  upon  the  legaHty  of  the  indicated  powers  of  a  charter 
application.  In  such  case  if  the  matter  were  of  sufficient 
importance  and  the  delay  not  too  serious,  the  courts  might  be 
invoked  and  the  points  in  question  be  decided  by  competent 
authority.  Generally,  however,  the  importance  of  the  matter 
will  not  justify  such  proceedings,  and  if  the  official  ruling  cannot 
be  changed  the  purposes  or  other  matters  in  question  must  be 
either  omitted  or  so  changed  as  to  meet  the  views  of  the 
authorities. 


Ch.  27]  CHARTER— EXECUTION  AND  FILING  2n 

In  some  states,  when  an  application  is  approved  a  chartei 
pro  forma  is  issued  under  the  seal  of  state  granting  to  the; 
corporation  the  desired  rights,  powers,  and  privileges.  In 
other  states  the  charter  application  itself  changes  its  nature, 
and  as  soon  as  filed  becomes  the  charter  of  the  then  authorized 
corporation.  Its  form  is  not  changed,  but  its  force  is,  and  it  is 
then  an  authorization  from  the  state  for  the  organization  of  the 
corporation  with  all  the  powers,  privileges,  and  characteristic 
features  detailed  in  the  one-time  application. 

§  246.    Alterations 

If  any  required  alteration  in  an  executed  charter  is  on 
some  non-essential  point,  and  all  the  incorporators  agree  thereto, 
it  is  not  usually  necessary  to  redraft  and  re-execute  the  entire 
instrument.  The  change  may  be  made  in  the  original  instru- 
ment either  as  an  interpolation  or  as  a  correction,  and  the 
document  be  then  returned  for  acceptance  in  its  amended  form. 

When  a  required  alteration  is  material,  the  better  practice 
is  to  have  the  instrument  redrawn  and  executed  afresh  by  the 
incorporators.  If,  however,  a  material  alteration  were  made 
in  the  instrument  without  any  re-execution,  but  with  the  consent 
or  subsequent  acceptance  of  the  incorporators,  and  the  charter 
so  altered  were  duly  allowed  and  filed  by  the  state  officials,  it  is 
not  probable  that  it  could  later  be  successfully  attacked. 

§  247.    Certified  Copies 

In  some  states,  as  already  said,  when  a  charter  application 
is  approved,  the  secretary  of  state  issues  a  duly  certified-  charter 
under  the  great  seal  of  state  as  part  of  the  regular  routine.  In 
others,  the  secretary  merely  notifies  the  party  filing  the  applica- 
tion that  it  has  been  accepted  and  filed,  this  accepted  application 
then  becoming  the  charter  of  the  corporation.  In  this  latter 
case  the  secretary  will  at  any  time  upon  payment  of  the  legal 
fees  furnish  certified  copies  of  the  accepted  application — now 
the  charter — which  is  always  due  legal  evidence  of  incorporation. 


212  CORPORATE  LAW  [Bk.  I- 

Where  certified  copies  of  the  charter  are  to  be  recorded 
with  the  local  authorities,  they  must  of  course  be  secured  from 
the  state  authorities  as  part  of  the  organization  routine.  Beyond 
this  the  possession  of  a  certified  copy  of  the  charter  is  of  no 
importance,  save  very  rarely  in  cases  of  litigation,  and  on 
occasion  for  its  effect  on  interested  parties — or  parties  to  be 
interested.  It  is  usual,  however,  to  secure  and  preserve  a 
certified  copy  among  the  archives  of  the  corporation. 

Amendment 

§  248.    Charter  Amendments 

The  connection  between  corporate  organization  and  charter 
amendments  is  not  at  first  sight  obvious.  Charter  amendments 
are,  however,  too  often  the  result  of  hasty  or  careless  preparation 
of  the  original  instrument.  Also  changed  or  unforeseen  condi- 
tions not  infrequently  render  charter  amendments  desirable 
before  the  corporate  organization  has  been  completed.  A  brief 
consideration  of  the  subject  is  therefore  in  place. 

New  Jersey,  with  its  usual  accommodating  recognition  of 
possible  corporate  needs,  permits  the  amendment  of  a  charter 
by  a  very  simple  process  at  any  time  before  the  corporate  organ- 
ization is  completed.  In  this  way  new  conditions  may  be 
provided  for  and  the  cruder  defects  of  a  hastily  prepared  charter 
may  be  easily  remedied.  Thereafter,  as  in  other  states,  the 
charter  may  be  amended  only  by  the  regular  procedure  provided 
for  such  cases.     Delaware  has  a  like  provision. 

In  New  York,  if  there  are  informalities  in  the  original  charter, 
or  defects  in  its  proof  or  acknowledgment,  or  if  the  charter 
contains  any  matter  not  authorized  by  law,  the  statute  provides 
a  simple  method  of  correcting  these  defects  by  permitting  the 
incorporators  or  directors  to  file  an  amended  charter.' 


» Gen.  Corp.  Law,  }  7. 


Ch.  27]  CHARTER— AMENDMENT  213 

§  249.    Subject  Matter 

Any  provisions  may  be  brought  into  a  charter  amendment 
that  might  have  been  brought  into  the  original  charter.  As 
soon  as  allowed,  the  provisions  of  such  amendment  become  to 
all  legal  intents  part  of  the  original  charter  and  as  permanently 
binding  on  the  corporation. 

When  an  amendment  has  been  made,  such  amendment  and 
the  original  charter  taken  together  constitute  the  working 
charter  of  the  corporation;  the  amendment,  however,  taking 
precedence  over  and  modifying  the  original  charter  in  all  points 
of  difference. 

§  250.    Procedure 

The  procedure  for  the  amendment  of  a  charter  is,  in  each 
state,  prescribed  by  law.  There  is  but  little  uniformity  in  the 
different  states,  though  in  all  the  procedure  is  troublesome  and 
at  times  expensive.  In  many  states  the  statutory  procedure 
varies  with  the  nature  of  the  amendment.  Formerly  in  New 
York,  to  change  the  name  of  a  corporation,  application  had  to 
be  made  to  designated  courts.  Now  the  corporate  name  may  be 
changed  by  amendment  of  the  charter  in  the  usual  way. 

Generally,  an  amendment  of  the  charter  requires  a  duly 
called  meeting  of  the  stockholders,  at  which  a  two-thirds  ma- 
jority of  the  stock  interests  outstanding  must  vote  in  favor 
of  the  proposed  changes.  The  amendment,  duly  acknowledged 
as  evidence  of  the  stockholders'  authorization,  must  usually  be 
filed  in  the  same  offices  and  with  the  same  formalities  as  the 
original  charter. 

In  some  states  advertisement  must  be  made  for  a  prescribed 
time  before  any  charter  amendment  goes  into  effect.  The 
proportion  of  the  stock  vote  required,  the  notices  to  be  given, 
and  the  other  formalities  also  vary  in  the  different  states.  In 
Delaware  a  bare  majority  have  power  to  amend  the  charter. 


Part  VI— The  By-Laws* 


CHAPTER  XXVTII 
BY-LAWS— GENERAL   CONSIDERATIONS 

§  251.    Functions  of  By-Laws 

A  medem  corporation  is  regulated,  first,  by  the  general 
laws  under  which  it  operates;  second,  by  the  provisions  of  its 
charter;  and  third,  by  its  by-laws.  When  the  incorporators 
meet  pursuant  to  the  authorization  of  their  charter  for  organ- 
ization, both  the  general  laws  and  the  charter  exist  for  the 
guidance  of  the  new  corporation.  To  these  must  be  added  the 
by-laws  to  provide  for  such  details  of  organization,  adminis- 
tration, and  business  routine  as  are  not  prescribed  by  the  laws 
nor  provided  for  in  the  charter.  This  is  the  first  and  most 
important  function  of  the  by-laws.    "^  "-•^'■'  1^'  "'i^'^>  "-  - 

Beyond  this  any  special  provisions  for  the  regulation  of  the 
corporation,  its  directors,  officers,  or  membership  may  be 
incorporated  in  the  by-laws  when  such  provisions  are  not 
permitted  in  the  charter  or  when  the  permanence  of  a  charter 
provision  is  not  desired. 

In  addition  the  by-laws  are  also  usually  so  drawn  as  to 
constitute  a  systematic  statement  of  the  more  important  working 
details  of  both  the  general  law  and  the  charter.  This  is  not 
done  with  any  idea  of  adding  to  the  binding  force  of  the  require- 
ments of  these  higher  authorities,  but  merely  as  a  restatement, 
the  by-laws  being  thereby  rendered  a  more  complete  code  for 
the  guidance  of  the  corporate  officials  and  stockholders. 

This  use  of  the  by-laws  is  customary  and  of  considerable 

» See  Book  IV,  Ch.  Ill,  "Bv-Law  Forms." 


2l6  CORPORATE  LAW  [Bk.  I- 

importance,  helping  to  secure  the  observance  of  those  statutory 
and  charter  provisions  which,  if  not  in  such  accessible  form, 
might  be  overlooked  or  forgotten. 

§  252.    Subject  Matter  of  By-Laws 

There  is  usually  no  law,  save  the  law  of  necessity,  com- 
pelling a  new  corporation  to  adopt  by-laws.  Its  operation 
without  by-laws  would,  however,  be  practically  impossible — 
so  much  so,  that  the  law  confers  the  power  to  make  by-laws 
and  takes  it  for  granted  that  this  right  will  be  exercised.  Pro- 
visions for  the  regulation  of  the  corporation  are  found  both  in 
the  statute  law  and  the  charter,  but  these  are  for  the  most  part 
general  in  their  nature.  There  are  none  of  the  specific  details 
essential  for  proper  corporate  operation. 

Just  what  matters  should  be  provided  for  in  the  charter 
and  what  in  the  by-laws  is  to  some  extent  determined  by  the 
conditions  of  the  particular  corporation.  The  statutes  usually 
prescribe  certain  essential  matters  that  must  appear  in  the 
charter.  In  addition  all  such  important  matters  outside  the 
ordinary  routine  of  corporate  procedure,  as  are  intended  to  be 
permanent  features  of  the  organization,  should  be  incorporated 
in  the  charter.2 

Beyond  this,  however,  the  routine  details  of  corporate 
procedure,  and  any  special  provisions  which  are  not  intended  to 
be  permanent  or  which  are  not  permissible  in  the  charter,  are 
reserved  for  the  by-laws.  Generally  speaking,  nothing  should 
be  incorporated  in  the  charter  that  may  be  as  effectually  pro- 
vided for  in  the  by-laws. 

The  by-laws,  as  has  been  stated,  also  usually  contain  many 
provisions  of  the  statute  law  and  the  charter  which  are  repeated 
in  the  proper  connection  in  the  by-laws  merely  that  these  latter 
may,  in  themselves,  be  a  complete  working  code.  The  by-laws 
will,  then,  contain  all  the  ordinary  working  details  of  corporate 
regulation  and  most,  if  not  all,  of  the  important  statutory  and 


'See  Ch.  XXVI,  "Charter— Special  Provisions." 


Ch.  28]  BY-LAWS— GENERAL  CONSIDERATIONS  217 

charter  provisions  directly  affecting  the.  corporation ;  frequent 
reference  to  the  charter  and  to  the  statutes  being  thereby  ren- 
dered unnecessary. 

Under  the  head  of  routine  details,  the  by-laws  should, 
in  strict  conformity  with  any  requirements  of  statutes  or  charter, 
provide  for  the  issuance  and  transfer  of  stock,  the  meetings  of 
stockholders  and  directors,  the  election  of  directors  and  officers, 
the  duties  and  limitations  imposed  upon  these,  the  care  and 
management  of  the  property  and  finances  of  the  corporation, 
and  the  other  connected  incidents  of  corporate  procedure. 

There  are  certain  general  restrictions  upon  the  making  of 
by-laws  which  the  courts  will  enforce : 

1.  By-laws  must  not  be  inconsistent  with  the  existing  laws 

or  with  the  charter  of  the  corporation. ^ 

2.  They  must  not  operate  unequally  upon  any  of  the  class 

which  they  are  intended  to  govern. ^ 

3.  They  must  not  impair  any  vested  right  of  any  stock- 

holder, s 

4.  They  must  not  be  unreasonable.* 

§  253.    Power  to  Make  By-Laws 

The  power  to  make  by-laws  is  one  of  the  common  law 
powers  enjoyed  by  corporations.  Where  the  common  law 
still  prevails,  the  right  to  make  by-laws  resides  in  the  stock- 
holders duly  assembled  in  lawful  meeting.  Power  to  make 
by-laws  may  be  delegated  by  the  stockholders  to  the  directors, 
but  may  be  resumed  at  any  time  by  the  stockholders,  and  may 
be  exercised  by  the  directors  only  under  such  limitations  as 
the  stockholders  prescribe.  This  power  over  the  by-laws  is 
perhaps  the  most  important  right  reserved  to  the  stockholders. 

This   is   so   because,   as   already   stated,    the   stockholders 

»Raub  V.  Gerken,  127  App.  Div.  (N.  Y.)  42  (igo8);  People  v.  Ittner,  165  111.  App.  360 
(1911). 

♦Griffith  V.  Klamath  Water  Users'  Assn.,  137  Pac.  (Ore.)  226  (1913);  10  Cyc.  356,  and 
cases  cited. 

»  State  V.  Board,  etc.,  164  S.  W.  (Tenn.)  iisi  (1914);  Wright  v.  Knights  of  the  Maccabees, 
196  N.  Y.  391  (1909). 

•  State  V.  Mayor,  etc.,  of  Jersey  City,  37  N.  J.  L.  348  (187s). 


2l8  CORPORATE  LAW  [Bk.  I- 

caiinot  manage  the  affairs  of  their  corporation  directly  but 
only  through  the  board  of  directors.  This  board  is  not  amen- 
able to  either  request  or  resolution  of  the  stockholders  and  has 
wide  latitude  and  great  independent  power  in  the  management 
of  the  corporate  affairs  and  property.  If  any  restrictions  are 
to  be  imposed  upon  the  directors'  powers,  recourse  must  be 
had  to  special  charter  or  by-law  provisions.  Special  charter 
provisions  are  of  limited  application  and  not  always  available, 
and  in  most  cases  the  wishes  of  the  stockholders  as  to  the  man- 
agement of  their  property  and  business  must  be  expressed  in  the 
by-laws,  and  can  be  effectively  expressed  in  no  other  way. 
For  this  reason  anything  affecting  the  stockholders'  sole  right 
to  make,  repeal,  and  amend  these  by-laws  is  a  matter  of  vital 
imoortance. 

§  254.    Power  of  Directors  to  Make  By-Laws 

In  New  Jersey  and  those  other  states  which  have  modeled 
after  her  corporation  laws,  the  charter  may  be  so  worded  as 
to  give  the  directors  power  to  make  and  amend  by-laws.  This 
gives  the  directors  the  power  to  alter  the  regulations  by  which 
they  themselves  are  controlled.  The  expediency  of  such  an 
arrangement  is  exceedingly  doubtful,  even  in  the  large  industrial 
combinations  for  whose  benefit  it  was  devised.  Its  tendency 
is  to  put  much  power  into  the  hands  of  the  directors  and  of  the 
majority  stockholders  by  whom  such  directors  are  elected,  and 
to  diminish  correspondingly  the  status  and  power  of  the  minority 
stockholders. 

In  New  York  the  directors  are  by  statute  provision  given 
the  power  to  adopt  by-laws  not  inconsistent  with  those  passed 
by  the  stockholders.  This  would  seem  to  be  quite  as  far  as  it 
is  safe  to  go.  It  allows  the  directors  to  pass  by-laws  to  meet 
an  emergency,  to  provide  for  new  conditions,  or  to  supplement 
and  make  more  effective  the  stockholders'  by-laws,  and  they 
are  fully  within  their  powers  so  long  as  these  by-laws  do  not 
conflict  with  the  by-laws  adopted  by  the  stockholders.     The 


Ch.  28]  BY-LAWS— GENERAL  CONSIDERATIONS  219 

directors  cannot,  however,  remove  any  of  the  safeguards  thrown 
round  the  conduct  of  the  business  by  the  by-laws  of  the  stock- 
holders, nor  modify  the  stockholders'  by-laws  in  any  material 
respect.  They  may  act  in  harmony  with  what  has  gone  before, 
but  cannot  alter  or  destroy.  It  is  to  be  noted  that  such  directors' 
by-laws,  until  repealed  or  superseded  by  action  of  the  stock- 
holders, are  the  by-laws  of  the  company  and  of  equal  force  with 
those  adopted  by  the  stockholders.  If  the  original  by-laws 
are  adopted  by  the  directors,  these  by-laws  are  the  law  of  the 
corporation,  and  can  be  amended  by  the  directors,  subject, 
however,  to  amendment  or  repeal  at  the  hands  of  the  stock- 
holders.' 

In  Illinois,  by  a  rather  strange  perversion  of  the  corporate 
theory  of  government  the  directors,  by  statute,  have  power  to 
make  by-laws  and  the  stockholders  have  power  neither  to  make 
nor  amend  the  by-laws. s 

§  25s.    Arrangement  of  By-Laws 

By-laws  intended  for  a  close  corporation  with  but  few  stock- 
holders and  perhaps  all  these  on  the  board  of  directors,  may 
be  simple  in  form  and  few  in  number.  When  intended  for  one 
of  the  great  corporate  combinations  with  plants  in  many  different 
states,  with  thousands  of  stockholders  scattered  throughout  the 
Union,  with  a  large  directorate,  many  officers,  and  numerous 
managing  committees,  an  extensive  and  comprehensive  set  of 
by-laws  is  usually  considered  essential. 

In  either  of  these  cases,  and  for  the  many  intermediate 
corporations,  it  is  of  much  advantage  to  have  the  by-laws 
classified  and  systematized  so  that  the  regulations  governing 
any  particular  subject  or  matter  may  be  readily  found.  In 
all  the  better  prepared  sets  of  by-laws  this  systematic  classifi- 
cation is  employed.  In  many  cases,  however,  the  by-laws 
are  hardly  more  than  a  heterogeneous  jumble  of  unconnected 


'  See  iS  231,  291. 

•Steinweg  v.  Antiseptol  Liquid  Soap  Co.,  168  111.  App.  479  (1912), 


220  CORPORATE  LAW  [Bk.  I- 

regulations,  badly  balanced,  incomplete,  difficult  in  operation, 
and  because  of  this,  the  less  likely  to  be  observed. 

In  the  present  volume  the  related  provisions  of  the  by-laws 
are  grouped  in  the  order  and  under  the  headings  given  below. 
This  arrangement  is  used  by  a  number  of  the  best  organized 
corporations  of  the  country  and  has  proved  very  satisfactory  in 
practice.  By-laws  from  the  simplest  to  the  most  comprehensive 
sets  may  be  readily  classified  on  these  lines: 

1.  Stock 

2.  Stockholders 

3.  Directors 

4.  Standing  committees 

5.  Officers 

6.  Dividends  and  finance 

7.  Sundry  provisions 

8.  Amendments 

§  256.    Preparation  of  By-Laws 

The  by-laws  usually  prescribe  the  general  organization  of 
the  corporation,  and  the  adoption  of  by-laws  is  therefore  the 
first  important  step  in  organizing  a  corporation.  As  the  by- 
laws are  needed  so  early  in  the  corporate  existence,  they  are 
customarily  prepared  in  advance  of  the  first  meeting,  this  duty 
usually  and  properly  falling  upon  the  counsel  conducting  the 
organization  of  the  corporation. 

The  preparation  of  a  set  of  by-laws  for  the  usual  small 
corporation  is  a  comparatively  simple  matter.  For  the  larger 
corporations,  with  their  more  complex  and  extended  organi- 
zations, the  undertaking  is  much  more  difficult.  Such  by-laws 
should  be  prepared  with  nice  adaptation  to  the  needs  of  the 
particular  corporation.  The  use  of  an  existing  set  of  by-laws 
as  a  basis  for  this  work  is  entirely  proper  and  good  practice, 
but  such  selected  set  should  be  carefully  studied  and  properly 
adapted  to  the  wants  of  the  new  corporation.  All  unnecessary 
matter  should  be  dropped,  the  matter  that  is  retained  be  made 


Ch.  28]  BY-LAWS— GENERAL  CONSIDERATIONS  221 

to  fit  the  case  in  hand,  and  such  new  matter  added  as  may  be 
necessary  to  cover  the  requirements  of  the  particular  corpor- 
ation. 

Too  often  the  preparation  of  the  by-laws  of  a  new  corpora- 
tion is  merely  a  wholesale  seizure  of  some  existing  set  with 
hastily  improvised  interpolations  to  meet  the  most  obvious 
individual  needs  of  the  new  organization.  These  by-laws  may 
have  been  a  very  admirable  code  of  procedure  for  the  original 
corporation,  but  so  diverted  they  can  hardly  fail  to  be  a  wretched 
misfit  and  prove  a  fruitful  source  of  trouble.  By-laws  so 
ill-prepared  give  seeming  grounds  for  the  demand  that  the 
directors  be  given  the  power  to  amend  by-laws  as  the  only  means 
of  avoiding  serious  hindrance  and  injury  to  the  business. 

§  257.     Adoption  of  First  By-Laws  ^ 

The  preparation  of  by-laws  requires  careful  consideration, 
and  it  is  usually  impossible  to  take  sufficient  time  at  the  first 
meeting  to  prepare  by-laws  or  even  properly  to  discuss  and 
amend  a  previously  prepared  set.  This  being  so,  the  responsi- 
bility for  the  by-laws  rests  almost  entirely  with  the  lawyers  to 
whom  their  preparation  is  entrusted.  If  the  by-laws  are  to 
be  adopted  formally,  this  is  accomplished  by  the  reading  of 
each  section  and  its  adoption  by  vote,  followed  by  the  adoption 
of  the  set  as  a  whole  at  the  completion  of  the  sectional  considera- 
tion. Usually,  however,  the  by-laws  are  presented  to  the 
meeting  in  their  entirety,  and,  without  reading  or  other  investi- 
gation of  their  details,  are  either  adopted  by  formal  vote  or 
accepted  by  acquiescence.  The  legal  effect  of  such  adoption  is 
the  same  as  under  the  more  formal  procedure. 

*See  1330. 


CHAPTER  XXIX 

BY-LAWS— STOCK 

§  258.    Preliminary 

The  subject  of  stock  which  is  considered  first  in  the  following 
comment  is  one  of  the  most  important  matters  of  by-law  regula- 
tion. In  most  of  the  states  general  requirements  relating  to  the 
stock  of  the  corporation,  its  certificates,  its  transfer  and  record, 
are  matters  of  statutory  regulation.  These  statutes  should  be 
summarized  and  classified  in  the  by-laws  and  such  additional 
special  regulations  brought  in  as  will  cover  the  entire  working 
details  of  the  subject.  No  open  question  should  be  left  to  cause 
later  differences  of  opinion,  vexations,  disputes,  and  perhaps  more 
serious  difficulties. 

In  former  days,  when  preliminary  subscriptions  to  the  stock 
of  a  corporation  were  usual  and  in  many  cases  payable  in  instal- 
ments, a  by-law  provision  as  to  the  payment  of  these  instalments 
and  the  procedure  in  case  of  default  was  customary  and  of  some 
importance.  In  the  present  day,  however,  the  formation  of  a 
corporation  with  instalment  subscriptions  is  comparatively  rare, 
and  when  it  does  occur  collection  of  the  subscriptions  is  usually 
provided  for  by  resolution  of  the  directors.  This  avoids  cum- 
bering the  by-laws  with  matter  that  is  of  no  permanent  utility. 

§  259.    Certificates  of  Stock 

Every  owner  of  stock  for  which  the  corporation  has  been  paid 
in  full  is  entitled  to  a  certificate  or  certificates,  showing  the  num- 
ber of  full-paid  shares  of  stock  owned  by  him.  A  subscriber, 
when  his  subscription  is  accepted,  becomes  a  stockholder  of  the 
company  and  entitled  to  vote  and  draw  dividends  if  any  are 
declared,  buf.  is  not  entitled  to  a  certificate  of  full-paid  stock  until 

222 


Ch.  29]  BY-LAWS— STOCK  223 

he  has  paid  the  full  subscription  price  of  his  stock.  If  he  has 
paid  in  part  he  is  entitled  to  a  receipt  evidencing  such  payment, 
and  if  the  by-laws  so  provide,  or  if  the  corporation  makes  a 
practice  of  issuing  certificates  for  partly  paid  stock  with  the 
amount  of  payments  indorsed  thereon,  he  has  a  right  to  demand 
such  a  certificate  as  soon  as  his  first  instalment  is  paid.  In  the 
absence  of  such  by-law  provision  or  of  such  a  custom,  it  does  not 
appear  that  a  stockholder  has  any  legal  right  to  a  stock  certificate 
until  he  has  paid  in  full  for  the  stock  represented  thereby.  It 
would  be  the  better  practice  to  issue  no  certificates  of  stock  until 
the  stock  represented  by  such  certificates  is  full-paid. 

The  holder  of  a  certificate  of  stock  has  the  right  to  assign  the 
same  to  others,  or  to  surrender  it  and,  if  for  more  than  one  share, 
have  it  split  up  and  issued  as  he  directs  in  certificates  of  total 
equivalent  value.  An  assignee  of  stock  has  the  same  right,  and 
whenever  a  duly  assigned  certificate  is  surrendered  to  the  com- 
pany a  new  certificate  or  certificates  must  be  issued  to  the  assig- 
nee in  his  own  name  if  so  demanded.  If  transfers  with  reissues 
of  certificates  are  frequent,  it  may  be  advisable  to  impose  a  small 
transfer  fee — usually  varying  from  10  to  25  cents  for  each  certif- 
icate issued — for  the  benefit  of  the  secretary  or  other  issuing 
officer.  This  is  occasionally  a  very  convenient  regulation  as  it 
compensates  the  secretary  for  the  time  and  labor  involved  in  the 
issue  of  new  certificates  and  also  tends  to  restrain  unnecessary 
transfers.     Such  a  fee,  if  reasonable  in  amount,  will  be  upheld.  1 

By-law  specifications  as  to  the  signature  and  sealing  of  certi- 
ficates are  useful  as  prescribing  in  detail  the  execution  of  the 
certificate  and  the  duties  of  the  different  officers  concerned. 
Such  by-law  regulations  must,  as  a  matter  of  course,  follow  any 
statute  provisions.  In  most  states  the  statutes  provide  for  the 
signature  of  stock  certificates  by  two  officers  of  the  corporation. 
In  some  states  the  statutes  designate  the  president  as  one  of 
these  officers,  leaving  to  the  corporation  the  designation  of  the 


'  See  {  344;  also  Giesen  v.  L.  &  N.  Mortgage  Co.,  102  Fed.  584  (1900). 


224  CORPORATE  LAW  [Bk  I- 

second  officer;  in  other  states  the  designation  of  both  officers  is 
left  to  the  corporation.  No  matter  who  the  signing  officers  may 
be,  the  sealing  and  actual  issuing  of  the  certificate  is  usually  left 
to  the  secretary.2 

§  260.    Transfers  of  Stock 

General  regulations  regarding  the  transfer  of  stock  as  well  as 
the  times  of  closing  the  stock  books,  are  in  many  states  a  matter 
of  statutory  provision,  but  may  also  properly  appear  in  the  by- 
laws with  any  other  connected  matter.  The  procedure  for  the 
transfer  of  stock  should  be  plainly  outlined  in  the  by-laws  as  a 
guide  to  the  officers  of  the  corporation,  and,  more  particularly, 
for  the  benefit  of  the  stockholders  who  are  thereby  informed  as 
to  their  exact  rights  in  the  matter.3 

§  261.    Transfer  Agent  and  Registrar 

In  the  larger  corporations,  or  in  any  corporation  where  the 
transfers  of  stock  are  numerous,  the  employment  of  special 
transfer  agents  and  registrars  is  usually  a  considerable  advantage. 
By  this  means  the  officers  are  relieved  of  much  responsibility, 
and  a  safety  and  a  convenience  in  the  issuance  of  stock  secured 
not  usually  possible  under  any  other  arrangement.  For  a  small 
or  close  corporation  where  transfers  are  few,  the  employment  of 
such  agents  is  a  needless  expense. 

Where  transfer  agents  and  registrars  are  to  be  employed, 
the  by-laws  should  give  the  power  to  appoint  these  to  either  the 
board  of  directors  or  to  one  of  the  standing  committees.  The 
by-law  provision  covering  this  matter  should  also  require  the 
signature  of  the  transfer  agent  and  of  the  registrar  to  every 
certificate  issued.  Where  a  trust  company  is  to  be  appointed  as 
transfer  agent  or  registrar  and  the  appointment  is  of  probable 
permanence,  such  appointee  is  sometimes  named  in  the  same 
by-law  provision.     As  this  necessitates  an  amendment  of  the 


2  See  S  97. 

»  See  Chs.  XXXVIII  and  XXXIX,  "Transfer  of  Stock";  also  Boole  III,  5S  42,  43. 


Ch.  29]    .  BY-LAWS— STOCK  225 

by-laws  in  case  of  any  change,  the  arrangement  is  of  doubtful 
expediency. 

The  duties  of  a  transfer  agent  and  of  a  registrar  are  distinct 
but  are  usually  performed  by  one  person  or  institution.^ 

§  262.    Stock  and  Transfer  Books 

All  requirements  as  to  the  stock  and  transfer  books  should 
appear  in  the  by-laws.  To  this  end  the  statute  laws  must  be 
carefully  consulted  as  to  what  books  must  be  kept,  where  they 
must  be  kept,  and  what  they  must  contain.  New  Jersey  cor- 
porations are  required  to  keep  their  stock  and  transfer  books  in 
the  principal  office  of  the  corporation  in  New  Jersey.  If  it  is 
desirable  that  duplicates  be  kept  elsewhere,  the  by-laws  might 
properly  so  provide.  Every  foreign  corporation  doing  business 
in  New  York  is  compelled  to  keep  a  stock  book  in  the  principal 
office  of  the  company  in  the  state.  Hence  the  by-laws  of  a 
corporation  organized  under  the  New  Jersey  laws  and  doing 
business  in  New  York  might  very  well  specify  in  this  particular 
the  duties  of  the  corporation  in  both  states. 

It  is  usual  to  close  the  transfer  books  a  certain  number  of  days 
before  the  annual  meeting,  and  during  this  period  stock  cannot 
be  transferred  on  the  corporate  records.  If  this  closing  of  the 
transfer  books  has  not  already  been  provided  for  in  the  by-laws 
relating  to  the  transfer  of  stock,  it  should  receive  attention  here. 
It  is  also  usual  to  provide  for  the  closing  of  the  transfer  books  a 
certain  number  of  days  before  dividends  are  paid,  and  any  pro- 
viso as  to  this  closing  might  be  covered  in  connection  with  the 
closing  of  the  transfer  books  for  the  annual  meeting.  5 

§  263.    Preferred  Stock 

The  preferred  stock  of  a  corporation  will  probably  have  been 
specifically  provided  for  in  the  charter.  It  is  customary,  how- 
ever, to  repeat  such  provisions  in  the  by-laws  for  easy  reference 


*  See  {  3S8;  also  Wills,  Estates,  and  Trusts,  by  T.  Conyngton  et  al.,  Ch.  LXI. 
•See  Book  III,  {{  38-43;  also  Book  IV,  Ch.  VII.  "Stock  Books"  (forms). 


226  CORPORATE  LAW  •   [Bk.  I- 

and  for  the  information  of  the  stockholders.  As  all  the  details 
relating  to  preferred  stock  are  usually  found  in  the  charter 
provisions  by  which  such  stock  is  created,  the  by-law  will  be 
merely  a  more  or  less  complete  repetition  of  the  charter  specifica- 
tions. In  some  few  states  preferred  stock  is  authorized  by  the 
provisions  of  the  by-laws,  which  in  such  event  become  of  much 
more  moment  and  should  be  drawn  with  the  same  care  and 
regard  for  the  necessities  of  the  case  as  would  any  charter  pro- 
vision. The  by-law  authorizing  the  issue  of  preferred  stock 
cannot  be  materially  altered  or  amended  after  stock  has  been 
sold  under  its  terms,  except  with  the  consent  of  the  holders  of 
the  outstanding  preferred  stock.  If  it  were  modified  without 
such  consent,  the  changes  would  be  ineffective  as  regards  out- 
standing stock,  unless  accepted  by  its  holders. e 

§  264.    Treasury  Stock 

The  term  "treasury  stock"  is  used  very  loosely,  and,  with- 
out some  defining  provision,  ambiguities  are  apt  to  arise.  For 
this  reason  a  provision  is  frequently  brought  into  the  by-laws 
for  the  purpose  of  defining  the  term  and  the  status  of  treasury 
stock.  Such  a  by-law  is  advisable  if  the  corporation  is  likely 
to  have  stock  of  the  kind. 

The  status  of  this  treasury  stock  is,  where  not  expressly 
fixed  by  statute,  a  matter  of  common  law,  but  should  neverthe- 
less be  clearly  expressed  in  the  by-laws  as  a  matter  of  information 
for  both  ofl&cers  and  stockholders.' 

§  265.    Lost  Certificates 

The  loss  of  stock  certificates  is  a  matter  of  not  uncommon 
occurrence,  and  the  procedure  in  such  cases  should  be  clearly 
outlined  in  the  by-laws.  Stockholders  have  a  right  to  certifi- 
cates and,  if  their  certificates  are  lost,  to  have  them  replaced, 
but  the  corporation  on  its  part  has  the  right  to  require  any 


•  See  Ch.  XI.  "Preferred  Stock." 
'  See  Ch.  XIII,  "Treasury  Stock." 


Ch.  29]  BY-LAWS— STOCK  227 

reasonable  safeguards  for  its  own  protection  before  the  reissuance 
of  such  certificates.  If  the  statutes  prescribe  the  procedure  to 
be  followed,  the  by-law  provisions  must  correspond.  It  is 
seldom  wise  to  reissue  lost  certificates  on  easier  terms  than  those 
laid  down  in  the  usual  by-law  form.s  Only  the  absolute  and 
final  loss  of  a  certificate,  as  in  the  case  of  its  unquestioned  de- 
struction by  fire,  would  justify  an  unprotected  reissue. 

§  266.    Fractional  Shares 

Some  few  corporations  issue  fractional  shares,  though  there 
is  no  legal  authority  for  such  action.  It  would  seem  undesirable 
on  every  account.  Apart  from  the  complexity  of  records  and 
accounts,  troublesome  questions  might  arise  as  to  legal  rights  of 
holders.  What  voting  or  dividend  rights  would  a  man  have  who 
owned,  say,  9/17  of  a  share  of  stock?  If  a  man  sells  a  fractional 
interest  or  interests  in  a  share  of  stock,  he  and  the  other  parties 
would  be  entitled  to  have  a  certificate  issued  in  their  joint  names, 
would  own  the  share  in  common,  and  would  have  to  arrange 
among  themselves  as  to  custody,  voting,  and  dividends.  The 
corporation  need  not  concern  itself  with  the  transaction. 


•See  Book  IV  Ch.  Ill,  "By-Law  Forms."  i 


CHAPTER  XXX 

BY-LAWS— STOCKHOLDERS 

§  267.    Annual  Meetings 

An  annual  meeting  of  stockholders  at  which  directors  for  the 
ensuing  year  are  elected  is  usually  required  by  the  statutes. 
Whether  or  not  so  required,  such  meeting  should  be  provided 
for  in  the  by-laws.  It  is  the  most  important  function  of  the 
stockholders,  and  the  portion  of  the  by-laws  devoted  to  the  stock- 
holders is  principally  occupied  with  provisions  relating  to  the 
annual  meeting.  -.---<« 

In  specifying  the  time  of  the  annual  meeting  it  is  advisable 
not  to  specify  a  fixed  day  of  the  month,  as,  for  instance  "J^^iuary 
26,"  but  to  fix  the  date  in  some  such  form  as  "the  third  Monday 
in  January,"  The  reason  for  this  is  that  if  the  specified  date  as 
first  given  falls  on  a  holiday  or  a  Sunday,  upon  which  the  meeting 
cannot  be  held,  various  questions  may  arise  as  to  the  validity 
of  the  corporation's  proceedings. 

It  is  also  a  good  precaution  to  name  the  time  of  the  day  at 
which  the  meeting  is  to  be  held,  as  precision  in  specifying  the 
time  and  place  may  at  some  time  be  much  needed  in  case  notice 
of  the  annual  meeting  should  be  defective.  If  the  hour  of  the 
meeting  is  not  specified,  it  has  been  held  that  the  by-law  is  not 
sufficient  notice  to  the  stockholders.! 

In  fixing  the  date  of  the  annual  meeting  it  is  generally  well 
to  fix  it  shortly  after  the  end  of  the  fiscal  year  of  the  corporation 
so  that  the  financial  report  to  the  stockholders  may  be  com- 
prehensive. 

For  the  same  reason,  the  place  should  be  definitely  fixed, 


'  Lowe  V.  Los  Angeles  Suburban  Gas  Co.,  24  Gal.  App.  367  (1914), 

228 


Ch.  3o]  BY-LAWS— STOCKHOLDERS  229 

and — except  where  it  is  expressly  provided  by  statute,  as  in 
Delaware  and  a  few  other  states,  that  the  stockholders'  meetings 
may  be  held  out  of  the  state — the  place  designated  must  be  in 
the  state  of  incorporation. 

The  by-laws  providing  for  the  annual  meeting,  in  addition 
to  fixing  the  time  and  place,  should  in  a  general  way  specify  the 
proceedings  of  that  meeting.  This  specification  of  the  business 
to  be  transacted  at  the  annual  meeting  is  not  mandatory.  Any 
portion  of  it  can  be  waived  by  the  meeting  at  will.  Nor  is  it 
intended  to  limit  the  stockholders'  proceedings  in  any  way  unless 
expressly  so  stated  in  the  charter  or  by-laws.  It  is  always  ex- 
pected that  in  addition  to  the  specified  procedure,  any  other 
business  or  matters  of  interest  to  the  stockholders  will  be  con- 
sidered, and  the  order  of  business  is  included  in  the  by-laws 
merely  to  prevent  important  action  being  omitted  or  overlooked 
and  as  a  matter  of  convenience. 

§  268.    Special  Meetings 

The  by-laws  must  provide  for  special  meetings  of  the  stock- 
holders, and  fix  the  preliminary  requirements  for  such  meetings. 
Frequently  the  president  is  given  authority  to  call  special  meet- 
ings at  his  discretion;  it  is  always  customary  to  provide  for 
such  meetings  to  be  held  pursuant  to  resolution  or  other  specified 
action  of  the  board;  at  times  it  is  provided  that  a  certain  number 
of  the  directors  may  call  special  meetings  by  a  written  request  or 
call;  it  is  also  customary  and  proper  to  allow  these  special  meet- 
ings to  be  called  on  demand  of  a  certain  proportion  in  interest 
of  the  stockholders — usually  one-third  or  a  majority  of  the  out- 
standing stock. 

It  is  usual  to  prescribe  in  the  by-laws  that  only  such  business 
as  is  specified  in  the  call  and  notice  shall  be  transacted  at  a 
special  meeting  of  stockholders.  This  is  a  matter  of  common 
law,  and  in  some  states  statutory  law,  and  is  included  in  the  by- 
laws merely  to  emphasize  the  fact  that  any  business  to  be  done 
at  any  such  meeting  must  be  previously  notified  to  the  stock- 


230  CORPORATE  LAW  [Bk.  I- 

holders.  The  call  and  notice,  to  be  sufficient,  must  give  the 
three  essential  facts — the  time,  place,  and  purpose  of  the  meeting. 
If  any  one  of  these  is  omitted,  the  meeting  is  improperly  called 
and  its  action  is  liable  to  be  held  illegal  and  may  be  set  aside. 

§  269.    Officers  of  Meetings 

It  is  customary  in  some  corporations  to  organize  each  stock- 
holders' meeting  with  officers  of  its  own  choosing,  who  may  or 
may  not  be  the  regular  officers  of  the  corporation.  Under  some 
conditions  this  plan  may  be  a  wise  one,  but  generally  it  would 
seem  better  to  provide  in  the  by-laws  that  the  officers  of  the 
corporation  shall  also  be  the  officers  of  the  stockholders'  meet- 
ings. In  such  case  the  president,  or  in  his  absence  the  other 
officials  in  due  order,  preside,  while  the  secretary  keeps  the 
records  of  the  meeting.  Such  an  arrangement  saves  much  con- 
fusion and  loss  of  time  on  occasion,  and  conduces  to  the  orderly 
transaction  and  proper  record  of  the  business  of  the  meeting. 

The  secretary  is  usually  and  properly  omitted  from  the 
officials  who  may  preside.  The  function  of  this  officer  is  to 
record  the  proceedings  of  the  meeting  and  it  would  not  be 
advantageous  to  withdraw  him  from  his  proper  duties  to  preside, 
even  though  all  the  other  officers  were  absent. 

§  270.    Notice  of  Meetings 

Unless  there  is  some  material  reason  for  not  so  doing,  it  will 
be  found  advantageous  to  adopt  the  same  requirements  as  to 
time  and  character  of  notice  for  both  regular  and  special  meet- 
ings. When  this  is  done  the  requirements  as  to  notice  may  be 
properly  included  in  a  single  by-law  section.  Where  the  notices 
for  the  two  kinds  of  meeting  differ  materially,  the  details  for  each 
meeting  should  occupy  a  separate  subsection  under  the  sections 
providing  for  annual  and  special  meetings. 

The  notice  of  regular  meetings  should  specify  the  time,  the 
place,  and  usually  the  most  important  objects  of  the  meeting. 
Where  unusual  business  is  to  be  transacted,  even  at  a  regular 


Ch.  3o]  BY-LAWS— STOCKHOLDERS  231 

meeting,  the  notice  of  the  meeting  should  state  that  unusual 
business.2 

The  notice  for  special  meetings  should  give  the  time  and 
place  of  meeting,  and  specify  in  detail  all  the  business  to  be  acted 
upon  at  that  meeting. 

Where  a  corporation  has  but  few  stockholders,  the  provisions 
as  to  notice  of  meetings  will  sometimes  include  the  following 
provision  for  special  meetings:  "With  the  presence  and  par- 
ticipation, or  with  the  consent  of  all  the  stockholders,  meetings 
may  be  held  at  any  time  and  place  and  for  the  transaction  of 
any  business,  without  notice." 

Notice  of  meetings  is  best  given  through  the  regular  postal 
channels;  personal  notice  is  allowable,  but  should  always  be 
served  in  writing.  Verbal  notice,  while  legally  held  sufficient,  is 
objectionable  because  it  is  usually  difficult  and  sometimes  im- 
possible of  proof.  Unless  expressly  authorized  in  the  by-laws, 
notice  by  telephone  is  not  sufficient  and  in  any  such  case  service 
could  not  be  legally  proved.  By-laws  as  to  notice  of  meetings 
should  include  all  statutory  requirements  of  publication  or  mail- 
ing of  notices. 

§  271.    Voting 

The  usual  rule  in  regard  to  voting  is  that  each  stockholder 
of  a  corporation  is  entitled  to  one  vote  for  each  share  of  stock 
standing  in  his  name  on  the  books  of  the  corporation.  If  there 
are  any  variations,  such  as  cumulative  voting,  classified  voting, 
or  reservation  of  voting  to  one  class  of  stock,  such  variation 
should  be  stated  as  clearly  as  possible.  Perspicuity  and  pre- 
cision in  the  by-laws  relating  to  voting  may  save  much  trouble 
later.     Such  provisions  must  conform  to  any  state  statutes. 

§  272.    Certified  List  of  Stockholders 

Under  the  laws  of  New  Jersey  and  of  some  other  states,  at 
each  regular  meeting  of  the  stockholders  of  a  corporation  a 


«  3  Ckwlc  on  Corp..  I  S9S- 


93^  CORPORATE  LAW  [Bk.  I- 

certified  list  of  the  stockholders  entitled  to  vote  thereat  must 
be  provided  by  the  secretary.  In  any  state  the  provision  is  a 
satisfactory  one  and  may  well  be  included  in  the  by-laws,  either 
as  a  separate  section,  or  as  a  part  of  the  by-law  providing  for 
annual  meetings  of  the  stockholders.  It  is  to  be  noted  that  the 
stock  books  are  the  final  authority  as  to  the  right  of  any  stock- 
holder to  vote,  and  the  certified  list  of  stockholders  cannot  be 
made  a  substitute  for  the  stock  book,  which  should  be  accessible 
in  case  of  dispute.  The  certified  list  will,  however,  usually  be 
found  all  sufficient,  saving  reference  to  the  stock  book  and 
giving  its  information  in  much  more  convenient  form.  The 
list  should  be  alphabetically  arranged, 

'•i  :,■' 

§  273.    Election  of  Directors 

As  the  election  of  directors  is  the  most  important  business 
of  the  annual  meeting,  the  by-law  directions  for  its  conduct 
should  be  very  explicit.  If,  as  is  the  case  in  certain  states,  the 
statutes  require  the  election  or  appointment  of  inspectors — who 
are  usually  sworn  to  the  proper  discharge  of  their  duties — the 
details  of  their  appointment  and  duties  should  be  fully  outlined. 
If  inspectors  are  not  prescribed  by  statute  and  are  not  desired, 
some  other  method  of  conducting  the  election  should  be  specified. 
It  is  usually  advisable  that  it  be  by  ballot,  though  this  is  not 
essential  save  when  prescribed  by  statute.  If  by  ballot,  pro- 
vision must  be  made  for  the  appointment  of  tellers  to  collect, 
count,  and  announce  the  vote. 

Unless  included  in  the  by-law  on  voting,  any  provisions  as 
to  cumulative  voting,  or  as  to  classification  of  the  stock  in  regard 
to  voting,  should  be  given  here.  Also,  if  the  directors  are 
classified  so  that  but  one-third  or  one-fourth  are  elected  each 
year,  such  fact  should  be  stated  under  this  heading. 

The  term  for  which  the  directors  are  elected  should  also  be 
stated  clearly.  Usually  this  is  for  the  ensuing  year  and  until 
the  election  of  their  duly  qualified  successors.     The  directors 


Ch.  30]  BY-LAWS— STOCKHOLDERS  233 

hold  until  the  election  of  their  successors  in  any  event,  but  the 
by-laws  should  state  the  fact.3 

§  274.     Quorum  cVS-  2 

In  a  number  of  the  states  the  proportionate  amount  of  the 
outstanding  stock  which  must  be  represented  at  a  stockholders' 
meeting  to  constitute  a  quorum  is  fixed  by  statute.  In  such 
case  the  by-laws  can  do  nothing  more  than  repeat  the  law  in 
order  that  it  may  be  remembered  and  observed.  If  the  statutes 
do  not  so  provide,  the  quorum  should  be  distinctly  prescribed 
by  the  by-laws.  If  not  provided  by  either  statute  or  by-law, 
the  common  law  rule  prevails,  that  the  stockholders  present, 
no  matter  how  few  their  number,  constitute  a  quorum.^ 

In  the  absence  of  any  statutory  provisions  to  the  contrary, 
the  by-laws  may  provide  that  less  than  a  majority  of  the  out- 
standing stock  shall  constitute  a  quorum;  but  for  most  corpo- 
rations it  is  not  safe  to  depart  from  the  usual  parliamentary  rule 
that  a  majority  of  the  outstanding  stock  is  necessary  to  consti- 
tute a  quorum.  To  illustrate  the  necessity  of  a  careful 
consultation  of  the  statutes  in  this  matter  and  in  matters  of 
corporate  procedure  generally,  attention  may  be  called  to  the 
fact  that  in  New  York  the  by-laws  may  prescribe  the  number 
necessary  to  constitute  a  quorum  at  stockholders'  meetings  for 
ordinary  business,  but  cannot  fix  a  quorum  for  the  election  of 
directors,  those  present  at  any  annual  meeting  being  a  sufficient 
quonun  for  this  purpose  no  matter  how  few  their  number  or 
how  small  a  proportion  of  the  outstanding  stock  they  represent. 
This  is  but  a  special  application  of  the  general  common  law  rule 
that  those  present  at  a  meeting  of  constituent  members  form  a 
quorum  and  may  act. 

It  is  to  be  noted  that  this  common  law  rule  applies  only  to 
the  constituent  membership  of  a  body,  such  as  the  stockholders 


»  2  Cook  on  Corp.,  {  634;  3  Ibid.,  {  713. 
*  See,!  402. 


234  CORPORATE  LAW  [Bk.  I] 

of  a  corporation.     The  directors,  being  a  selected  body,  require 
a  majority  of  the  entire  board  to  constitute  a  legal  quorum.  ^ 

§  275.    Proxies 

Proxies  play  such  an  important  part  in  all  corporate  meet- 
ings that  the  by-law  provisions  relating  to  them  should  be  clear 
and  explicit.  At  common  law  the  stockholder  does  not  have 
the  right  to  be  represented  at  corporate  meetings  by  a  proxy. 
The  right  is  given  by  stature  in  many  states,  and  elsewhere 
proxies  may  be  authorized  by  charter  provision,  or  in  most 
states  by  by-law  enactment.  Where  created  by  statute,  the 
by-law  provision  must  follow  the  statute. 


§  276.    Order  of  Business  ,     ^ 

The  order  of  business  is  purely  formal  but  quite  essential  to 
the  proper  transaction  of  the  corporate  business.  It  may  be 
varied  to  meet  the  needs  of  any  particular  corporation.  The 
order  given  in  the  by-law  forms  ^  indicates  the  usual  and  logical 
arrangement.  The  formal  order  of  business  may  be  suspended 
at  any  meeting,  in  whole  or  in  part,  by  a  majority  vote  of  those 
present,  or  by  their  mere  assent. 


s  I  Morawetz,  2nd  Ed.,  §  476;  2  Kent's  Com.,  §  293;  Matter  of  Rapid  Transit  Ferry   is 
Aop.  Div.  (N.  Y.)  530  (1897). 
"  6  See  Book  IV,  Ch.  Ill,  "By-Law  Forms." 


ijt 


CHAPTER  XXXI 
BY-LAWS— THE  BOARD  OF  DIRECTORS 

§  277.    General  Considerations 

Regulations  affecting  the  directors  and  any  restrictions  upon 
their  powers  and  action  will,,for  the  most  part,  appear  only  in 
the  by-laws.  Statutory  provisions  of  general  scope  are  found 
in  practically  all  the  states,  more  specific  provisions  appear  in 
some  states,  and  especially  important  matters  are  sometimes 
brought  into  the  charter;  but  in  the  main  the  stockholders 
must  look  to  the  by-laws  to  direct  and  control  the  operations 
of  their  directors. 

Much  latitude  is  allowable  in  the  arrangement  of  the  by- 
laws affecting  directors.  In  the  larger  corporations  the  subdi- 
visions are  frequently  carried  further  than  indicated  in  the 
present  chapter;  in  the  smaller  corporations,  ordinarily  not 
so  far. 

Many  of  the  details  appearing  in  the  by-laws  affecting  direc- 
tors are  matters  of  law,  or  are  fixed  by  charter  provision  and 
are  brought  into  the  by-laws  merely  to  save  reference  to  the 
authorities  from  which  they  are  taken. 

§  278.    Number 

In  many  states  the  number  of  directors  is,  within  certain 
minimum  and  maximum  limits,  fixed  by  statute.  In  some 
states,  as  New  Jersey  and  Massachusetts,  the  minimum  is  pre- 
scribed by  statute  and  any  number  in  excess  of  this  minimum 
may  be  fixed  by  the  by-laws.  In  most  states  the  minimum 
number  of  directors  allowed  is  three. 

For  a  small  or  close  corporation  a  limited  board  of  directors 
is  usually  advantageous.    Such  a  board  is  easily  assembled,  is 

235 


236  CORPORATE  LAW  [Bk.  I- 

likely  to  keep  In  touch  with  the  business,  and  is  generally 
prompt  in  consideration  and  action. 

In  the  larger  corporations  a  more  numerous  directory  is 
usual.  Frequently  this  is  necessary  in  order  to  provide  represen- 
tation for  the  different  stockholding  interests,  as  well  as  to 
have  the  requisite  managing  representatives  upon  the  board. 
Though  necessary,  the  arrangement  has  many  disadvantages. 
A  quorum  is  only  secured  with  difficulty;  the  members  are  not 
close  to  the  business  and  are  not  interested  actively  in  its  man- 
agement, and  lengthy  explanations,  much  discussion,  and  pro- 
longed consideration  are  the  rule  when  important  questions  are 
really  taken  up.  As  a  result  the  actual  management  of  the 
business  and  of  the  corporate  affairs  is  delegated  to  the  standing 
committees,  the  board  meeting  only  to  listen  to  reports,  or  to 
act  in  matters  of  exceptional  importance. 1 

§  279.     Qualifications 

The  most  common  qualification  required  of  a  director  is  the 
ownership  of  stock.  This  is  usually  regulated  by  statute.  In 
some  states  such  qualifying  stock  must  be  owned  when  the  direc- 
tor is  elected.  In  most  states,  if  the  director-elect  is  given  or 
secures  stock  after  his  election,  the  requirements  of  the  law  are 
held  to  be  satisfied.  If  the  statutes  merely  state  that  directors 
must  be  stockholders,  the  ownership  of  one  share  of  stock  is 
sufficient.  If  the  statutes  are  silent  on  the  subject  of  stock 
qualifications  of  directors,  or  if  they  require  merely  that  directors 
be  stockholders,  the  by-laws  may  legally  provide  that  such  rea- 
sonable number  of  shares  as  may  seem  desirable  shall  be  the 
qualification. 

, .  In  some  states  it  is  provided  that  a  director  parting  with  his 
qualifying  stock  thereby  ipso  facto  ceases  to  be  a  director.  In 
order  to  prevent  any  misunderstanding  on  this  point,  the  by- 
laws should  repeat  the  statute  provision  where  it  exists.  Else- 
where it  would  be  prudent  to  state  explicitly  either  that  the 

'  See  i  229. 


Ch.  31]  BY-LAWS— BOARD  OF  DIRECTORS  237 

parting  with  the  quaHfying  stock  does  or  does  not  terminate  the 
director's  tenure  of  office.  As  a  general  rule  it  would  seem 
advisable  that  directors  should  be  stockholders,  of  the  corpora- 
tion to  some  material  extent,  and  that  if  they  part  with  this 
qualifying  stock  they  should  by  such  disposal  sever  their  official 
connection  with  the  board.2 

If  there  is  any  statutory  requirement  as  to  citizenship  of 
directors,  it  should  be  included  in  the  by-laws. 

§  280.    General  Powers 

At  common  law  the  directors  have  entire  charge  of  the 
property  and  affairs  of  the  corporation  with  full  power  and 
authority  to  manage  and  conduct  the  same.  The  statement  of 
the  general  powers  of  the  directors  as  it  usually  appears  in  the 
by-laws  is  therefore  nothing  more  than  a  reiteration  of  the  con- 
ditions as  they  exist,  brought  into  the  by-laws  as  a  matter  of 
information.  If  the  powers  of  the  directors  are  materially 
modified  or  restricted  by  the  statutes,  by  the  charter  of  the 
corporation,  or  by  the  by-laws  themselves  in  other  parts,  the 
by-law  statement  of  general  powers  should  be  drawn  to  cor- 
respond.s 

§  281.    Tenn  of  Office 

The  statutes  in  most  states  provide  that  the  directors  shall 
be  elected  annually,  and  shall  hold  over  until  their  successors 
are  elected  and  qualify.  When  the  statutes  so  provide,  no  by- 
law provision  for  a  longer  term  would  be  valid.  In  many  of  the 
states,  however,  classification  whereby  only  part  of  the  directors 
are  elected  each  year  is  provided  for.  The  by-laws  should  in 
any  event  contain  provisions  as  to  the  term  of  office  of  the 
directors,  and  the  provision  that  they  shall  hold  over  until  their 
successors  are  elected  and  qualify. 


<  See  f  228. 
*  -See  {{  230,  231. 


238  CORPORATE  LAW  [Bk.  I- 

§282.    Classification  „.l  ■Ji-,o1^ -iwiA'- 

The  usual  object  of  a  classification  of  directors  is  to  provide 
against  any  radical  action  or  sudden  alteration  of  policy  that 
might  occur  if  the  whole  board  were  changed  at  one  time.  In 
perhaps  the  greater  number  of  states  it  must,  when  desired,  be 
secured  through  by-law  provision. 

To  be  effective  any  such  classification  of  directors  must  be 
permanent,  and  therefore,  wherever  possible,  should  be  by 
charter  provision.  If  dependent  only  upon  the  provisions  of  the 
by-laws,  a  majority  of  the  stockholders  might  at  any  time 
assemble  with  due  formality,  repeal  the  by-laws  in  question,  and 
thereby  abrogate  the  whole  arrangement.'' 

Classification  in  a  small  or  close  corporation  is  generally  a 
useless  and  somewhat  troublesome  formality. 

§  283.    Removal 

It  may  infrequently  happen  that  the  stockholders  wish  to 
have  more  control  over  the  board  than  they  have  under  the  com- 
mon law,  and  wish  to  reserve  to  themselves  the  power  of  removal 
of  directors  without  the  troublesome  procedure  necessary  to 
remove  them  for  adequate  cause. 

If  the  statute  does  not  give  them  this  power,  and  their  charter 
does  not,  provision  may  be  made  in  the  by-laws,  and  a  director 
accepting  office  under  a  by-law  giving  the  stockholders  power  of 
removal  will  be  bound  thereby.  ^ 

§  284.    Vacancies 

The  board  of  directors  is  usually  given  power  to  fill  vacancies 
occurring  in  its  own  body.  Unless,  however,  it  is  so  provided  by 
statute,  charter,  or  by-laws,  the  board  does  not  have  this  power, 
and  in  such  event  the  power  is  reserved  to  the  stockholders.  Any 
vacancies  in  the  board  must  then  either  wait  until  the  next  annual 


*  See  §  232. 

5  Douglass  V.  Merchants'  Ins.  Co.,  118  N.  Y.  484  (1890);  Raub  v.  Gerken.  127  App.  Div. 
fN.  Y.)  42  (ipcSi-  • 


Ch.  31I  BY-LAWS— BOARD  OF  DIRECTORS  235 

meeting  with  its  election  of  directors,  or  be  filled  by  a  special 
election,  the  stockholders  being  called  together  for  the  purpose/ 

As  long  as  the  board  can  assemble  a  quorum  of  its  entire 
membership,  it  may  continue  to  act  despite  vacancies,  but  it  is 
safer  to  keep  the  membership  up  to  the  prescribed  quota,  and 
it  is  almost  an  invariable  rule  to  give  the  board  the  power  to  fill 
vacancies  as  they  occur.  In  this  way  the  board  is  self -per- 
petuating in  the  intervals  between  the  annual  meetings. 

The  usual  board  vacancies  provided  for  by  the  by-laws  are 
those  caused  by  death  or  resignation.  Beyond  this  the  by-laws 
might  very  properly  provide  that  continued  absence  from  meet-, 
ings  of  the  board  should,  in  itself,  vacate  the  position  of  the 
absentee  director.  In  such  case  the  by-laws  should  specify 
the  exact  number  of  consecutive  absences  from  regular  meetings, 
or  from .  regular  and  special  meetings,  necessary  to  create  a 
vacancy. 

By-laws  sometimes  provide  that  in  case  the  membership  of 
the  board  falls  below  the  number  required  for  a  quorum,  so  that 
the  board  is  unable  either  to  transact  business,  or  to  fill  the  va- 
cancies and  thereby  re-establish  a  quorum  to  enable  it  to  transact 
business,  a  special  meeting  of  the  stockholders  shall  be  called  to 
elect  such  number  of  directors  as  may  be  necessary  to  restore 
the  board  to  its  normal  membership. 

§  285.    Meetings 

The  frequency  of  regular  meetings  of  the  board  is  to  be 
decided  by  the  particular  conditions.  Monthly  meetings  arc 
usual,  but  in  close  corporations  with  a  small  board  it  is  often 
unnecessary  to  meet  regularly  more  than  once  in  each  quarter, 
or  even  once  each  year.  In  case  of  any  emergency  requiring 
action,  a  special  meeting  of  a  small  board  can  be  quickly  and 
easily  called. 


*  In  rf  Griffing  Iron  Co.,  63  N.  J.  L.  168,  3S7  (1899). 


24©  CORPORATE  LAW  [Bk.  I- 

The  by-laws  should  provide  the  time  and  place  of  regular 
meetings  of  the  board,  and  should  make  provision  for  calling 
special  meetings.  The  nature  and  formalities  of  the  call  neces- 
sary to  summon  a  special  meeting  of  the  board  are  purely 
matters  for  the  corporation  to  determine.  Usually  the  president 
is  given  authority  to  call  such  meetings  at  his  discretion.  Gen- 
erally it  is  provided  also  that  such  meeting  shall  be  called  upon 
written  request  of  a  certain  number — usually  two-thirds — of  the 
directors.  More  rarely  it  is  provided  that  a  special  meeting 
shall  be  called  upon  the  written  request  of  a  certain  proportion  in 
.interest  of  the  stockholders. 

Where  the  board  is  small,  it  is  customary  and  advisable  to 
provide  that  meetings  may  be  held  at  any  time  and  place  and 
without  previous  notice,  by  the  unanimous  consent  or  unanimous 
participation  of  the  board  membership.  Such  a  provision  would 
usually  be  useless  if  the  board  were  large. 

The  place  of  meeting  should  be  fixed  by  the  by-laws,  though 
a  proviso  may  be  added  that  special  meetings  may  be  held  else- 
where by  unanimous  consent  of  the  board.  The  office  of  the 
corporation  is  the  proper  place  for  directors'  meetings  and  they 
should  be  held  there  unless  otherwise  agreed  by  all  the  directors. 
To  allow  a  majority  of  the  board  to  call  meetings  in  private 
offices,  or  in  places  difficult  of  access,  or  to  permit  of  adjourn- 
ment to  such  places,  except  by  unanimous  agreement,  is  to 
invite  the  gravest  abuses.''  ..     ..       „ 

§  286.    Notice  of  Meetings 

It  is  supposed  that  members  of  the  board  are  familiar  with 
the  date  of  regular  meetings.  Hence,  there  is  not  the  same 
legal  necessity  for  notice  that  exists  in  the  case  of  special  meet- 
ings. It  is  usual  though,  as  a  matter  of  convenience  and  to 
prevent  such  meetings  from  being  overlooked,  to  provide  that 
notice  of  regular  meetings  shall  be  given  by  the  secretary,  and 

'  See  i  420. 


Ch.  31]  BY-LAWS— BOARD  OF  DIRECTORS  241 

where  specially  important  action  is  to  be  taken  at  any  such 
meeting,  notice  of  this  is  also  usually  given.  In  the  more  com- 
prehensive sets  of  by-laws  it  is  customary  to  add  a  proviso  that 
failure  to  give  such  notice  shall  not  afifect  the  validity  of  the 
meeting  or  of  any  proceedings  thereof.  It  is  not  probable  that 
the  proceedings  of  a  regular  meeting  of  directors  would  in  any 
case  be  invalidated  on  account  of  failure  to  give  notice,8  but  the 
proviso  is  added  out  of  abundant  caution. 

Special  meetings,  unless  assembled  with  adequate  notice, 
are 'not  legally  called  and  their  action  may  be  set  aside.  Re- 
quirements as  to  notice  may,  however,  be  waived  and  special 
meetings  be  held  without  notice  by  unanimous  consent  or  with 
the  participation  of  all  the  directors.  Business  of  any  kind  may 
be  transacted  at  any  meeting  if  all  the  directors  have  given  writ- 
ten consent  thereto  or  are  participating  in  the  proceedings  and 
do  not  object. 

Notices  of  special  meetings  of  directors  are  usually  sent  by 
either  mail  or  telegraph  such  reasonable  time  before  the  meeting 
as  will,  under  ordinary  conditions,  permit  the  attendance  of  all 
the  members  of  the  board.  The  by-laws  should  prescribe  the 
conditions  of  such  notice.  If  it  is  desirable  to  notify  directors 
of  meetings  by  telephone,  a  provision  authorizing  such  notice 
should  be  given  in  the  by-laws.  Otherwise,  if  anyone  objected, 
such  notice  would  not  be  legally  sufficient.  The  by-laws  also 
usually  reiterate  the  common  law  rule  that  no  business  except 
that  specifically  notified  in  the  call  and  notice  shall  be  considered 
or  acted  upon  at  special  meetings. 

§  287.     Quorum 

J  If  the  statutes  are  silent  as  to  the  number  of  directors  requisite 
for  a  quorum,  the  charter  or  by-laws  will  control.  If  the  statutes 
and  also  the  charter  and  by-laws  are  silent,  the  common  law  con- 
trols and  a  majority  of  the  full  membership  of  the  board  is  then 
requisite  for  a  quorum.  *^^l"iu.- 


•But  see  Trendley  v.  Illinois  Traction  Co.,  14s  S.  W.  (Mo.)  i  (1912). 


242  CORPORATE  LAW  [Bk.  1- 

•  If  the  matter  is  regulated  by  the  by-laws,  any  desired  number 
may  be  designated  a  quorum  even  though  this  number  may  be 
much  less  than  a  majority  of  the  board.  It  is  customary  and 
advisable,  however,  to  require  a  majority  of  the  entire  board  to 
constitute  a  quorum.  Under  such  provision  any  reduction  in 
the  membership  of  the  board  by  death,  removal,  or  resignation 
would  not  affect  the  number  requisite  to  a  quorum,  which  still 
remains  the  same.9  The  by-law  should  be  carefully  worded  to 
avoid  any  misunderstanding  on  this  or  other  points. 

Directors,  on  the  principle  of  delegatus  non  delegare  (power 
delegated  to  one  cannot  by  him  be  passed  on  to  another),  can- 
not appear  at  directors'  meeting  by  proxy.  However,  as  a  mat- 
ter of  general  law  and  to  prevent  misunderstandings  and  dis- 
sension, a  statement  might  be  included  in  this  by-law  that 
directors  cannot  be  represented  by  proxies. 

§  288.    Election  of  Officers 

The  by-laws  should  designate  the  officials  of  the  corporation, 
the  time  of  their  election,  and  the  period  for  which  they  are 
elected.  It  is  also  usual  to  provide  that  they  shall  hold  office 
until  the  election  and  qualification  of  their  successors,  unless 
sooner  removed  by  action  of  the  board.  It  is  also  usually  speci- 
fied that  election  shall  be  by  ballot,  and  that  the  board  shall  fix 
the  compensation  of  officers  and  fill  any  vacancies  that  may  occur 
among  them. 

In  arranging  the  respective  dates  of  the  stockholders'  annual 
meeting  at  which  the  directors  are  elected,  and  the  meeting  of 
the  directors  thereafter  at  which  the  officers  are  usually  elected, 
the  latter  meeting  should  not  succeed  the  former  so  closely  as 
to  give  inadequate  time  for  the  notification  of  newly  elected 
directors.  Frequently  such  directors'  meeting  will  be  arranged 
to  follow  the  stockholders'  meeting  on  the  same  day,  but  a  few 
hours  elapsing  between  the  two  meetings.  '  If  the  board 
be  small  and  any  possible  new  members  readily  accessible,  or 


•  Erie  R.  R.  Co.  v.  City  of  Buffalo,  180  N.  Y.  192,  197  (1904). 


Ch.3il  BY-LAWS— BOARD  OF  DIRECTORS  243 

if  the  entire  membership  be  re-elected,  the  juxtaposition  of  the 
two  meetings  is  immaterial.  Where,  however,  these  conditions 
do  not  exist,  it  may  occur  that  some  newly  elected  member  of 
the  board  fails  to  receive  notice  of  his  election  and  of  the  subse- 
quent directors'  meeting  in  time  to  permit  of  his  attendance. 
This  might  prevent  the  election  of  officers  or  invalidate  it  if  held. 
For  this  reason  the  board  meeting  for  the  election  of  officers 
should  as  a  rule  be  fixed  at  such  date  subsequent  to  the  annual 
meeting  as  will  give  full  time  for  the  regular  by-law  notice  of 
the  board  meeting. 

It  is  customary  and  entirely  proper  to  provide  that  the  elec- 
tion of  officers  shall  follow  the  election  of  the  board  with  reason- 
able closeness,  in  order  that  the  new  board  may  without  delay 
elect  its  own  corps  of  officers. 

§  289.    Removal  of  Officers 

Speaking  generally,  if  an  officer  is  elected  for  a  specified  term 
he  cannot  be  legally  removed  except  for  sufficient  cause,  and 
not  then  until  he  has  had  opportunity  to  appear  in  his  own  behalf. 
In  a  few  states  the  power  to  remove  officers  at  pleasure  is  given 
the  directors  by  statute.  Otherwise,  if  it  is  desired  that  the 
directors  shall  have  the  power  of  removal,  it  should  be 
clearly  conferred  on  them  by  the  by-laws.  The  by-law  giving 
the  power  should  be  explicit,  and  to  be  effective  should  provide 
for  removal  at  pleasure  with  or  without  cause.  If  such  power 
of  removal  is  given  the  directors  by  the  by-laws,  each  officer 
accepts  his  office  subject  to  this  regulation,  knows  upon  what 
tenure  he  holds  it,  and  may  thereafter  be  removed  at  the  pleasure 
of  the  board  by  a  mere  majority  resolution.io 

§  290.    Compensation  of  Directors  • 

Directors  cannot  claim  any  salary  or  compensation  for  their 
services  as  directors  other  than  is  expressly  set  forth  in  the  by- 


>"  See  5312;  Douglass  v.  Merchants  Ins.  Co.,  118  N.  Y.  484  (1890). 


244  CORPORATE  LAW  [Bk.  I- 

laws.ii  Definite  salaries  might  be  fixed,  but  compensation  is 
usually  provided  in  the  form  of  a  certain  stipend  for  attendance 
at  meetings.  The  amounts  paid  for  attendance  at  meetings  vary, 
rarely  falling  below  $5  or  exceeding  $25.  Sometimes  a  certain 
fixed  sum  is  appropriated  for  each  meeting  and  is  divided  among 
the  directors  present.  The  whole  matter  is  one  that  rests 
entirely  in  the  discretion  of  the  stockholders.12 

§  291.    Power  to  Pass  By-Laws  1 

In  many  of  the  states  the  directors  are,  by  statute,  given 
extensive  powers  over  the  by-laws.  Elsewhere  it  is  a  matter 
for  charter  or  by-law  regulation.  It  is  doubtful  whether  it  is 
wise  in  any  case  to  allow  the  directors  full  power — as  may  be 
done  by  charter  provision  in  New  Jersey — to  override  by-laws 
passed  by  the  stockholders.  The  only  direct  control  of  the  stock- 
holders over  the  affairs  of  the  corporation  is  exercised  through 
the  by-laws,  and  if  the  directors  can  repeal  and  abrogate  these 
by-laws  at  will,  they  are  practically  unrestrained  in  their  man- 
agement of  the  corporate  affairs. 

At  times  it  is  undoubtedly  advantageous  for  the  board  to 
have  some  power  over  the  by-laws  in  order  to  provide  for  matters 
or  emergencies  not  foreseen  by  the  stockholders.  All  necessary 
power  in  this  direction  is,  however,  given  when  the  board  is 
allowed  to  pass  by-laws  in  harmony,  or  not  inconsistent,  with 
those  passed  by  the  stockholders.  Anything  further  is  dangerous 
and  susceptible  of  abuse." 

§  292.     Order  of  Business 

The  order  of  business  at  directors'  meetings  is  a  purely  formal 
regulation  included  in  the  by-laws  as  a  matter  of  convenience. 
Although. incorporated  in  the  by-laws,  it  is  not  mandatory,  and 
any  item  may  be  passed,  or  the  entire  regular  order  of  business 
may  be  suspended  or  varied  at  the  pleasure  of  the  board. 


"  Godley  v.  Crandall  &  Godley  Co.,  212  N.  Y.  121,  131  (1914). 
12  Sees  31 1.  , 

•»  See  a  231,  253. 


CHAPTER  XXXII 

BY-LAWS— STANDING  COMMITTEES 

§  293.    Purpose 

In  most  of  the  larger  corporations  the  board  of  directors  is 
composed  of  many  members.  These  are  usually  busy  men, 
sometimes  living  in  different  parts  of  the  country,  and  almost 
always  difficult  to  assemble.  Many  of  them  are  on  the  board 
for  the  sole  purpose  of  representing  special  interests,  and  with- 
out peculiar  qualifications  or  ability  for  the  conduct  of  the  par- 
ticular corporate  business.  Under  such  circumstances  the  board 
is  not  an  efficient  instrument  for  the  direction  of  the  corporate 
affairs,  and  something  better  adapted  to  the  purpose  is  neces- 
sary. The  standing  committee  fills  this  need,  replacing  the 
slow,  cumbrous,  and  uncertain  action  of  a  large  board  with  the 
prompt  and  effective  action  of  a  small  selected  committee, 

§  294.    Power  of  the  Board  to  Delegate  Authority  to  Committees 

The  courts  are  clear  as  to  the  power  of  the  board  to  delegate 
its  authority  in  this  manner: 

The  directors  convened  as  a  board  are  the  primary  possessors  of 
all  the  p)owers  which  the  charter  confers,  and  like  private  prin- 
cipals they  may  delegate  to  agents  of  their  own  appointment  the 
performance  of  any  acts  which  they  themselves  can  perform. 
The  recognition  of  this  principle  is  absolutely  necessary  in  the 
affairs  of  every  corporation  whose  powers  are  vested  in  a  board  of 
directors.' 

If  the  defendant  can  be  deemed  a  business  corporation  there 
can  be  no  question  but  its  board  of  managers  would  have  power  to 
appoint  an  executive  committee  of  their  own  number  to  transact 


•  Manson  v.  Curtis,  223  N.  Y.  322  (1918);  Hoyt  v.  Thompson's   Express,  19  N.  Y.  207 
(i8S9).  »  •'■■'    '- 

245 


246  CORPORATE  LAW  [Bk.  I- 

the  business  of  the  corporation  during  the  interval  of  meetings  of 
the  board.'' 

§  295.    The  Usual  Standing  Committees 

Standing  committees  are  permanent  committees  of  the  board 
of  directors  as  opposed  to  committees  of  the  board  appointed 
for  temporary  purposes.  The  membership  of  such  committees 
is  seldom  less  than  three  nor  more  than  five.  To  increase  this 
membership  too  greatly  would  involve  the  very  ills  the  commit- 
tees were  created  to  avoid. 

As  many  standing  committees  may  be  appointed  as  the  con- 
ditions demand.  In  many  cases  the  executive  committee  alone 
is  found  sufficient.  In  others  a  finance  committee  is  added.  It 
is  but  seldom  that  other  standing  committees  are  necessary. 

If  the  executive  committee  is  the  only  standing  committee, 
it  is  usually  given  all  the  powers  of  the  board  in  the  interim 
between  board  meetifigs,  and  becomes  the  active  agent  by  whom 
these  powers  are  exercised.  If  there  is  a  finance  committee, 
such  matters  as  come  within  its  purview  will  be  reserved  froin 
the  powers  of  the  executive  committee,  and  the  two  committees 
will  then  between  them  exercise  all  the  powers  of  the  board.  In 
such  case  the  executive  committee  usually  controls  in  all  general 
matters,  while  the  powers  of  the  finance  committee  are  confined 
to  the  management  and  supervision  of  the  corporate  finances. 
•  These  standing  committees,  appointed  with  such  powers,  are 
the  real  managing  bodies  of  the  corporation,  the  board  merely 
supervising  their  operations.  They  usually  act  and  then  report 
their  action  to  the  board.  In  some  cases  where  they  prefer  to 
throw  responsibility  upon  the  board,  or  where  some  statute 
provision  requires  action  of  the  board,  or  when  it  is  desirable  to 
lend  added  weight  to  a  contemplated  measure,  they  will  report 
the  matter  to  the  board  with  a  recommendation  that  the  desired 
action  be  taken. 


'  First  National  Bank  v.  Commercial  Travellers'  Association,  108  App.  Div.  (N.  Y.)  81 
(^90S). 


Ch.  32]  BY-LAWS— STANDING  COMMITTEES  247 

§  296.    Misuse  of  Standing  Committees 

It  is  to  be  noted  that  sometimes  an  executive  committee  is 
provided  when  the  board  itself  is  sufficiently  small  to  permit 
of  prompt  action  and  proper  attention  to  the  corporate  business. 
In  such  case  the  committee  may  become  of  real  injury  to  the 
corporate  interests,  the  few  members  composing  it  managing 
the  entire  business  of  the  corporation  to  the  practical  and  im- 
proper exclusion  of  the  board.  In  such  cases  the  directors,  as  a 
body,  usually  lose  interest,  board  meetings  are  neglected,  and 
the  executive  committee  controls  without  supervision. 

In  this  same  general  direction  is  to  be  found  the  only  danger 
to  be  apprehended  from  the  employment  of  the  standing  com- 
mittee: the  possibility  that  it  may  be  used  as  a  convenient 
means  for  the  elimination  of  the  board — or  certain  elements  of 
the  board — from  control  of  the  corporate  affairs,  the  real  man- 
agement of  the  corporation  being  placed  in  the  hands  of  the 
selected  few  who  constitute  the  committees.  This  danger  can 
be  avoided  only  by  careful  definition  and  judicious  regulation 
of  the  powers  of  these  committees,  this  to  be  done  in  the  charter 
or  by-law  provisions  by  which  they  are  created.* 

§  297.    Appointment 

f.  The  standing  committees  are  usually  created  and  empowered, 
and  the  manner  of  appointing  or  electing  their  members  pre- 
scribed, by  charter  or  by-law  provisions.  Since  the  powers  of 
the  board  are  to  a  greater  or  less  degree  to  be  delegated  to  these 
committees,  they  must  be  composed  of  members  of  the  board. 
The  provisions  as  to  the  appointment  of  members  are  therefore 
confined  to  the  manner  of  their  selection  from  this  body.  Some- 
times the  creating  provision  will  provide  that  certain  officials 
of  the  board  shall  constitute  the  standing  committees,  as  for 
instance  that  the  president,  vice-president,  and  treasurer  shall 
constitute  the  executive  committee.  Generally  the  treasurer  is 
designated  as  a  member  of  the  finance  committee.     Also  it  is 

'See  3  Cook  on  Corp.,  {  71S.  ^tU  tj(u    oi    [yJiiii 


248  CORPORATE  LAW  [Bk.  I- 

quite  usual  to  provide  that  the  president  of  the  company  shall 
ex  officio  be  a  member  of  the  executive  committee,  and  some- 
times it  is  provided  that  he  shall  be  a  member  and  the  presiding 
officer  of  all  standing  committees.  At  times  it  is  provided  that 
the  president  shall  appoint  the  different  standing  committees. 
The  most  common,  and  perhaps  the  safest,  plan  leaves  the  mem- 
bership of  these  committees  to  be  decided  by  an  election  in  the 
board. 

If  there  is  any  danger  of  the  committees  being  used  as  a 
device  to  exclude  minority  interests  from  management  of  the 
corporate  affairs,  the  charter  or  by-laws  may  prescribe  such 
majority  vote  of  the  board  for  the  election  of  their  members  as 
to  require  the  aid  of  the  minority  to  elect.  A  provision  of  this 
kind  might  result  in  a  deadlock,  but  in  that  case  the  board  would 
continue  in  the  direct  management  of  the  corporate  interests 
until  some  agreement  was  reached  and  acceptable  standing 
committees  elected. 

There  is  no  general  rule  as  to  the  appointment  or  selection 
of  officers  for  the  standing  committees.  In  some  cases  they  are 
designated  by  the  creating  provisions,  in  others  they  are  elected 
by  the  board,  while  in  many  cases  the  selection  of  officers  is 
left  to  be  decided  by  each  committee  for  itself.  It  is  probably 
simplest  and  most  satisfactory  to  provide  that  the  chairman 
of  each  committee  shall  be  designated  by  the  board.  The  only 
other  necessary  officer  is  the  secretary.  At  times  it  is  provided 
that  the  secretary  of  the  corporation  shall  also  act  as  secretary 
of  the  committees.  If,  however,  there  is  more  than  one  standing 
committee,  and  especially  if  these  committees  are  active,  it  may 
be  found  advantageous  for  each  committee  to  have  a  distinct 
recording  official  who  may  or  may  not  be  a  member  of  that 
committee. 

§  298.    Composition 

The  membership  of  the  standing  committees  must  be  .con- 
fined to  the  membership  of  the  board,  otherwise  the  power  of 


Ch.  32]  BY-LAWS— STANDING  COMMITTEES  249 

the  board  to  delegate  its  authority  to  the  committees  would  be 
more  than  questionable,  and  the  action  of  such  committees  be 
of  doubtful  legality. 

Within  this  limitation,  the  standing  committees  should  be 
formed  on  the  principles  of  specialization.  Those  most  familiar 
with  the  corporate  business  and  most  capable  in  its  practical 
management  will  naturally  be  grouped  as  the  executive  commit- 
tee. Those  of  most  skill  and  standing  in  financial  matters  will 
properly  be  selected  for  the  membership  of  the  finance  commit- 
tee. Other  considerations  frequently  intervene  to  prevent  this 
ideal  formation  of  the  standing  committees,  but  the  nearer  it  is 
attained  the  better  will  be  the  results. 

"'  The  creating  provisions  not  uncommonly  provide  that  the 
president,  vice-president,  and  treasurer,  with  or  without  addi- 
tional members,  shall  constitute  the  executive  committee.  These 
officers  being  elected  by  the  board  to  the  positions  they  already 
occupy,  are  presumably  men  of  executive  ability,  familiar  with 
the  corporate  affairs  and  therefore  peculiarly  qualified  to  act 
as  members  of  the  managing  committee.  On  the  other  hand, 
such  appointment  adds  materially  to  the  responsibility,  the 
power,  and  the  importance  of  these  officials  and  may  for  that 
reason  at  times  be  inadvisable. 

The  treasurer  should  obviously  be  a  member  of  the  finance 
committee  unless  special  reasons  to  the  contrary  exist.  If  a 
member  of  the  finance  committee,  he  should  not  ordinarily  also 
act  on  the  executive  committee. 

§  299.    Powers 

There  is  no  doubt  that  the  board  may  legally  delegate  its 
authority  to  properly  constituted  standing  committees.*  This 
delegated  authority  may  be  coextensive  with  the  powers  of  the 
board  in  the  interim  between  board  meetings,  or  may  be  limited 
to  certain  specified  actions  or  lines  of  action.    It  has  been  held 


•The  Sheridan  El.  L.  Co.  v.  The  Chatham  Nat.  Bank,  127  N.  Y.  517  (1891);  Kavanagh 
V.  Gould,  147  App.  Div.  (N.  Y.)  281  (1911).  ■"■'  .bui^r.i 


«30  CORPORATE  LAW  .v  A  r  \'^'  [Bk.  I- 

that  the  "full  powers"  of  the  board  in  the  interim  between  board 
meetings  are  limited  to  conducting  the  ordinary  business  opera- 
tions of  the  corporation.  5  The  extent  of  the  power  to  be  dele- 
gated to  the  standing  committees  is  usually  fixed  by  the  charter 
or  by-law  provisions  by  which  the  committees  are  created, 
though  it  may  be  left  to  be  determined  by  the  board  itself.  If 
the  powers  of  the  standing  committees  are  fixed  by  the  creating 
provisions,  the  board  cannot  delegate  powers  in  excess  of  those 
prescribed. 

o;f;The  creating  provisions  frequently  go  into  detail  as  to  the 
powers  and  duties  of  such  committees.  These  powers  should 
be  carefully  defined,  and,  speaking  generally,  should  not  be  too 
extended.  Standing  committees  should  be  required  to  keep  full 
and  adequate  written  records  of  their  proceedings,  and  these 
records  should  be  open  to  inspection  by  members  of  the  board. 
Frequent  reports  to  the  board  are  desirable, 
it). Properly  constituted  and  empowered,  and  within  the  limits 
of  their  authority,  standing  committees  act  with  the  same 
binding  force  and  effect  as  the  board  itself.  Their  contracts  are 
not  affected  by  any  subsequent  disapproval  of  the  board,  nor 
can  the  corporation  refuse  to  carry  out  any  of  their  proper 
undertakings. 

§300.    Procedure  .^ 

The  standing  committees  act  as  do  other  parliamentary 
bodies.  Their  usual  officers  are  a  chairman  and  secretary,  and 
these  ofl&cers  perform  the  customary  duties.  Regular  meeting 
may  be  provided  for  by  the  by-laws  with  full  provision  as  to 
their  conduct  and  record,  or  the  matter  may  be  left  to  the  com- 
mittees. Owing  to  their  compactness  and  the  manner  in  which 
they  are  constituted,  the  standing  committees  are  easily  assem- 
bled and  a  large  portion  of  the  business  of  such  committees  is 
usually  accomplished  in  special  meetings,  either  regularly  called 
or  assembled  by  unanimous  consent. 

•  Hayes  v.  Canada,  etc.,  S.  S.  Co.,  181  Fed.  289  (ipio). 


Ch.  32]  BY-LAWS— STANDING  COMMITTEES  251 

All  special  meetings  should  be  duly  notified  to  the  members 
and  in  the  case  of  "consent  meetings"  the  consent  or  participa- 
tion of  every  member  must  be  secured.  If  it  is  desirable  to 
notify  members  of  meetings  by  telephone,  a  provision  authoriz- 
ing such  notice  should  be  made. part  of  the  by-laws.  Otherwise, 
if  anyone  objected,  such  notice  would  not  be  legally  sufficient. 
All  decisions  reached  and  action  taken  should  be  expressed  in 
duly  adopted  resolutions,  and  minutes  should  be  kept  contain- 
ing a  faithful  record  of  all  committee  proceedings.  These  pro- 
ceedings should  from  time  to  time  be  reported  to  the  board, 
either  by  direct  report  or  by  the  reading  of  the  committee 
minutes.  Vacancies  in  the  committees  should  be  filled  as  pre- 
scribed by  the  by-laws,  usually  either  by  the  committee  itself 
or  by  action  of  the  board,  except  in  the  case  of  an  ex  officio 
member,  who  succeeds  to  his  position  on  the  committee  by 
virtue  of  his  election  to  ofl&cial  position  in  the  corporation  with- 
out further  formality,  ilamuor 

§  301.     Quorum  of  Standing  Committee 

A  majority  of  a  standing  committee,  unless  otherwise  ex- 
pressly provided,  constitutes  a  quorum,  and  in  case  of  a  vote 
a  majority  of  that  quorum  would  decide  the  question.  ^  It  may 
be  prudent  on  this  account  to  provide  that  the  affirmative  vote 
of  a  majority  of  the  whole  committee  shall  be  necessary  for 
action.  This  does  not  necessitate  any  increase  in  the  number 
necessary  to  a  quorum,  but  if  a  mere  common  law  quorum  be 
present  the  affirmative  vote  of  all  the  members  present  would 
be  required  to  secure  action. 

A  standing  committee  cannot  delegate  its  legislative  power 
to  one  or  more  of  its  members,  but  must  act  as  a  body. 


'Youngv.  Canada,  etc  ,  Co.,  97  N.E.  (Mass.)  1098  (1912). 


CHAPTER   XXXITI 
BY-LAWS— OFFICERS 

§  302.    The  Corporate  Officers 

The  term  "officers"  is  here  appHed  to  those  agents  of  the  cor- 
poration appointed  or  elected— usually  by  the  board  of  directors 
— as  the  direct  executive  representatives  of  the  board  and  of  the 
corporation.  The  directors  are  themselves  at  times  styled  officers, 
and  with  legal  correctness,!  but  to  avoid  confusion  the  directors 
are  not  designated  as  officers  in  the  present  volume. 

In  regard  to  the  corporate  officers  and  their  duties  the 
statutes  are  usually  silent,  the  charter  seldom  takes  cognizance 
of  anything  pertaining  to  them,  and  the  by-laws  therefore  con- 
trol. Under  these  circumstances  the  stockholders  as  the  by- 
law-making power  have  wide  discretion.  They  fix  the  number, 
titles,  qualifications,  duties,  method  of  election,  and  all  other 
details  relating  to  the  officers,  and  their  wishes  as  expressed  in 
the  by-laws  prevail.  If  not  covered  in  the  by-laws,  such  mat- 
ters are  regulated  by  common  or  parliamentary  law  or  custom, 
or,  as  to  some  of  these  matters,  are  determined  by  the  directors. 

The  necessary  officers  of  a  corporation  are  the  president, 
secretary,  and  treasurer.  In*  the  smaller  corporations  two  of 
these  offices  are  sometimes  held  by  one  person.  In  most  cases, 
however,  the  number  of  officers  is  increased,  according  to  the 
needs  of  the  particular  corporation,  by  the  addition  of  one  or 
more  vice-presidents,  a  managing  director  or  general  manager, 
a  chairman  of  the  board,  counsel,  and  an  auditor.  The  officials 
named  are  for  the  most  part  elective,  and,  with  the  occasional 
exception  of  the  general  manager,  are  supposed  to  report  directly 
to  the  board  or  to  one  of  the  standing  committees.    The  general 


•  I  Cook  on  Corp.,  {  10. 

252 


Ch.  33]  BY-LAWS— OFFICERS  253 

manager  In  some  corporations  reports  to  the  president  or  other 
designated  official.  Outside  of  the  executive  officials,  other 
agents  and  employees  are  not  officers,  and  but  seldom  come  in 
contact  with  the  board. 

The  election  of  officers  naturally  follows  closely  on  the  elec- 
tion of  directors,  and  is  usually  held  as  soon  thereafter  as  the 
newly  elected  board  can  be  properly  assembled. 

The  president  and  vice-president  are  chosen  from  the  board 
itself,  as  they  may  be  called  upon  to  preside  at  its  meetings. 
This  is  not  necessary  in  regard  to  the  other  officers,  though  the 
treasurer  is  frequently  chosen  from  the  membership  of  the 
board,  and  other  officials  are  so  selected  when  convenient.  The 
treasurer  of  the  larger  corporations  is  usually  selected  on  the 
basis  of  his  financial  standing  or  ability.  It  would  seem  obvious 
that  the  corporate  officials  should  all  have  special  qualifications 
and  a  knowledge  of  the  duties  of  their  positions,  though  other 
considerations  frequently  prevail, 

§  303.    Presiding  Officers 

Y'nThe  president  is  the  usual  presiding  officer.  His  duties  vary 
widely  according  to  the  size  and  character  of  the  corporation. 
In  the  smaller  corporations  he  is  frequently  assigned  the  active 
management  of  the  business  in  addition  to  the  duties  more 
strictly  pertaining  to  his  office.  In  the  larger  corporations  the 
duties  incident  to  the  president's  office  are  frequently  allotted 
in  greater  or  less  degree  to  other  officers.  If  a  chairman  of  the 
board  exists,  that  official  presides  at  all  meetings  of  the  board. 
If  there  is  a  chairman  of  the  finance  committee,  he  takes  over 
the  supervision  and  direction  of  the  financial  matters  usually 
assigned  to  the  president.  At  times  certain  of  the  duties  ordi- 
narily pertaining  to  the  president  are  performed  by  the  vice- 
presidents. 

When  the  office  of  chairman  of  the  board  exists,  its  duties 
should  be  clearly  defined  by  the  by-laws.  As  the  chairman  of 
the  board  presides  at  meetings  of  the  board,  the  general  rule 


254  CORPORATE  LAW  [Bk.  I- 

that  the  president  must  be  a  member  of  the  board  is  not  so 
imperative  when  a  chairman  is  provided.  Even  in  such  case, 
however,  if  the  president  is  to  be  the  chief  executive  of  the 
company,  he  must  almost  of  necessity  be  present  at  meetings  of 
the  directors,  participate  in  their  discussions  and  deliberations, 
and  should  therefore  be  a  member  of  the  board-'i'-'J-'yiii'  *<J  "^i' 
Vice-presidents,  designated  and  ranked  as  first,  second,  third; 
and  so  on,  may  be  provided  for  in  accordance  with  the  corporate 
needs.  These  perform  the  duties  of  the  president  in  the  absence 
of  that  ofl&cial,  or  of  the  ranking  official,  in  the  order  of  prece- 
dence. In  addition,  in  the  larger  corporations  active  functions  are 
usually  provided  for  several  of  the  vice-presidents.  Frequently 
their  number  is  swelled  merely  to  afford  honorary  positions  for 
members  of  the  board.  Heads  of  departments  are  sometimes 
made  vice-presidents  as  a  "broadening"  measure,  tending  to 
avoid  the  friction  and  the  jealousies  that  so  often  exist  between 
departments.  In  the  smaller  corporations,  the  duties  of  the 
vice-president  are  sometimes  assigned  to  the  treasurer,  or  this 
latter  is  elected  as  vice-president  and  treasurer. 

The  presiding  officers  of  the  standing  committees  are  usually 
provided  for  either  by  the  by-laws  or  by  action  of  the  board, 
but  are  sometimes  left  for  the  committees  to  elect.  The  presi- 
dent of  the  company  is  usually  president  of  the  executive  com-^ 
mittee;  the  treasurer  is  frequently  placed  at  the  head  of  the 
finance  committee. 

§  304.    Secretary 

The  duties  of  the  secretary  should  be  fully  and  explicitly 
prescribed  in  the  by-laws,  especially  as  to  signatures.  He  would 
naturally  have  charge  of  the  corporate  seal  and  affix  and  attest 
it  when  necessary,  though  the  president  is  occasionally  author- 
ized thereto  as  well.  Unless  the  statutes  call  for  the  signatures 
of  the  president  and  treasurer  to  stock  certificates,  the  secretary 
is  commonly  designated  to  sign  such  certificates  with  the  presi- 
dent.   He  generally  has  entire  charge  of  the  details  of  the  issue 


Ch.  33]  BY-LAWS— OFFICERS  255 

and  recording  of  stock.  The  corporate  records  are  entrusted 
to  him,  and  the  various  state  reports  are  usually  prepared  by 
him.  His  powers  and  duties  as  to  signing  contracts  are  entirely 
dependent  upon  the  by-laws  or  conditions  of  the  particular  cor- 
poration. Usually  he  signs  with  the  president,  but  frequently 
the  president  signs  alone  or  with  the  treasurer,  or  the  matter  is 
decided  in  each  important  instance  by  resolution  of  the  board. 
When  the  secretary's  signature  is  not  affixed  to  sealed  contracts, 
it  should  appear  on  such  instrument  in  attestation  of  the  seal. 

§  305.    Treasurer 

The  treasurer  is  usually  given  full  charge  of  the  corporate 
finances  and  all  that  immediately  relates  thereto;  also  the  cus- 
tody of  all  corporate  instruments  and  evidences  of  value.  He 
signs  all  checks,  with  or  without  the  president  as  the  by-laws 
or  directors  may  prescribe,  and  participates  in  the  execution  of 
all  instruments  pertaining  to  the  fiinancial  transactions  of  the 
corporation.  The  by-laws  should  clearly  define  the  extent  of 
the  treasurer's  powers  and  responsibilities. 
hui^Whenever  the  treasurer's  position  involves  the  handling  or 
possession  of  large  svuns  of  m9ney,  or  of  considerable  property 
values,  he  should  be  required  to  give  bond.  In  a  small  corpora- 
tion, or  one  where  the  responsibilities  of  the  treasurer  are  light, 
such  requirement  is  an  unnecessary  formality. ,  maicliidJ  s;  ■ 

The  finance  committee,  if  such  a  committee  exists,  takes  on 
itself  many  of  the  duties  and  responsibilities  of  the  treasurer, 
and,  unless  that  official  is  chairman  of  the  finance  committee, 
renders  his  position  much  less  onerous, 

§  306.    Managing  Officers 

1,:  tThe  position  of  managing  director  is  found  only  in  the  larger 
corporations,  and  the  position  and  duties  of  this  official  are  often 
somewhat  indeterminate.  In  some  cases  his  duties  are  practi- 
cally those  of  the  general  manager;  in  others  he  is  given  much 
of  the  power  and  many  of  the  duties  of  the  president.  At  times 


2S6  COkPORATE  LAW  [Bk.  I- 

the  position  is  in  the  nature  of  a  compromise,  the  duties  of  the 
managing  director  being  carved  from  those  of  the  president  and 
general  manager. 

The  position  of  managing  director  is  supposed  to  be  more 
dignified  than  that  of  the  general  manager.  Its  duties  should 
be  clearly  prescribed  by  the  by-laws  in  order  to  prevent  possible 
conflicts  of  authority.  This  is  the  more  necessary,  as  the  duties 
of  the  position  are  not  so  definite  or  so  well  understood  as  those 
of  the  other  officials,  and  custom  cannot  be  referred  to  for 
missing  details. 

The  general  manager  is  accounted  an  officer  of  the  company 
— ^in  contradistinction  to  the  employees — only  because  he  is 
selected  by  and  usually  reports  to  the  board.  His  position 
generally  differs  materially  from  that  of  the  other  officials.  At 
times  he  is  instructed  to  report  and  act  under  the  direction  of 
the  president,  and  if  the  by-laws  did  not  specifically  provide  for 
the  election  of  a  general  manager  the  directors  would  have 
authority  to  appoint  or  employ  such  official  and  prescribe  his 
duties  and  salary,  just  as  they  might  employ  any  other  neces- 
sary agent  or  employee  of  the  company.  In  such  case  the  usual 
laws  and  customs  relating  to  his  employment  would  control. 

§  307.    Counsel 

In  the  larger  corporations  an  attorney  is  usually  retained  as 
a  regular  and  permanent  feature  of  the  management.  Such 
official  has  no  original  powers,  even  his  control  of  litigation 
being  subject  to  the  direction  of  the  board,  or,  if  it  be  so  referred, 
to  one  of  the  standing  committees. 

In  the  smaller  corporations  by-law  provision  for  counsel  is 
not  usual,  the  board  being  left  to  employ  legal  assistance  at 
such  times  and  on  such  terms  as  it  may  deem  expedient.  The 
employment  of  counsel  then  becomes  merely  a  matter  of  con- 
tract. 

■  The  compensation  of  counsel,  when  regularly  retained,  is 
usually  fixed  at  some  minimum  amount,  which  is  considered  a 


Ch.  33]  BY-LAWS— OFFICERS  257 

retainer,  any  further  payments  depending  upon  the  services 
rendered. 

§  308.    Auditor 

The  auditor  is  usually  an  essential  officer  of  the  larger 
corporations : 

This  officer  has  charge  of  all  matters  pertaining  to  the  keeping 
of  the  financial  records.  He  plans  books  of  account,  devises  ' ' 
methods  of  recording  and  accounting  best  calculated  to  fulfil  the 
purpose  of  the  company,  and  watches  over  the  faithful  recording  of 
all  facts.  He  submits,  at  stated  periods,  statements  showing  the 
financial  status  of  the  enterprise  and  the  causes  which  have  con- 
tributed to  its  success  or  to  its  failure.* 

Where  the  work  that  may  properly  be  referred  to  the  auditor 
is  not  sufficient  to  justify  his  regular  employment,  the  by-laws 
may  provide  for  periodical  audits,  or  the  whole  matter  may  be 
left  to  the  discretion  of  the  board.  Where  the  volume  of  cor- 
porate business  is  at  all  large,  the  employment  of  an  auditor  or 
some  provision  for  suitable  audits  of  the  corporate  books  and 
accounts  is  a  usual  and  advisable  precaution. 

§  309.    Assistant  Officers 

The  president  is  usually  well  provided  with  assistants  in  the 
vice-presidents.  Aij  assistant  treaJsurer  is  not  unusual.  In  the 
larger  corporations  an  assistant  secretary  also  is  frequently 
appointed. 

Such  official  duties  as  the  board  may  deem  expedient  are 
delegated  to  these  assistant  officers,  or  their  duties  may  be 
prescribed  at  discretion  by  the  officials  they  assist.  In  any 
event,  the  by-laws  should  clearly  prescribe  their  status  and 
manner  of  appointment.  If  these  assistant  officers  are  to  per- 
form the  duties  of  their  principals  in  the  absence  of  these  latter, 
the  by-laws  should  so  prescribe. 


» Esquerr^  on  Applied  Theory  of  Accounts.  V  .K  cvr  ,: 


258  CORPORATE  LAW  [Bk.  I- 

In  the  smaller  corporations  assistant  officers,  outside  of  the 
vice-presidents,  are  an  unnecessary  and  possibly  complicating 
addition  to  the  corporate  mechanism. 

§  310.    Delegation  of  Official  Powers 

Exigencies  may  arise  in  which  it  may  be  desirable  or  even 
necessary  for  one  corporate  official  to  exercise  the  powers  and 
perform  the  duties  of  another,  in  whole  or  in  part!  The  board 
would  have  authority  to  delegate  temporarily  the  powers  of 
certain  officers  under  such  circumstances  without  special  by- 
law provision,  but,  to  save  question  and  possible  trouble,  the 
power,  if  likely  to  be  necessary,  should  be  specifically  conferred 
by  the  by-laws.  One  official  cannot  delegate  his  powers  to 
another,  even  temporarily,  in  any  material  matter,  unless  spe- 
cially authorized  thereto  by  the  by-laws  or  action  of  the  board. 

§  311.    Salaries 

Unless  it  is  specified  that  officers  are  to  receive  salaries,  they 
are  not  as  a  rule  entitled  to  charge  for  their  official  services. » 
Neither  is  it  ordinarily  legal  for  the  directors  to  vote  compen- 
sation for  such  official  services  after  they  are  performed. ^  To 
avoid  misunderstanding,  however,  the  conditions,  whatever  they 
may  be,  should  be  clearly  stated  in  the  by-laws — that  the  officers 
of  the  corporation  shall  receive  no  salaries,  or  that  the  officers 
shall  receive  only  such  compensation  for  their  services  as  the 
board  may  designate  at  the  time  of  their  appointment,  or  that 
the  officers  shall  receive  the  specified  salaries,  stated  in  the 
by-laws.  The  whole  matter  is  one  to  be  adjusted  from  a  busi- 
ness standpoint  and  much  trouble  is  likely  to  be  saved  by  a 
definite  arrangement,  s 

^     If,  however,  such  an  officer  is  neither  stockholder  nor  director 
of  the  company  and  stands  in  no  relation  which  would  make  it 


'  Hayes  v.  Canada,  etc.,  S.  S.  Co.,  181  Fed.  289  (1910). 

*  Lewis  V.  Matthews,  161  App.  Div.  (N.  Y.)  107  (1914);  Ellis  v.  Ward,  137  111-  S09  (1890). 
'See  Henry  Woods  Sons'  Co.  v.  Schaefer,  173  Mass.  443  (1899);  Met.  El.  R.  Co.  v. 
Kneeland,  120  N.  Y.  134  (1890). 


Ch.  33]  BY-LAWS— OFFICERS  259 

his  interest  to  serve  without  compensation,  there  will  be  a  prima 
facie  obligation  to  pay  him.e 

Officers  who  are  also  directors  cannot  vote  salaries  to  them- 
selves even  though  they  are  also  holders  of  a  majority  of  the 
stock.  7  But  an  officer  who  is  also  a  stockholder  and  director 
may  recover  for  services  rendered  outside  his  official  duties  if 
such  services  are  authorized  by  the  directors. « 

§  312.    Removals;  Vacancies 

The  power  to  remove  officers  and  to  fill  vacancies  among 
them,  when  given  the  directors,  is  usually  provided  for  in  the 
by-laws  under  the  head  of  ''Directors. "9  It  would  be  proper, 
however,  to  repeat  any  powers  given  the  board  in  this  direction, 
in  a  short  by-law  under  the  heading  of  officers,  or  the  ground 
might  be  covered  by  a  reference  to  the  by-law  by  which  this 
power  was  conferred..  If  the  occasion  arises  for  the  exercise  of 
the  power  of  removal,  or  it  becomes  necessary  to  fill  a  vacancy, 
there  should  be  no  possible  basis  for  any  doubt  or  question  as 
to  the  authority  of  the  board  to  act. 


•  Smith  V.  Long  Island  R.  R.  Co.,  102  N.  Y.  190  (1886). 

'Jacobson  v.  B.  Lumber  Co.,  184  N.  Y.  152  (1906);  Davids  v.  Davids,  135  App.  Div. 
(N.  Y.)  206  (1909). 

'Bagby  v.  Carthage,  etc.,  Co.,  165  N.  Y.  179  (1900);  Corinne  Mill  Co.  v.  Toponce,  152 
U.  S.  40s  (i803).     See  also  S  189. 

•  See  {  289. 


M.djoi^^.r  CHAPTER  XXXIV 

„  BY-LAWS— DIVIDENDS  AND  FINANCE;    SUNDRY 
Y,   ...  PROVISIONS  • 

§  313.    Financial  Provisions 

All  those  by-law  provisions  directly  relating  to  the  financial 
management  of  the  corporation  are  usually  grouped  under  the 
general  heading  of  "Dividends  and  Finance."  Any  desired 
hmitations  on  the  control  exercised  by  the  directors  over  the 
finances  of  the  corporation,  and  any  directions  as  to  the  man- 
agement of  these  finances,  must,  unless  incorporated  in  the 
charter,  appear  in  the  by-laws.  Otherwise  the  directors  are  in 
complete  control,  except  as  restrained  by. statute  law. 

It  is  to  be  noted  that  any  restrictions  on  the  salaries  of 
officials,  if  of  a  general  nature,  should  appear  in  the  by-laws 
relating  to  finance.  If  the  amount  of  each  official  salary  were 
fixed,  such  Hmitations  might  appear  under  "Dividends  and 
Finance,"  but  would  also  be  included  in  the  by-laws  relating  to 
the  officers  affected. 

§  314.    Dividends 

By-law  provisions  as  to  dividends  are  for  the  most  part 
merely  declaratory  of  the  common  or  statutory  law  on  the  sub- 
ject. Their  inclusion  in  the  by-laws  is  very  desirable,  not  only 
on  account  of  the  importance  of  the  matter,  but  because  the 
statutory  or  common  law  provisions  against  illegal  dividends 
are  otherwise  frequently  overlooked  or  disregarded. 

§  315.    Reserve  Funds 

In  most  of  the  states  the  directors  have  full  power,  unless 
otherwise  provided  by  charter  or  by-laws,  to  set  aside  any  por- 

260 


Ch.  34]  BY-LAWS— DIVIDENDS  AND   FINANCE  261 

tion  or  all  of  the  corporate  profits  at  their  discretion,  as  a  reserve 
fund  or  for  the  purpose  of  accumulating  a  working  capital.  In 
New  Jersey,  on  the  contrary,  the  directors,  unless  otherwise 
expressly  authorized  by  charter  or  by-laws,  must  annually  dis- 
tribute all  the  corporate  profits  as  dividends.  Such  compulsory 
distribution  of  profits  might  at  times  be  prejudicial  and  even 
disastrous  to  the  corporate  interests,  and  accordingly  it  is  usual 
in  New  Jersey  to  authorize  the  accumulation  of  a  reserve  fund 
by  charter  or  by-law  provision. 

In  other  states  the  matter  of  reserves  is  sometimes  left 
entirely  to  the  discretion  of  the  directors,  but  is  usually  regu- 
lated by  suitable  provisions  in  the  by-laws.  The  minimum  re- 
serve fund  to  be  maintained  will  be  prescribed,  in  which  case 
no  dividends  must  be  paid  while  the  reserves  are  below  this 
minimum;  or  a  stipulated  annual  dividend  will  be  required 
from  the  annual  profits  before  anything  is  passed  to  the  reserve ; 
or  a  certain  percentage  of  the  annual  profits  will  be  passed  to 
the  reserve  fund.  Whatever  the  arrangement  it  should  be  so 
clearly  expressed  as  to  admit  of  no  misunderstanding. 

§  316.    Limitations  on  Power  to  Incur  Debt 

By-law  restrictions  upon  the  power  of  the  directors  to  incur 
debts  are  not  uncommon.  These  limitations  are  of  various 
forms.  At  times  the  debt-incurring  power  of  the  board  will  be 
limited  to  a  stated  gross  amount  which  must  not  be  exceeded 
without  special  authorization  by  the  stockholders ; '  or  it  may 
be  provided  that  such  limit  of  indebtedness  shall  not  be  exceeded 
unless  authorized  by  a  specified  'majority  of  the  directors,  as  a 
two-thirds  vote  of  the  entire  board,  or  perhaps  by  unanimous 
action  of  that  body.  Occasionally  the  board  will  be  restricted 
as  to  the  amount  of  any  onp  contract  or  obUgation,  as  for  in- 
stance that  no  contract  or  obligation  involving  liabilities  of 
more  than  $10,000  shall  be  entered  into  or  incurred  by  the  board 
unless  specifically  authorized  thereto  by  resolution  of  the  stock- 
holders. 


262  CORPORATE  LAW  [Bk.  I- 

The  advisability  of  such  limitations  is  open  to  question. 
Peculiar  cases  will  undoubtedly  arise  where  such  restrictions  are 
desirable,  and  at  times  they  are  necessary,  but  as  a  general  rule 
it  would  seem  better  to  elect  a  responsible  board  rather  than  to 
attempt  to  place  restraints  upon  its  action. 

§  317.    Bank  Deposits  ^i , 

The  by-law  provisions  as  to  the  corporate  bank  deposits  are' 
important  and  should  be  very  explicit  in  their  terms.  They 
should  prohibit  absolutely  any  irregular  retention  or  disposition 
of  the  funds  by  the  treasurer,  and  provide  that  all  moneys 
coming  into  his  hands  be  promptly  deposited  in  the  name  of  the 
company.  This  latter  point  should  be  covered  specifically  and 
clearly  by  the  by-laws,  as  the  practice  of  allowing  deposits  to 
be  made  in  the  individual  name  of  the  treasurer,  or  in  his  name 
as  treasurer,  is  a  standing  invitation  to  irregularities  and  re- 
sulting trouble. 

The  by-laws  should  also  prescribe  the  signature  to  corporate 
checks.  Practice  varies  as  to  this  matter  but  as  it  saves  time 
and  trouble  to  have  checks  signed  with  but  one  signature,  it  is 
usually  preferable  for  the  smaller  corporation.  The  treasurer 
may  be  the  only  person  authorized  to  sign  checks,  but  to  avoid 
inconvenience  when  he  is  absent,  it  is  better  to  have  the  presi- 
dent or  some  other  responsible  officer  also  authorized  to  sign. 

It  is  a  common  enough  practice  to  require  two  signatures 
to  all  checks,  but  where  many  small  checks  are  to  be  signed, 
one  of  the  persons  is  almost  sure  to  sign  mechanically,  trusting 
to  the  other,  or  in  case  of  abse'nce  or  vacation  to  sign  or  coun- 
tersign a  number  ahead — and  this  nulHfies  any  possible  advan- 
tage from  the  rule. 

In  the  case  of  the  larger  corporations  the  usual  custom  is  to 
have  all  important  checks  signed  by  two  officials,  and  in  the 
absence  of  either,  some  other  official  is  deputed  to  sign,  so  that 
every  check  of  material  amount  is  signed  by  two  officials.  In 
all  such  cases  there  would  probably  be  also  something  in  the 


Ch.  34]  BY-LAWS— DIVIDENDS  AND  FINANCE  263 

nature  of  a  current  expense  account  to  take  care  of  the  smaller 
items,  and  the  checks  against  this  would  require  but  one  signa- 
ture. In  any  case,  if  one  person  makes  out  the  body  of  the 
check,  and  the  signature  is  by  another,  nearly  all  of  the  practical 
advantage  of  two  signatures  is  secured. 

The  by-laws  relating  to  bank  deposits  should  cover  the 
ground  fully  and  clearly,  leaving  nothing  to  the  discretion  of 
the  board  or  finance  committee  save  the  designation  of  the 
depositaries. 

Sundry  Provisions 

§  318.    General  r  ;; 

Under  this  head  will  come  all  those  by-laws  that  cannot  be 
included  under  the  titles  already  discussed  and  that  are  too 
few  or  unimportant  to  justify  separate  classification.  Some  of 
these  matters  are  of  particular  application.  A  few  of  general 
application  are  found  in  all  complete  sets  of  by-laws  and  are 
considered  in  the  following  sections  of  the  present  chapter. 

§  319.    Corporate  Seal 

It  is  customary  to  prescribe  the  details  of  the  corporate  seal 
in  the  by-laws,  the  provision  being  usually  so  worded  as  to 
serve  as  a  formal  adoption  of  the  described  seal.  This  seal 
usually  gives  the  corporate  name,  the  year,  and  the  state  of 
incorporation.  These  are  customary,  but  unless  prescribed  by 
statute  are  not  essential,  as  any  other  wording  or  device,  if 
properly  adopted,  would  be  the  legal  seal  of  the  corporation. 
Any  additional  designs,  mottoes,  or  ornamentation  may  Ue 
added  as  desired  and  will  neither  add  to,  nor  detract  from,  the 
legal  effectiveness  of  the  seal. 

§  320.    Penalties 

The  enforcement  of  by-laws  by  means  of  penalties  is  of 
doubtful  utility.     Cases   may  arise   where  penalties  may  be 


264  CORPORATE   LAW  *  [Bk.  I- 

profitably  employed,  but  usually  such  measures  are  futile  and 
inadequate.  Where  the  power  of  removal  exists,  persistent 
disregard  of  the  by-laws  by  officials  of  the  corporation  would 
undoubtedly  be  proper  grounds  for  the  exercise  of  this  power. 
If  such  power  is  not  given  by  the  by-laws  or  statutes,  official 
disregard  of  the  by-laws  would  probably  be  sufficient  reason  for 
a  removal  on  common  law  grounds.  If  the  directors  act  in  dis- 
regard of  the  requirements  of  the  by-laws,  such  action  is  illegal, 
and  the  personal  liability  that  may  follow  is  a  much  more  effec- 
tive penalty  than  anything  that  could  be  inflicted  by  direct 
by-law  provision. 

§  321.    Amendments 

The  usual  by-law  provisions  on  this  subject  require  majority 
action  of  the  stockholders  for  amendment  of  the  by-laws.  This 
conforms  to  the  provisions  of  the  common  law.  Where  greater 
stability  is  desirable  on  account  of  special  provisions  incor- 
porated in  the  by-laws,  or  generally  as  a  protection  to  minority 
interests,  it  is  sometimes  provided  that  two- thirds  in  interest, 
or  even  a  larger  proportion  of  the  stockholders,  must  vote  in 
favor  of  any  amendment  before  it  is  effected. 

Such  provisions,  merely  made  part  of  the  by-laws,  unless 
reinforced  in  some  way  are  of  but  little  avail.  The  majority 
have  the  right  to  amend  and  repeal  the  by-laws,  and  it  cannot 
be  taken  from  them  by  a  mere  unsupported  by-law  inhibition.i 

§  322.    By-Laws  as  Contracts 

Such  a  provision,  to  be  effective,  must  either  be  incorporated 
in  the  charter,  or,  if  in  the  by-laws  only,  must  be  so  established 
and  confirmed  by  vested  rights  accrued  under  it  as  to  have 
become  in  effect  a  contract  between  the  corporation  and  the 
Stockholders.    When  this  is  done  the  by-law  becomes  unchange- 


'  Smith  V.  Nelson,  18  Vt.  511  (1846);    Manufacturing  Bldg.  Co.,  v.  Landay,  219  111.  168 
fi905). 


Ch.  34]  BY-LAWS— SUNDRY  PROVISIONS  265 

able,  except  in  accordance  with  its  own  provisions.  As  stated 
in  a  noted  New  York  case :  2 

"A  private  corporation  cannot  repeal  a  by-law  so  as  to  impair 
rights  which  have  been  given  and  become  vested  by  virtue  of 
the  by-law;  and  this  although  the  power  is  reserved  by  its 
charter  to  alter,  amend,  or  repeal  its  by-laws." 

This  is  stated  yet  more  strongly  in  a  New  Jersey  case,3  a 
case  where  stock  had  been  sold  on  the  strength  of  the  safety 
afforded  by  special  charter  and  by-law  provision,  and  the 
court  states  the  settled  law  to  be: 

That  the  certificate  of  organization  and  the  by-laws  contem- 
poraneously adopted,  constitute  a  contract  between  the  stock- 
holders, and  that  it  is  not  competent  for  the  legislature  to  authorize 
either  to  be  changed  without  the  consent  of  all  the  stockholders, 
except  it  be  done  in  the  mode  provided  by  the  by-laws  themselves. 

It  is  worthy  of  note  that  it  has  been  decided  in  Pennsylvania 
that  the  by-laws  cannot  be  amended  by  a  majority  of  the 
stockholders  at  an  annual  meeting  in  any  important  particular, 
such  as  an  increase  of  directors,  unless  the  notice  of  that  meet- 
ing informed  all  the  stockholders  that  such  action  was  con- 
templated.* 

In  other  states,  such  notice  should  be  given  as  may  be  re- 
quired by  the  local  statutes,  by  the  charter,  or  by  the  by-laws 
themselves.  Usually  a  regular  meeting  of  stockholders,  duly 
assembled,  would  have  power  to  act  on  any  business  unless  the 
state  law,  the  charter,  or  the  by-laws  prescribed  otherwise. 


'  The  New  York  Court  of  Appeals  in  Kent  v.  Quicksilver  Mining  Co.,  78  N.  Y.  159  (1897). 

•  Loewenthal  v.  Rubber  Reclaiming  Co.,  52  N.  J.  Eq.    440,  441  (1894);  see  also  Mills  v. 
Cent.  R.  R.  Co..  41  N.  J.  Eq..,i  (1886). 

*  Bagley  v,  Reno,  etc.,  Co..''3qi  Pa.  St.  78  (1902). 


Part  VII — Organization  Meetings 


CHAPTER  XXXV 
FIRST  MEETING  OF  STOCKHOLDERS 

§  323.    General 

In  the  great  majority  of  the  states,  procedure  for  the  organi- 
zation of  a  corporation  is  uniform  as  to  the  main  features.  First, 
the  charter  is  prepared  and  is  executed  by  the  incorporators; 
next,  this  duly  executed  charter  is  filed  with  the  officials  pre- 
scribed by  statute;  then  the  meeting  of  incorporators  is  held, 
by-laws  adopted,  directors  elected,  and  such  other  action  taken 
as  may  be  necessary.  The  directors  then  meet,  elect  the  ofiicers 
of  the  corporation,  and  its  organization  is  complete. 

In  a  few  states,  however,  this  procedure  is  practically  re- 
versed, the  election  of  directors  and  officers  and  adoption  of 
by-laws  preceding  the  filing  of  the  charter.  In  other  words, 
the  by-laws  are  adopted  and  directors  and  officers  elected  before 
the  corporation  has  any  legal  existence.  The  arrangement  seems 
somewhat  illogical,  but  is  prescr  bed  by  the  statutes  of  certain 
states  and  in  those  states  must  be  followed.  It  merely  amounts 
to  a  preliminary  determination  of  these  details,  of  no  force 
unless  the  charter  application  is  allowed,  but  then  becoming 
automatically  effective  and  binding  on  the  new  corporation. 
This  variation  of  the  usual  procedure  is  found  in  Maine,  Massa- 
chusetts, and  some  other  states.  In  these  states  the  proceedings 
outlined  in  the  present  and  following  chapters  must  be  modified 
to  meet  the  statute  requirements. 

Under  the  customary  procedure,  the  duly  prepared  charter 

267 


268  CORPORATE  LAW  [Bk.  I- 

application,  accompanied  by  the  proper  fees,  is  submitted  to 
the  official  designated  by  the  statutes,  for  approval  and  filing. 
After  the  application  has  been  approved  and  filed  and  this  has 
been  notified  to  the  incorporators,  these  latter  are  authorized 
to  assemble  and  perfect  the  organization  of  the  new  corporation. 

§  324.    Who  May  Participate 

The  incorporators  or  their  proxies  are  the  only  persons  entitled 
to  act  at  this  time.  Their  power  to  call  the  first  meeting  and  to 
act  thereat  for  the  corporation  is  derived  from  the  recognition 
and  express  authorization  given  them  by  statute.  K  their  sub- 
scriptions are  set  forth  in  the  charter  itself,  each  incorporator 
votes  at  this  first  meeting  in  accordance  with  such  stock  sub- 
scription, one  vote  for  each  share  subscribed  for.  In  those 
states  where  the  first  meeting  is  held  before  the  charter  is 
granted,  each  incorporator  is  usually  entitled  to  but  one  vote 
in  the  organization  meeting. 

There  may  be  numerous  subscribers  to  the  stock  of  the  new 
corporation  who  are  not  named  in  the  charter,  but  these  sub- 
scribers are  not  yet  stockholders  of  the  corporation,  and  do  not 
become  stockholders  and  are  not  entitled  to  any  participation 
in  its  affairs  until  after  express  acceptance  of  their  subscriptions 
by  the  corporation. 

Unless  there  is  some  good  reason  to  the  contrary,  the  number 
of  incorporators  is  usually  fixed  at  the  minimum  allowed  by  the 
statutes.  This  is  done  purely  as  a  matter  of  convenience  and 
as  simplifying  the  formalities  prehminary  and  incident  to  the 
first  meeting. 

§  325.    Assembling  the  Meeting 

Where  the  number  of  incorporators  is  small,  the  first  meeting 
is  most  conveniently  assembled  by  means  of  a  written  call  and 
waiver  of  notice  which  must  be  signed  by  all  the  incorporators.! 
This  call  and  waiver  fixes  the  time  and  place  of  meeting,  and 


»  See  Book  IV.  Form  90. 


Ch.  35]  FIRST  MEETING  OF  STOCKHOLDERS  269 

should  also  specify  the  business  to  be  transacted  thereat,  though, 
by  reason  of  all  the  interested  parties  signing,  so  much  particu- 
larity is  not  necessary  as  in  the  call  for  the  usual  special  meeting. 
A  blanket  phrase  consenting  to  the  transaction  of  any  and  all 
business  brought  before  the  meeting  is  in  this  case  allowable 
and  authoritative.  Such  a  call  and  waiver,  to  be  effective,  must 
be  signed  by  every  incorporator  at  or  before  the  time  of  meeting. 
If  it  is  not,  a  meeting  held  pursuant  thereto  is  not  legally  called 
and  its  proceedings  are  liable  to  be  set  aside.2  The  call  and  waiver 
need  not  be  issued  or  signed  at  any  definite  time  before  the  meet- 
ing, as  it  is  a  waiver  of  all  statutory  requirements  of  notice.  A 
meeting  assembled  by  means  of  a  duly  signed  call  and  waiver, 
and  properly  conducted,  is  legal  in  any  state.  Often  the  call  is 
signed  at  the  meeting  as  the  first  order  of  business. 

Where  for  any  reason  the  call  and  waiver  of  notice  cannot  be 
used,  any  form  or  method  of  procedure  prescribed  by  the 
statutes  for  the  assembling  of  the  first  meeting  should  be  followed 
to  the  letter.  If  no  form  is  prescribed  by  the  statutes  it  will  be 
necessary  for  a  majority  of  the  incorporators  to  unite  in  a  call 
for  the  first  meeting.^  This  call  must  fix  the  time,  place,  and 
business  to  be  transacted  at  the  meeting,  and  must  be  served  on 
the  incorporators  who  have  not  signed  the  call.  Any  convenient 
place  of  meeting  may  be  selected,  the  time  of  notice  must  be 
sufficient  to  permit  all  the  incorporators  to  be  conveniently 
present,  and  the  business  to  be  transacted  should  be  set  forth 
in  detail.  The  meeting  is  practically  nothing  more  than  a  special 
meeting  of  the  stockholders,  and  in  the  absence  of  statutory 
prescription,  its  notice  should  follow  the  general  rules  in  regard 
to  notice  for  special  meetings.^ 

§  326.    Preparation  of  Minutes 

The  first  meeting  of  stockholders,  and  usually  the  first  meet- 
ing of  the  directors  as  well,  is  of  the  cut-and-dried  order.    In 

'Braintree,  etc.,  Co.  v.  Braintree,  146  Mass.  482  (1888);  Holcombe  et  al.  v.  Trenton 
White  City  Co.,  82  Atl.  (N.  J.)  618  (1912), 
'  See  Book  IV,  Form  oo. 
«See  ii  268,  270.  ^    •      ! 


27©  CORPORATE  LAW  [Bk.  I- 

most  cases  the  incorporation  is  undertaken  for  a  specific  purpose 
and  usually  by  certain  people,  who  have  already  settled  among 
themselves  just  how  the  corporation  is  to  be  organized  in  all 
main  details.  The  organization  meetings  are  merely  a  formal 
execution  of  these  prearranged  plans.  It  is  therefore  customary 
to  have  the  minutes  of  these  first  meetings  written  out  in  ad- 
vance and  often  with  much  particularity,  s  The  advantages  of 
the  plan  are  found  in  the  orderly  procedure  thereby  outlined, 
the  better  presentation  of  the  matters  to  be  considered,  and  the 
inclusion  of  all  matters  that  ought  to  be  considered.  If  anything 
occurs  at  or  during  the  time  of  the  meeting  to  modify  the  minutes 
as  already  written,  the  necessary  changes  are  quickly  made  on 
the  prepared  draft  by  erasure  or  interlineation,  and  are  properly 
incorporated  in  the  minutes  when  these  are  entered  in  the 
minute  book. 

§  327.    Conduct  of  First  Meetings 

The  manner  of  conducting  the  first  meetings  varies  widely 
with  the  conditions.  In  certain  cases,  where  everything  is  set- 
tled in  advance  and  is  to  be  kept  in  the  precise  shape  determined 
upon,  the  entire  minutes  are  put  in  final  shape  before  the  time 
of  meeting.  Then  the  attorney,  or  other  party  having  the  in- 
corporation in  hand,  after  due  assembling  of  the  incorporators, 
reads  to  them  these  cut-and-dried  minutes  as  the  proceedings 
of  the  meeting.  With  the  assent  of  those  present,  or  in  the 
absence  of  express  objection,  the  minutes  so  presented  are  de- 
clared to  be  the  minutes  of  the  meeting,  which  is  thereupon 
adjourned  The  minutes  are  then  transcribed  in  the  minute 
book,  are  signed  by  the  parties  respectively  mentioned  in  the 
minutes  as  the  presiding  officer  and  secretary,  and  the  matter 
is  closed.  The  directors'  meeting  is  conducted  in  the  same 
perfunctory  manner  and  with  the  same  precision  of  result. 

This  method  though  informal  and  irregular  cannot  be  said 


*  See  Book  IV.  Form  8g. 


Ch.  35]  FIRST  MEETING  OF  STOCKHOLDERS  271 

to  be  illegal.  The  presence  of  all  the  parties  in  interest  and 
their  assent  and  active  participation,  act  to  estop  them  from 
objecting  to  the  proceedings  and  no  one  else  would  have  the 
right  to  object. 

It  is  needless  to  say  that  when  this  method  is  employed  the 
incorporators  are  frequently  dummies,  who  after  the  completion 
of  the  organization  make  way  for  the  real  parties  in  interest. 

When  the  exact  proceedings  of  the  minutes  are  to  be  carried 
out  but  the  attorney  in  charge  does  not  wish  it  to  be  so  purely 
a  matter  of  form,  the  minutes  will  be  read  but  the  parties  named 
therein  will  go  through  the  indicated  motions.  Thus,  if  the 
minutes  state  that  the  charter  is  presented  by  the  president,  or 
chairman,  a  copy  of  the  charter  will  be  handed  the  party  named 
in  the  minutes  as  the  presiding  officer  and  the  minutes  verified 
by  its  due  presentation  to  the  meeting.  Likewise  the  parties 
named  as  making  and  seconding  motions  will  be  asked  if  they 
make  and  second  such  motions,  their  ready  assent  usually  veri- 
fying the  predictions  of  the  minutes  to  a  nicety.  Also,  as  each 
motion  is  reached  in  the  reading,  the  meeting  will  be  asked  if 
it  favors  such  motion,  the  assent  of  the  meeting  usually  being 
readily  obtained.  Such  a  meeting  is  less  of  a  legal  fiction  than 
the  meeting  conducted  entirely  by  the  reading  of  the  niinutes, 
and  is  to  be  preferred.  -  vbii'nlt; 

Where  the  real  parties  in  interest  participate  in  the  first 
meetings,  the  proceedings  are  not  usually  of  such  a  perfunctory 
nature.  The  minutes  then  serve  more  as  a  detailed  order  of 
business  and  are  varied  as  the  needs  of  the  occasion  seem  to 
indicate.  The  presiding  ofiicer  really  presides,  the  secretary 
performs  his  functions,  motions  are  made,  the  necessary  elec- 
tions actually  take  place,  discussions  are  in  order  if  the  necessity 
arises,  and,  in  short,  the  assemblage  is  a  meeting  intelligently 
acting,  and  not  a  collection  of  dummies,  useful  mainly  as  pegs 
upon  which  to  hang  the  prescribed  proceedings. 

In  the  comments  which  follow,  it  has  been  taken  for  granted 
that  the  actions  of  the  meeting  are  to  be  really  taken. 


272  CORPORATE  LAW  [Bk.  I- 

§  328.    Opening  the  First  Meeting  of  Stockholders 

At  the  duly  appointed  time  and  place,  the  incorporators  or 
a  majority  of  them,  having  assembled,  some  one  of  those  present 
calls  the  meeting  to  order,  and,  in  the  absence  of  objection 
thereto,  calls  on  some  other  incorporator  present  to  take  the 
chair.  If  there  is  any  objection  to  the  appointee,  or  to  the  selec- 
tion of  a  chairman  by  appointment,  the  party  calling  the  meeting 
to  order  should  let  the  matter  be  decided  by  vote.  The  chair- 
man, as  soon  as  his  appointment  or  election  is  announced,  takes 
charge  of  the  meeting  and,  if  there  is  no  objection  thereto, 
appoints  some  one  present  to  act  as  secretary.  If  there  should 
be  any  objection  to  the  chairman's  appointment  of  a  secretary, 
it  will  be  necessary  to  settle  the  matter  by  vote.  The  secretary, 
as  soon  as  appointed  or  elected,  will  note  the  names  of  those 
present  and  ask  for  the  proxy  of  any  incorporators  not  present 
in  person.  It  is  always  desirable  to  have  all  the  incorporators 
represented  at  this  first  meeting  in  person  or  by  proxy,  though 
a  majority  in  interest  can  legally  act  if  properly  assembled. 

The  next  step  is  to  show  that  the  meeting  has  been  properly 
called.  This  is  a  matter  for  the  secretary.  If  it  has  been  assem- 
bled by  call  and  waiver  signed  by  all  the  incorporators,  this  call 
and  waiver  should  be  produced,  be  given  to  the  secretary— if  not 
already  in  his  possession — and  be  ordered  entered  on  the  minutes 
of  the  meeting.  If  called  by  publication,  copies  of  the  news- 
papers in  which  the  notice  appeared,  or  the  affidavit  of  the 
printer,  are  adequate  evidence.  If  called  by  notice  served  per- 
sonally or  by  mail,  a  copy  of  the  notice  should  be  presented, 
accompanied  by  a  certificate  of  the  party  by  whom  it  was 
served  that  such  service  was  duly  effected.  If  the  meeting 
assembled  in  any  other  way,  the  procedure  and  the  evidence 
should  be  laid  before  the  meeting  and  appear  in  the  minutes. 

§  329.    Reception  of  Charter 

The  chairman  or  secretary  should  now  produce  a  copy  of 
the  certificate  of  incorporation,  and  report  the  fact  and  date  of 


Ch.  3s]  FIRST  MEETING  OF  STOCKHOLDERS  273 

its  allowance,  its  filing  in  the  office  or  offices  required  by  the 
statutes,  and  the  payment  of  the  required  fees.  It  is  not  essen- 
tial that  this  copy  of  the  charter  be  certified  by  the  secretary  of 
state,  though  such  certified  copy  is  customarily  procured  and 
is  generally  more  satisfactory  to  the  interested  parties  than  an 
uncertified  copy. 

When  the  charter  is  presented  a  motion  is  in  order  that  the 
certificate  of  incorporation  as  presented  be  accepted  or  received 
and  spread  upon  the  minutes  as  a  part  of  the  record  of  the 
meeting.  The  charter  is  entered  preferably  on  the  first  pages 
of  the  minute  book,  followed  by  the  by-laws,  with  the  other 
instruments  that  are  made  part  of  the  record  following  the 
minutes  proper,  each  beginning  at  the  head  of  a  page.  So 
arranged,  these  instruments  are  much  more  easily  found  and 
referred  to  than  if  incorporated  and  buried  in  the  body  of  the 
minutes.  Also  the  minutes  themselves  are  clearer  and  more 
intelligible  if  not  broken  up  by  the  interjection  of  the  lengthy 
instruments  ordered  spread  upon  the  minutes.  The  legal  effect 
of  the  entry  of  these  instruments  in  the  way  indicated  is  exactly 
the  same  as  if  they  appeared  in  the  context.  The  minutes 
should,  of  course,  note  in  the  proper  place  the  action  on  these 
instruments,  and  refer  to  the  pages  of  the  minute  book  on 
which  they  are  entered. 

§  330.    Adoption  of  By-Laws 

The  by-laws  are  usually  prepared  in  advance  of  the  first 
meeting  and  have  been  fully  considered  by  those  interested.s 
At  the  time  of  the  meeting,  they  are  presented,  read  article  by 
article  by  the  secretary  or  by  such  other  person  present  as 
may  be  designated  by  the  presiding  officer,  and  adopted  as  a 
whole.  At  times  each  article  will  be  adopted  as  read,  followed 
by  the  adoption  of  the  by-laws  as  a  whole,  though  this  is  not 
a  necessary  formality. 

•See  1257.  .irl.'>l>iOii 


274  CORPORATE  LAW  [Bk.  I- 

If  serious  objection  is  offered  to  any  of  the  by-law  provisions, 
such  objection  will  be  taken  under  consideration  by  the  meeting 
and  any  proposed  modifications  settled  by  formal  action.  As 
the  time  at  this  first  meeting  is,  however,  usually  fully  occupied 
with  routine  procedure,  such  matters  carmot  be  given  the  con- 
sideration they  deserve  and  any  objections  or  suggestions  in 
regard  to  the  by-laws  should  be  discussed  and,  if  possible,  set- 
tled before  the  meeting. 

Where  the  by-laws  have  been  fully  considered  by  the  in- 
terested parties  in  advance  of  the  meeting  and  all  are  familiar 
with  their  provisions,  the  reading  of  the  by-laws  may,  either 
by  unanimous  consent,  or  by  formal  motion,  be  dispensed  with 
and  the  by-laws  adopted  as  presented  and  as  a  whole.  The 
reading  of  the  by-laws  before  adoption  is,  however,  the  safer 
plan,  preventing  disagreement  later  as  to  just  what  was  adopted. 

Usually  the  resolution  by  which  the  by-laws  are  adopted 
closes  with  a  clause  directing  their  entry  in  the  book  of  minutes 
immediately  following  the  certificate  of  incorporation, 

§  331.    Election  of  Directors 

In  most  of  the  states  the  election  of  directors  properly  fol- 
lows the  adoption  of  the  by-laws,  such  election  being  the  only 
method  by  which  the  directors  may  be  properly  designated 
and  empowered.  In  New  York  and  in  some  other  states,  how- 
ever, the  directors  for  the  first  corporate  year  are  named  in  the 
charter.  In  New  York  these  directors  have  certain  powers  as 
to  adoption  of  by-laws.  In  such  case  no  action  in  regard  to  the 
directors  is  necessary  at  the  first  stockholders'  meeting,  and, 
indeed,  the  first  meeting  loses  much  of  its  importance,  as  the 
board  is  already  in  existence  with  full  power  to  make  by-laws 
and  to  take  up  and  manage  the  affairs  of  the  corporation.  A 
prompt  first  meeting  of  stockholders  is,  however,  still  advisable, 
as  otherwise  the  board  must  adopt  by-laws  of  more  or  less 
completeness  and  may  be  forced  to  take  other  action  which  is 
better  taken  by  the  stockholders. 


Ch.  35l  FIRST  MEETING  OF  STOCKHOLDERS  275 

W^ere  directors  are  to  be  elected  at  the  incorporators'  meet- 
ing, any  statutory  directions  must  be  followed  exactly  and 
the  minutes  should  show  in  detail  that  this  has  been  done.  In 
the  absence  of  statutory  provisions,  an  election  by  ballot,  con- 
ducted by  tellers  appointed  by  the  presiding  officer,  is  legal  and 
proper.  In  such  case  the  meeting  is  the  judge  of  the  qualifica- 
tions of  voters,  and  each  incorporator  or  other  participant  votes 
according  to  the  number  of  shares  of  stock  subscribed  for  by 
him.  If  an  agreement  exists  as  to  the  parties  to  be.  elected  as 
directors,  these  parties  might  be  nominated  by  the  meeting, 
and  the  secretary  by  motion  be  instructed  to  cast  the  vote  of 
the  meeting  for  the  parties  so  nomiiiiated. 

§  332.    Exchange  of  Stock  for  Property 

The  board  of  directors  is  the  proper  and  final  authority  to 
conclude  an  exchange  of  stock  for  property.  Where,  however, 
as  is  often  the  case,  a  large  proportion  or  possibly  all  the  stock 
of  the  corporation  is  to  be  issued  in  payment  for  some  particular 
property,  it  is  customary  and  advisable  to  have  the  proposed 
purchase  sanctioned  and  authorized  by  express  action  of  the 
stockholders.  Such  action  if  unanimous  commits  all  the  stock- 
holders to  the  purchase,  and  estops  the  participants  from  later 
objection  to  the  transaction.  The  incorporators  also  usually 
specifically  approve  the  price  at  which  the  property  is  taken 
over.    This  is  a  desirable  precaution.  ^ 

The  proposal  for  exchange  of  stock  for  property  is  usually 
presented  to  the  meeting,  read,  discussed  if  desired,  and  then  a 
resolution  passed  approving  the  proposed  purchase,  referring  it 
to  the  directors  and  instructing  them  to  consummate  the  same.^ 

§  333.    Other  Business 

Usually  there  will  be  other  business  to  come  before  the 
stockholders  at  this  first  meeting,  depending  upon  the  condi- 


'  McBryan  v.  Elevator  Co.,  130  Mich,  iii  (1902). 
•  See  Book  IV.  Forms  89,  94.  97. 


276  CORPORATE  LAW  [Bk.  I- 

tions  surrounding  the  particular  corporation.  In  some  states, 
specific  action  is  required  of  the  stockholders  by  the  statutes. 
If  there  is  any  action  to  be  taken  by  the  directors  in  which  there 
is  doubt  of  their  power,  or  in  which  some  advantage  is  to  be 
gained  by  an  authorization  from  the  stockholders,'  the  necessary 
action  should  be  taken  at  this  time.  Beyond  this  it  is  not  ad- 
visable for  the  stockholders  to  go.  All  matters  of  general  man- 
agement are  in  the  hands  of  the  board,  and  any  uncalled-for 
action  in  regard  thereto  on  the  part  of  the  stockholders  can 
have  no  advantageous  results  and  may  embarrass  the  proper 
action  of  that  body. 


CHAPTER  XXXVI 

FIRST  MEETING  OF  DIRECTORS 

§  334.    Calling  the  Meeting 

In  the  majority  of  the  states  the  directors  of  a  new  corpora- 
tion are  elected  at  the  first  meeting  of  stockholders,  and,  of 
necessity,  the  first  board  meeting  is  held  subsequent  thereto. 
Even  in  those  states  where  by  charter  appointment  of  the  board 
that  body  might  meet  in  advance  of  the  first  meeting  of  stock- 
holders, it  is  the  general  practice  for  the  meeting  of  stockholders 
to  come  first. 

At  their  first  meeting  the  stockholders  usually  adopt  by- 
laws. The  board  in  its  first  meeting  has  therefore  the  guidance 
of  these  by-laws  so  far  as  they  apply.  As  the  first  meeting  of  the 
board  is  not  a  regular  meeting,  it  is  governed  by  the  by-law 
provisions  relating  to  special  meetings,  except  as  variations  are 
made  necessary  by  the  unorganized  condition  of  the  board  at 
this  time. 

No  secretary  having  as  yet  been  elected,  the  meeting  cannot 
be  called  or  assembled  as  it  otherwise  might,  but  must  be  as- 
sembled by  a  call  signed  by  a  majority  of  the  members  of  the 
board,  such  call  being  in  its  general  form  similar  to  the  usual  call 
for  special  meetings  and  complying  in  every  way  with  its  requis- 
ites;! or  otherwise,  and  as  is  usually  done,  the  meeting  may  be 
assembled  by  a  written  call  and  waiver  of  notice  signed  by 
every  member  of  the  board  at  or  before  the  time  of  the  meeting.2 
Signatures  affixed  after  the  time  of  the  meeting  have  been  held 
non-effective.3 


« See  Book  IV,  Form  117. 

'  See  Book  IV,  Forms  95,  117. 

»  Holcombe  et  al.  v.  Trenton  White  City  Co.,  82  Atl.  (N.  J.)  618  (1912). 

277 


278  CORPORATE  LAW  [Bk.  I- 

The  call,  or  call  and  waiver,  as  the  case  may  be,  should  specify 
the  time  and  the  place  of  meeting,  and  give  in  detail  the  various 
matters  to  be  considered  and  acted  upon.  If  the  stockholders 
have  selected  any  office  or  definite  headquarters  for  the  new 
corporation,  the  meeting  of  the  directors  will  naturally  be  called 
for  that  place;  if  not,,  any  convenient  place  is  proper.  Often 
the  office  of  its  attorney  is  chosen.  The  most  important  matters 
for  consideration  at  this  meeting  are  the  election  of  officers,  the 
issuance  of  stock  for  property — where  this  is  to  be  done — and  the 
authorization  of  any  proceedings  necessary  to  the  commence- 
ment of  business.  A  blanket  provision  permitting  the  trans- 
action of  any  and  all  business  pertaining  to  the  affairs  of  the 
corporation  should  be  included  in  the  call  and  waiver.  Signed 
by  the  entire  membership  of  the  board  this  provision  is  effectual 
and  permits  action  on  any  corporate  matters  that  may  come  up 
for  consideration.  At  times  this  latitude  of  action  is  of  con- 
siderable advantage, 

§  335«    Minutes 

As  in  the  case  of  the  stockholders'  first  meeting,  the  proceed- 
ings of  the  first  meeting  of  directors  may  usually  be  anticipated 
and  minutes  be  prepared  in  advance  with  considerable  accuracy. 
Occasionally  in  such  case  the  minutes  are  prepared  in  permanent 
form  and  the  proceedings  conducted  in  accordance  by  a  mere 
reading  of  these  minutes — their  adoption  as  the  minutes  of  the 
meeting  being  signified  by  silent  acquiescence,  by  express  assent, 
or  by  a  more  particularized  assent  on  each  important  point  as 
the  reading  progresses.  Usually,  however,  the  prepared  minutes 
are  used  more  as  memoranda,  the  meeting  going  through  the 
motions  at  least  of  transacting  the  outlined  business.^ 

It  is  hardly  necessary  to  say,  that  "cut  and  dried"  minutes 
should  not  be  prepared  or  used  where  there  is  any  probability 
of  a  difference  of  opinion  in  the  board.     Courtesy  would  forbid, 


*  See  Book  IV,  Form  94. 


Ch.  36]  FIRST  MEETING  OF  DIRECTORS  279 

even  if  there  were  a  decided  majority  in  favor  of  the  outHned 
action.  Also,  speaking  generally,  it  would  be  neither  politic 
nor  advisable  to  ignore  so  openly  the  consideration  and  delibera- 
tion which  should  characterize  board  action  in  case  of  disagree- 
ment. 

§  336.    Opening  the  First  Meeting  of  Directors 

When  the  board  assembles  in  its  first  meeting  it  is  unorganized 
and  must  therefore  be  called  to  order  by  some  one  of  its'  members, 
who,  on  his  own  volition  or  at  the  request  of  other  members, 
takes  the  initiative.  This  member  merely  calls  the  meeting  to 
order,  and,  in  the  absence  of  objection,  names  a  temporary 
chairman  or  presides  until  a  temporary  chairman  is  appointed 
or  elected  by  the  meeting.  This  chairman  then  takes  charge 
of  the  meeting,  a  temporary  secretary  is  at  once  appointed  or 
elected,  and  the  temporary  organization  of  the  board  is  complete. 

The  call,  or  call  and  waiver,  or  other  authorization  under 
which  the  board  has  assembled,  should  then  be  presented,  and 
if  it  appears  that  the  meeting  has  been  duly  assembled,  the 
evidence  thereof  should  be  ordered  entered  on  the  minutes.  In 
the  absence  of  objection  this  might  be  so  ordered  by  the  presiding 
officer,  otherwise  by  formal  action.  As  the  meeting  is  a  special 
meeting  it  is  important  that  it  shall  have  been  properly  called 
and  that  due  record  be  made  of  this  fact. 

A  roll  call,  or  its  equivalent,  the  recording  of  those  present 
by  the  secretary,  completes  the  opening  formaU ties  and  the  meet- 
ing is  ready  for  business. 

§  337.    Election  of  Officers 

If,  as  is  almost  invariably  the  case,  the  officers  of  the  corpora- 
tion are  to  be  elected  by  the  board,  their  election  is  the  first 
business  before  the  meeting.  The  by-laws  already  adopted  by 
the  stockholders  usually  designate  the  officers  to  be  elected  and 
the  manner  of  their  election,  and  these  requirements  should  be 
strictly  followed.     Generally  the  election  is  by  ballot.     Candi- 


28o  CORPORATE  LAW  [Bk.  I- 

dates  for  the  various  offices  might  be  severally  nominated  with 
due  second  thereto,  but  when,  as  is  usually  the  case,  all  these 
candidates  have  been  agreed  upon  in  advance,  formal  nomina- 
tions are  dispensed  with  and  the  details  of  election  taken  up  at 
once.  Where  all  are  agreed,  a  motion  is  frequently  passed  in- 
structing the  secretary  to  cast  the  single  ballot  of  the  meeting 
for  the  recited  list  of  officers.  This  is  proper  and  at  times  con- 
venient. 

If  the  'election  is  to  be  carried  out  in  detail,  the  presiding 
officer  will,  in  the  absence  of  objection,  appoint  tellers.  The 
members  of  the  board  then  prepare  their  respective  ballots  and 
the  tellers  collect  and  count  these  ballots  and  announce  the 
results.  Each  officer  may  be  balloted  for  separately,  or, 
as  is  usually  the  case,  one  ballot  be  made  to  serve  for  all  the 
officers. 

Immediately  after  the  election  the  newly  elected  president 
and  secretary,  if  present,  take  charge  of  the  meeting  and  assume 
their  respective  official  duties.  If,  however,  these  officials-elect 
are  absent,  or  if  anything  prevents  their  immediate  assumption 
of  their  duties,  the  temporary  officers  will  continue  to  act  until 
the  close  of  the  meeting,  unless  the  permanent  officers  sooner 
take  charge.  If  the  secretary  is  required  to  be  sworn,  as  in  New 
Jersey,  he  should  comply  with  this  requirement  before  under- 
taking to  act  in  his  official  capacity,  though  his  failure  so  to  do 
would  not  vitiate  his  records,  nor  affect  in  any  way  the  legality 
of  the  meeting. 

§  338.    Adoption  of  Stock  Certificate 

The  stockholders  may,  if  they  so  desire,  either  by  resolution 
or  by-law  provision,  adopt  a  form  of  stock  certificate.  The 
matter  is  one,  however,  that  is  usually  and  better  left  to  the 
discretion  of  the  board.  Frequently  temporary  certificates  are 
adopted,  to  be  replaced  later  by  more  elaborate  permanent 
certificates.  Changes  of  conditions  may  occur  necessitating 
change  in  the  certificate  originally  adopted.     Other  contingen- 


Ch.  36]  FIRST  MEETING  OF  DIRECTORS  28 1 

cies  affecting  its  form  not  infrequently  arise.  For  these  and 
other  reasons  the  matter  is  one  best  handled  by  the  board. 

Frequently  a  form  of  stock  certificate  is  selected  and  possibly 
printed  or  engraved  before  the  time  of  the  first  board  meeting. 
Even  if  this  be  so,  the  selected  form  should  be  formally  adopted, 
and  either  the  secretary  should  be  authorized  and  instructed  to 
procure  the  necessary  books  of  stock  certificates,  or  if  the  books 
have  already  been  procured,  such  action  should  be  ratified  and 
the  books  as  presented  be  accepted.  The  resolution  by  which 
this  is  effected  should  also  authorize  the  secretary  to  provide  a 
.seal,  minute  book,  and  such  other  corporate  books  and  stationery 
as  may  be  required.  5 

The  form  of  seal  is  customarily  determined  in  the  by-laws 
which  have  already  been  adopted  by  the  stockholders.  If  this 
is  not  the  case  the  form  of  seal  should  be  selected  and  adopted 
by  the  directors. 

§  339*    Acceptance  of  Subscriptions 

Subscriptions  made  by  the  incorporators  of  a  new  company 
need  no  formal  acceptance.  The  mere  fact  of  their  having 
executed  the  charter,  in  which  their  subscriptions  usually  appear, 
and  of  having  participated  in  the  organization  meetings,  obviates 
the  necessity  of  acceptance.  If  there  are  other  subscribers  to 
the  stock  of  the  new  company,  these  other  subscriptions  require 
formal  acceptance.  This  is  accomplished  by  resolution  of  the 
board  of  directors.  The  acceptance  of  these  subscriptions  com- 
pletes and  makes  binding  the  contract  between  the  corporation 
and  those  who  have  offered  to  take  its  stock.  Neither  party  can 
then  recede,  and  the  accepted  subscribers  at  once  become  stock- 
holders of  the  corporation,  entitled  to  all  the  rights  of  stock- 
holders. The  issue  of  certificates  to  these  subscribers  does  not 
usually  take  place  until  their  subscriptions  are  fully  paid,  but 
this  does  not  affect  their  rights  as  stockholders  in  any  way,  the 
certificate  being  merely  a  convenient  method  of  evidencing  their 

•  See  Book  IV,  Form  94. 


282  CORPORATE  LAW  [Bk.  I- 

status.  If  "accepted"  subscribers  do  not  fulfill  the  conditions  of 
subscription,  their  stock  may  be  forfeited  when  statutory  author- 
ity for  such  procedure  exists,  but  until  such  forfeiture  takes  place 
their  rights  are  in  full  existence. e 

The  acceptance  of  subscriptions  is  followed  by  such  action  in 
regard  to  the  payment  thereof  as  may  be  necessary.  If  part  or 
all  of  the  subscription  price  of  the  stock  were  due  on  acceptance, 
the  treasurer  of  the  company  would  be  empowered  to  collect  the 
amounts  due.  If,  as  in  New  Jersey,  thirty  days'  call  must  be 
made — unless  waived  by  the  subscribers — before  any  part  of 
the  subscription  price  of  stock  can  be  collected,  the  board  should^ 
either  instruct  the  treasurer  to  issue  such  call,  or,  as  is  usually 
done,  secure  a  waiver  of  this  condition  by  the  subscribers  and 
take  immediate  steps  for  the  collection  of  the  amounts  then  due. 

If  the  corporation  has  been  organized  with  the  minimum 
amount  of  subscriptions  permitted  by  the  statutes  and  additional 
subscriptions  are  necessary  or  desired,  the  action  taken  will  be 
governed  entirely  by  the  conditions  of  the  particular  corpora- 
tion. In  most  cases  the  proper  officers  of  the  corporation  would 
be  instructed  to  offer  for  sale  or  subscription  such  portion  of  the 
capital  stock  as  was  to  be  sold. 

§  340.    Exchange  of  Stock  for  Property 

If,  as  is  almost  invariably  the  case  with  business  corporations 
of  the  present  day,  all  or  a  portion  of  the  corporate  stock  is  to 
be  issued  in  exchange  for  property,  the  matter  is  usually  brought 
before  the  first  meeting  of  the  board  by  the  submission  of  a  for- 
mal written  proposition  for  the  exchange,  accompanied  by  a 
resolution  of  the  stockholders  approving  the  exchange  and  in- 
structing the  directors  to  accept  the  proposition.  These  matters 
are  presented  with  proper  explanations  by  the  presiding  officer, 
or  may  with  entire  propriety  come  through  the  secretary. 
Usually  the  proposition  is  ordered  received  and  spread  in  full 


•  I  Cook  on  Corp.,  {S  52.  72;  2  Ibid.,  i  540;  but  see  Bole  et  al.  v.  Fulton  et  al.,  83  Atl. 
(Pa.)  947  (1912). 


Ch.  36]  FIRST  MEETING  OF  DIRECTORS  283 

upon  the  minutes  of  the  directors'  meeting.  If  it  has  already 
been  entered  in  full  in  the  stockholders'  minutes,  the  entry  in  the 
directors'  minutes  would  not  be  necessary,  but  preferably  the 
proposition  should  be  reserved  to  appear  in  the  directors'  minutes 
in  connection  with  the  final  action  taken  thereon. 

Usually  such  a  proposal  calls  for  little  discussion  as  the  matter 
has  already  been  fully  considered.  The  presentation  and  formal 
disposal  of  the  documents  in  the  case  is  therefore  generally  fol- 
lowed by  a  formal  resolution  of  acceptance.  This  resolution 
should  briefly  recite  the  conditions,  specifically  accept  the  propo- 
sition, and  instruct  the  officers  to  take  the  necessary  steps  to 
consummate  the  transaction.  It  should  also  authorize  the 
proper  officers  to  issue  the  stock  consideration  and  deliver  it 
against  the  delivery  of  the  duly  assigned  property  for  which  it 
pays.  7 

§341.    Treasurer's  Bond;  Depositary       . noi jxi^^T 

In  all  cases  where  a  bond  is  required  of  the  treasurer,  the 
details  of  this  bond  should  be  submitted  to  the  board  and  be 
formally  approved  by  it  before  the  treasurer  assumes  the  active 
duties  of  his  office.  When  the  treasurer  is  agreed  upon  before 
this  first  meeting  of  the  board — as  is  usually  the  case — it  will 
be  possible  and  entirely  proper  for  him  to  have  the  form  of  his 
bond  and  the  name  or  names  of  his  proposed  sureties  ready  for 
submission  at  the  first  convenient  interval  in  the  board  proceed- 
ings after  his  election.  The  form  and  sureties  of  the  bond,  if 
approved,  should  be  formally  accepted,  and  the  instrument  after 
execution  be  entrusted  to  either  the  president  or  secretary  for 
safe-keeping.  The  treasurer  will  then  at  once  enter  on  his 
duties.  At  times  the  approval  of  the  treasurer's  bond  is  left  to 
the  executive  committee  or  even  to  the  president. 

The  by-laws  should  already  have  provided  that  the  funds  of 
the  corporation  be  deposited  in  some  bank  or  trust  company,  or 
one  or  more  of  these  institutions  as  may  be  necessary  and  as 


'  See  Book  IV,  Forms  94,  97. 


284  CORPORATE  LAW  [Bk.  I- 

may  be  designated  by  the  directors,  and  that  such  funds  be 
drawn  out  only  by  check  signed  usually  by  specified  officers  of  the 
corporation.  It  now  devolves  upon  the  board  to  designate  the 
corporate  depositary.  This  is  done  by  means  of  a  resolution, 
of  which  a  copy  is  furnished  the  selected  institution  at  the  time 
of  opening  the  account.  This  copy  should  be  certified  by  the 
secretary,  and  the  names  of  the  officers  authorized  to  sign  checks 
and  the  form  of  signature  should  also  be  certified  to  the  bank.* 
Often  the  banks  have  their  own  special  forms  for  such  resolutions 
of  corporate  depositors.  In  this  case  the  resolution  would  con- 
form to  the  bank's  requirements. 

§  342.    Other  Business 

Many  matters  of  lesser  importance  will  be  brought  before  the 
first  meeting  of  directors,  according  to  the  particular  conditions. 
Authority  may  be  needed  to  rent  and  furnish  suitable  offices 
for  the  new  corporation.  In  some  states  provision  must  be  made 
for  a  state  agent  and  office.  Various  statutory  requirements 
must  be  fulfilled.  Certain  certificates  and  reports  may  need 
authorization.  Details  of  the  general  business  require  considera- 
tion. The  treasurer  should  also  be  authorized  and  instructed  to 
pay  out  of  the  new  corporation's  funds  the  expenses  of  incorpora- 
tion, including  counsel  fees  and  organization  taxes. 

If  all  the  matters  requiring  attention  cannot  be  properly  con- 
sidered at  this  first  session  of  the  board,  adjournment  should  be 
taken  to  the  next  day  or  to  some  other  convenient  date.  Such 
adjourned  meeting  is  considered  as  merely  a  part  or  a  continua- 
tion of  the  original  meeting,  and  reassembles  at  the  appointed 
time  without  formality  and  completes  its  work.  If,  on  the  other 
hand,  the  board  adjourned  without  date,  it  could  only  be  reas- 
sembled— prior  to  the  next  regular  meeting — by  the  methods 
prescribed  in  the  by-laws  for  the  calling  of  special  meetings. 

Matters  requiring  the  attention  of  the  board  are  usually  so 
numerous  in  the  first  days  of  the  corporate  existence  that  it  is  a 


'See  Book  IV,  Forms  144-146,  224-226. 


Ch.  36]  FIRST  MEETING  OF  DIRECTORS  285 

wise  precaution — even  if  not  necessitated  by  business  actually 
on  hand — to  adjourn  the  first  meeting  over  a  few  days.  Then 
if  necessary,  the  adjourned  meeting  may  be  held.  If  not  neces- 
sary, the  members  need  not  attend  and  the  meeting  will  lapse, 
the  effect  being  then  exactly  the  same  as  if  the  board  had  ad- 
journed without  date  at  the  first  meeting. 


Part  VIII— Stock  Records  and  Stock  Transfer 


CHAPTER  XXXVII 
THE  STOCK  RECORDS 

§  343.    Transfer  of  Stock  on  Books  of  Corporation 

As  a  rule,  the  issue  of  stock  is  evidenced  by  the  issue  of  stock 
certificates,  and  transfers  of  stock  are  effected  by  assignment  of 
these  certificates.  The  due  possession  of  a  properly  issued  stock 
certificate,  or  of  such  a  stock  certificate  duly  assigned,  is  there- 
fore sufficient  evidence  of  the  ownership  of  stock  for  all  ordinary 
business  purposes. 

For  all  corporate  purposes,  however,  stock  certificates  are 
merely  secondary  evidence  of  stock  ownership,  the  stock  books 
of  the  corporation  affording  the  highest  evidence  of  title.i  In 
many  states  this  is  a  matter  of  statutory  regulation;  elsewhere, 
of  charter  or  by-law  provision,  such  statutory  or  corporate 
regulations  ordinarily  prescribing  that  transfers  of  stock  shall 
be  made  only  upon  the  stock  books  of  the  corporation  and  that 
"stockholders  of  record,"  i.e.,  those  whose  names  appear  upon 
the  stock  books  of  the  corporation,  are  alone  entitled  to  exercise 
the  usual  rights  of  stockholders. 

Thus  it  will  be  seen  that,  while  the  duly  assigned  stock  cer- 
tificate is  good  evidence  of  the  ownership  of  stock,  such  ownei- 
ship  is  not  effective  for  corporate  purposes  until  the  transfer  has 
been  recorded  upon  the  stock  books  of  the  corporation.    The 


•Cleveland,  etc.,  R.  R.  v.  Robbins,  3S  O.  St.  483  (1880);  Brisbane  v.  Del.,  etc.,  R.  R., 
.  Y.  204  (1883). 


94  N.  Y.  204  (1883) 

287 


288  CORPORATE  LAW  (Bk.  I- 

holder  of  such  a  certificate  may  force  the  proper  entries  upon  the 
corporate  books  but  he  cannot  exercise  the  rights  of  a  stock- 
holder until  such  record  has  been  made;  hence  the  importance 
of  a  carefully  kept  stock  book. 

Upon  the  wrongful  refusal  of  the  corporation  to  transfer 
stock,  the  owner  has  three  remedies.  He  may  treat  the  refusal 
to  transfer  as  a  conversion  of  the  shares  in  the  corporation  and 
sue  for  their  value;  he  may  assert  his  ownership  and  sue  for  the 
dividends;  or  he  may  commence  an  action2  to  compel  the 
transfer  upon  the  books  of  the  company.  The  conditions  must 
determine  which  is  the  best  course. 

A  practical  application  of  this  rule  is  found  in  the  usual 
provision  that  the  transfer  books  of  the  corporation  shall  be 
closed  a  specified  number  of  days  before  elections  or  dividend 
days.  This  absolutely  prevents  any  change  of  ownership  for 
corporate  purposes  during  the  closed  period  and  avoids  the 
confusion  that  would  otherwise  exist  when  preparing  for  pay- 
ment of  dividends,  sending  out  notices  of  meetings,  and  deter- 
mining who  is  entitled  to  vote  at  elections.  Stock  may  be  sold 
without  restriction  during  this  closed  period,  transfers  being 
evidenced  by  assigned  certificates,  but  the  record  of  these  trans- 
fers on  the  corporate  books  cannot  be  effected  until  the  stock 
books  are  again  opened. » 

If  no  stock  certificates  were  issued,  the  interests  of  the  stock- 
holders of  a  corporation  might  still  be  assigned  very  simply, 
cither  by  transfer  on  the  books  of  the  corporation  by  the  parties 
in  person  in  the  presence  of  a  corporate  official,  or  by  the  execu- 
tion of  formal  instruments  of  assigimient  so  attested  as  to  satisfy 
the  corporate  transfer  officer  of  their  validity. ^ 

The  books  of  the  corporation  used  in  connection  with  the 
issue  and  transfer  of  stock  are  the  stock  certificate  book,  the 
stock  ledger,  and  the  stock  transfer  book. 


'  Travis  v.  Knox  Terpezone  Co.,  215  N.  Y.  259  (1915). 

*  See  I  349- 

*May  V.  McQuillan,  129  Mich.  392  (1902);  Lipscomb  v.  Condon,  56  W.  Va.  416  (1904). 


Ch.  37]  THE  STOCK  RECORDS  289 

§  344.    Stock  Certificate  Book 

The  stock  certificate  book  consists  of  blank  stock  certificates 
which,  numbered  and  in  serial  order  and  each  with  its  corre- 
sponding stub,  are  bound  up  in  book  form.  The  board  of  direc- 
tors has  power  to  prescribe  the  form  of  stock  certificates  and  to 
direct  their  issue.  ^ 

The  stock  certificate  book  is  usually  prepared  at  the  time  the 
company  is  organized  or  sometimes  even  before,  so  that  cer- 
tificates may  be  issued  as  soon  as  the  corporate  officials  have 
been  authorized  thereto.  In  this  case  the  form  of  stock  certifi- 
cate is  approved  and  the  issue  of  certificates  authorized  at  the 
first  meeting  of  the  board.  On  the  other  hand,  the  issue  of 
permanent  certificates  is  sometimes  deferred  for  a  considerable 
period  on  account  of  the  time  required  for  their  preparation,  or 
to  temporarily  save  expense,  or  for  some  other  reason.  Under 
such  circumstances,  temporary  receipts  or  certificates  are  issued 
which  are  exchangeable  tor  the  permanent  certificates  as  soon 
as  the  latter  are  ready  for  delivery,  e 

When  an  issue  of  stock  is  directed,  the  secretary  fills  out 
and  seals  in  numerical  order  the  proper  certificates.  At  the 
same  time  he  enters  on  the  stub  of  each  certificate  the  name  of 
the  party  to  whom  it  is  to  be  issued,  the  number  of  shares  repre- 
sented by  the  certificate,  the  date  of  issue,  and,  if  it  is  an  original 
issue,  that  fact  is  noted  on  the  stub;  if  a  reissue,  the  number  of 
the  certificate  surrendered  is  entered.  The  stub  also  usually 
includes  a  receipt  to  be  signed  by  the  party  to  whom  the  certifi- 
cate is  issued,  and  a  blank  on  which,  when  the  certificate  is 
surrendered  for  cancellation  and  reissue,  the  number  of  the  cer- 
tificate issued  in  its  stead  is  entered.  The  stub  when  filled  out 
thus  contains  a  complete  record  of  its  particular  certificate. 

When  stock  is  to  be  transferred,  a  new  certificate  should 
never  be  issued  until  the  old  certificate,  properly  indorsed,  has 
been  surrendered;  except  that  where  a  certificate  has  been  lost 

»  See  Book  IV,  Ch.  VI,  "Stock  Certificates"  (forms). 

» See  Book  IV,  Ch.  V,  "Subscription  Receipts  sod  Records"  (forms)- 


290  CORPORATE  LAW  [Bk.  I- 

or  destroyed,  it  should  be  replaced  upon  the  filing  of  a  proper 
bond  of  indemnity  and  compliance  with  any  other  requirements 
of  the  by-laws.  The  surrendered  certificate  should,  as  soon  as 
received,  be  canceled  by  cutting,  punching,  or  crossing  out  the 
signatures  and  by  writing  or  stamping  across  the  certificate  the 
word  "Canceled."  This  is  done  to  prevent  the  certificate  from 
being  reissued  or  from  being  used  for  fraudulent  purposes  in 
case  it  is  stolen  or  otherwise  comes  into  the  hands  of  improper 
parties.  After  cancellation  the  certificate  is  gimimed  to  the 
stub  from  which  it  was  originally  taken,  the  proper  entries  are 
made  upon  the  stub,''  and,  so  far  as  that  particular  certificate 
is  concerned,  the  matter  is  closed.  A  surrendered  certificate 
should  never  be  reissued  or  again  put  in  circulation  under  any 
circumstances. 

Every  precaution  should  be  taken  to  avoid  mistakes  in  issuing 
certificates.  The  entries  on  the  stub  should  be  made  before  the 
certificate  is  separated  from  it.  Certificates  with  space  for  the 
name  left  blank  to  be  filled  in  later,  should  never  be  issued. 
Such  a  practice  prevents  absolutely  the  accurate  recording  of 
the  stockholders  of  the  corporation,  which  is  legally  essential. 
A  corporation  is  responsible  for  any  fraud  or  error  committed 
by  its  agents  in  the  issuance  of  stock. « 

The  secretary  usually  has  charge  of  the  stock  certificate 
book  and  prepares  the  certificates  for  issue.  Where  the  secre- 
tary receives  no  regular  salary  or  in  cases  where  there  are  numer- 
ous small  transfers  of  stock,  he  is  sometimes  authorized  by  the 
by-laws  or  by  resolution  of  the  board  of  directors  to  charge  a 
small  fee  for  transfers.' 

In  the  smaller  corporations  the  stock  certificate  book  is  fre- 
quently the  only  "stock  book"  maintained.  This  practice  is 
informal  and  does  not  keep  the  record  of  stockholders  in  con- 
venient shape  for  reference,  but — in  the  absence  of  statutes 


'  See  Book  IV,  Forms  78-81. 

»  N.  Y.  &  N.  H.  R.  R.  Co.  v.  Schuyler.  34  N.  Y.  30  (i86s). 

»  See  I  259;  also  Giesen  v.  London,  etc.,  Mortgage  Co.,  102  Fed.  Rep.  584  (1906). 


Ch.  37]  THE  STOCK  RECORDS  291 

requiring  other  stock  books  to  be  kept — is  not  legally  objection- 
able. The  stock  certificate  book  then  affords  the  sole  record  of 
those  who  are  stockholders  and  entitled  to  vote  and  receive 
dividends.  1" 

§  345.    Taxes  on  Stock  Transfers 

In  most  of  the  states  there  are  inheritance  tax  laws,  taxing 
the  transfer  of  property  of  decedents,  including  shares  of  stock. 
If  the  estate  equals  or  exceeds  $50,000  in  value,  the  federal  in- 
heritance law  taxes  it  on  a  sliding  scale,  beginning  at  1%, 
and  going  up  to  25%  on  an  estate  of  $10,000,000  or  more. 

In  Massachusetts,  New  York,  and  Pennsylvania,  a  stamp  tax 
is  imposed  upon  the  sale  or  transfer  of  all  stock. 

The  federal  law  imposes  a  stamp  tax  of  5  cents  on  the  origi- 
nal issue  of  each  $100  of  par  value  or  fraction  thereof,  and  2 
cents  on  each  transfer  thereafter. 

The  corporation  is  responsible  for  any  transfers  permitted  on 
its  books  without  payment  of  taxes." 

§  346.    Stock  Ledger  and  Stock  Book 

In  almost  every  state  some  form  of  stock  record  is  prescribed 
by  statute,  variously  termed  a  "stock  book,"  "stock  ledger," 
"transfer  book,"  or  "stock  and  transfer  book."  In  some  states 
both  "stock  books"  and  "transfer  books"  are  required.  The 
intent  in  all  these  states  is  to  preserve  an  accurate  record  of  the 
stockholders  and  the  stock  held  by  them. 
.  The  stock  ledger  and  the  stock  book  are  practically,  and 
should  be,  one  and  the  same  book,  ordinarily  kept  under  the 
title  "stock  ledger"  or  such  other  title  as  may  be  prescribed  by 
the  statutes.  This  stock  ledger  must  show  in  alphabetical  order 
the  names  and  addresses  of  the  stockholders  of  record,  the 
amount  of  stock  held  and  from  whom  and  when  this  stock  was 
acquired,  and,  if  any  of  their  stock  has  been  disposed  of,  to 

»  Chemical  Nat.  Bank  v.  Colwell,  132  N.  Y.  250  {1892);  In  re  U.  S.,  etc.,  Co.,  74  N.  J.  L. 
31S  {1907). 

*' See  Ch.  XLI,  "Stock  Transfer  Taxes;  Corporate  Taxes." 


292  CORPORATE  LAW  IBk.  I- 

whom  and  when  it  was  transferred.  It  must  also  show  the  bal- 
ance of  stock  at  any  time-  to  the  credit  of  any  stockholder.  This 
balance  gives  the  number  of  shares  upon  which  such  stockholder 
is  entitled  to  vote  and  draw  dividends.12 

In  some  states  additional  data  must  be  entered.  Thus  in 
New  York  the  amount  received  by  the  corporation  on  any 
stock  acquired  by  a  stockholder  must  be  recorded;  in  Missouri 
the  amount  of  capital  stock  subscribed,  the  corporate  assets  and 
liabilities,  and  addresses  of  corporate  officers  must  be  included; 
in  North  and  South  Dakota  instalments  paid  and  unpaid  and 
any  assessments  levied  and  paid  or  unpaid  must  be  recorded; 
and  in  Colorado  all  pledges  must  be  shown  by  the  stock  book. 

§  347.    Statutory  Rules  as  to  Stock  Books     /^^^j  ijjiabt)!  oril 

The  statutes  in  many  states  are  very  peremptory  in  regard 
to  the  keeping  of  stock  books,  providing  severe  penalties  for 
failure.  Thus  in  New  York  the  statutes  not  only  prescribe  heavy 
penalties  for  failure  to  keep  stock  books,  but  provide  that  no 
transfer  of  stock  shall  be  valid  as  against  the  corporation,  its 
stockholders,  and  creditors — save  to  render  the  transferee  sub- 
ject to  a  liability  as  a  stockholder — until  the  record  thereof  has 
been  duly  entered  in  the  stock  book.is 

In  most  of  the  states  the  stock  book  must  be  kept  open  for 
inspection  of  stockholders  or  creditors  of  the  corporation,  and 
the  provisions  relating  to  the  stock  books  apply  both  to  domes- 
tic corporations  and  also  to  foreign  corporations  doing  business 
in  the  particular  state.  Under  a  recent  statute  in  New  Yorki< 
this  right  of  inspection  has  been  somewhat  curtailed,  and  the 
right  is  limited  to  judgment  creditors  of  the  corporation,  stock- 
holders who  have  been  stockholders  of  record  for  at  least  six 
months  immediately  preceding  the  demand,  and  to  persons 
holding  or  authorized  by  persons  holding  stock  to  an  amount 


"  See  Book  IV,  Ch.  VII.  "Stock  Books"  (forms). 
«  N.  Y.  Stock  Corp.  Law,  {  32;  Penal  Law,  {  665. 
"Laws  of  1916.  Ch.  127;  and  Laws  of  1918,  Ch.  137. 


Ch.  37]  THE  STOCK  RECORDS  293 

equal  to  5%  of  all  its  outstanding  shares.  There  had  un- 
doubtedly been  abuse  of  the  right  of  inspection  for  improper 
purposes,  or  for  purposes  entirely  foreign  to  the  corporation, 
but  the  statute  in  question  has  received  much  criticism. 

The  stock  ledger  is  usually  posted  from  the  transfer  book, 
though  it  may  be  posted  from  the  stubs  of  the  stock  certificate 
book;  and  its  balances  may  be  checked  from  time  to  time  by 
comparison  with  the  number  of  shares  outstanding  as  shown 
by  the  open  stubs  of  the  stock  certificate  book. is 

§  348.    Transfer  Book 

The  transfer  book  contains  not  only  a  record  of  transfers  of 
stock  of  the  particular  corporation,  but  also  the  actual  instru- 
ments of  assignment  by  which  these  transfers  were  effected.  It 
is  the  book  referred  to  by  the  usual  form  of  stock  certificate  in 
the  clause  reading  "transferable  only  on  the  books  of  the  com- 
pany, etc."i6  In  some  of  the  states  a  transfer  book  is  a  statutory 
requirement. 

The  transfer  book  is  found  in  two  general  forms.  As  usually 
kept  by  the  smaller  corporations,  it  consists  of  a  series  of  blank 
transfers  or  assignments  bound  in  book  form.  These  are  filled 
out  and  signed  by  the  owner  of  stock  or  his  duly  authorized 
attorney  when  the  actual  transfer  of  stock  disposed  of  by  him 
is  made  upon  the  books  of  the  company.  They  are  primarily 
designed  to  be  formal  evidence  of  the  transfer  of  stock.  They 
are  also  the  secretary's  authority  for  the  issuance  of  new  certifi- 
cates of  stock  to  the  assignee  in  place  of  the  old  certificates 
surrendered. 

A  different  form  of  transfer  book  is  used  by  the  larger  cor- 
porations where  the  number  of  transfers  is  too  great  to  permit 
of  the  convenient  use  of  the  form  already  described.  In  this 
book  but  one  line  is  required  for  each  transfer  of  stock,  the 
transferee  or  his  duly  authorized  attorney  signing  in  the  right- 
hand  column. 


»  See  Book  IV.  Fomi  78. 
"  See  Book  IV.  Form  85. 


294  CORPORATE  LAW  [Bk.  I- 

By  reference  to  the  assignment  on  the  back  of  the  stock 
certificate,"  it  will  be  seen  that  the  assignment  of  the  transfer 
book  is  practically  •  a  duplication  of  that  on  the  back  of  the 
stock  certificate,  save  that  the  power  of  attorney  to  transfer 
the  stock  on'  the  books  of  the  corporation  is  omitted  from  the 
transfer  book.  As  the  duly  executed  assignment  on  the  back 
of  a  surrendered  stock  certificate  is  a  full  and  sufficient  transfer 
of  the  actual  ownership  of  the  stock  and  justifies  the  secretary 
in  issuing  another  certificate  in  the  name  of  the  assignee,  many 
of  the  smaller  corporations  never  keep  a  stock  transfer  book, 
relying  entirely  upon  the  stock  certificate  book  with  its  stubs 
and  duly  assigned  and  canceled  certificates  for  the  record  and 
evidence  of  authorization  of  transfers. 

When  the  transfer  book  is  used,  its  assignment  forms  are 
signed  either  by  the  party  making  the  transfer  or  by  his  duly 
authorized  agent.  Should  the  transferrer  come  in  person — as 
he  has  the  right  to  do — and  sign  a  transfer  on  the  stock  transfer 
book,  there  is  no  legal  necessity  for  his  signature  to  the  assign- 
ment on  the  back  of  the  stock  certificate.  It  is,  however,  always 
customary  for  him  to  execute  the  assignment  on  the  back  of  the 
surrendered  stock  certificate  as  well.      ''Jn':tffti 

It  is  but  seldom  that  the  transferrer  makes  the  transfer  on 
the  books  of  the  corporation  in  person.  In  perhaps  ninety-nine 
cases  out  of  a  hundred  he  merely  signs  in  blank  the  assignment 
on  the  back  of  the  certificate  and  turns  it  over  to  the  purchaser. 
The  name  of  the  attorney  to  make  the  transfer  is  then  inserted 
at  the  time  the  certificate  is  presented  for  transfer,  either  by  the 
.party  by  whom  the  certificate  is  surrendered  or  by  the 
secretary,  who  usually  inserts  his  own  name  and  makes  the 
transfer. 

§  349.    Closing  the  Books 

In  all  the  larger  corporations  it  is  customary  to  close  the 
stock  books  to  transfers  prior  to  both  elections  of  directors  and 

"  See  Book  IV,  Form  81. 


Ch.  37]  THE  STOCK  RECORDS  295 

the  payment  of  dividends,i8  for  a  period  of  from  2  to  40  days. 
This  is  done  to  enable  the  corporate  officers  to  make  an  accurate 
list  of  those  entitled  to  receive  notice  of  meetings  and  to  vote 
thereat  or  to  receive  dividends. 

In  a  number  of  states  the  statutes  expressly  authorize  the 
stock  books  to  be  so  closed  to  transfers.  Where  this  is  not  the 
case,  it  may  be  provided  for  in  the  charter  or  by-laws.  The 
precise  number  of  days  for  which  the  transfer  books  are  closed 
is  usually  fixed  by  the  by-laws.  The  resolution  declaring  divi- 
dends usually  fixes  the  number  of  days  for  which  the  books  shall 
be  closed  before  the  dividend  day,  if  this  is  not  prescribed  by 
the  by-laws. 

i-  In  some  cases  the  statutes  or  by-laws  merely  provide  that 
•stock  shall  be  voted  by  the  owner  of  record,  as  shown  by  the 
books  of  the  company,  10,  20,  30,  or  40  days  before  an  election. 
This  wording  does  not  justify  closing  the  stock  books  and  refus- 
ing to  make  transfers.  In  such  case  transfers  are  made  without 
interruption,  but  the  secretary,  in  making  up  his  lists  of  stock- 
holders for  the  election,  ignores  transfers  made  after  the  fixed 
date. 

!■,  No  formality  attends  the  closing  of  the  stock  books  and 
usually  no  entry  thereof  is  made  upon  the  books,  the  secretary 
merely  refusing  to  transfer  certificates  presented  to  him  for 
that  purpose  during  the  prescribed  period.  The  notice  of  the 
annual  meeting  or  of  dividends  usually  sets  forth  the  days  for 
the  closing  and  reopening  of  the  transfer  books. 


w  Jones  V.  Terre  Haute,  etc.,  R.  R.  Co..  SI  N.  Y.  196  (1874). 


CHAPTER  XXXVIII 

TRANSFER  OF  STOCK 

§  350.    Procedure  of  Transfer 

When  stock  is  to  be  transferred,  one  of  the  following  courses 
is  ordinarily  pursued : 

1.  The  certificate  is  assigned  in  blank  and  delivered  to  the 
transferee,  in  which  case  the  assignment  is  absolute^  and  the 
certificate  may  then  be  passed  from  hand  to  hand  and  the  owner- 
ship of  the  stock  it  represents  be  thereby  transferred  any  desired 
number  of  times  without  change  of  or  addition  to  the  assignment. ' 

2.  The  assignment  on  the  back  of  the  certificate  is  completed 
by  the  insertion  of  the  name  of  the  tratisferee  and  the  delivery 
of  the  certificate  to  the  transferee,  in  which  case  the  certificate 
must  be  surrendered  and  a  new  certificate  taken  out  by  the  trans- 
feree before  it  can  be  again  transferred. 

3.  The  assignor  completes  the  assignment  form  on  the  back 
of  the  certificate,  surrenders  the  certificate  to  the  secretary  of 
the  company,  and  secures  and  makes  deKvery  of  a  new  certificate 
in  the  name  of  the  transferee. 

4.  The  certificate  is  delivered  to  the  transferee  without  in- 
dorsement, but  accompanied  by  an  instrument  of  assignment  or 
power  of  attorney  having  the  same  effect  as  the  indorsement 
upon  the  back  of  the  certificate. 

When  transfer  is  made  by  delivery  of  the  certificate  with  the 
name  of  the  transferee  inserted  in  the  assignment,  the  transfer 
is  not  made  on  the  books  of  the  corporation  until  the  assigned 
certificate  is  surrendered.  In  the  meantime  the  original  owner 
is  still  the  owner  of  record  and  will  therefore  be  held  should  any 


'  People  V.  Utah,  etc.'Mines  Co.,  I3S  App.  Div.  (N.  Y.)  418  (1909);  Morris  v.  Hussong, 
etc.,  Co.,  81  N.  J.  Eq.  256  (igi3). 

296 


Ch.  38]  TRANSFER  OF  STOCK  297 

stockholders'  liabilities  arise,  although  as  between  the  immediate 
parties  the  transfer  is  complete,  and  the  transferrer  could  recover 
from  the  transferee  any  assessment  or  other  moneys  which  he 
might  be  compelled  to  pay  as  a  stockholder  of  record.  This 
objection,  when  the  stock  transferred  is  full-paid,  is  not  in  most 
states  material  in  the  case  of  ordinary  business  corporations; 
but  when  stock  of  banks,  trust  companies,  or  other  financial 
corporations  is  transferred,  or  when  stock  is  not  full-paid,  it  may 
be  material  and  even  vital. 

§  351.    Assignment  in  Blank 

When  transfer  is  made  by  assignment  in  blank,  and  the 
blank  has  been  filled  so  that  it  is  a  completed  assignment,  the 
transfer  on  the  books  of  the  corporation  is  not  made  until  the 
transferee  surrenders  the  assigned  certificate. 

In  practice  the  assignment  in  blank,  on  account  of  its  con- 
venience, is  employed  in  the  great  majority  of  stock  transfers. 

When  the  holder  of  a  certificate  assigned  in  blank  wishes  to 
perfect  his  title  and  make  himself  a  holder  of  record,  he  fills  in  his 
own  name  as  assignee  and  surrenders  the  certificate  to  the  secre- 
tary or  transfer  agent  for  transfer.  He  may  also,  if  he  sees  fit, 
fill  in  the  name  of  the  party  who  is  to  make  the  transfer  upon  the 
books  of  the  corporation,  though  this  is  usually  left  blank.  If 
the  signature  to  the  assignment  is  genuine  and  there  are  no  rea- 
sons for  suspecting  any  irregularity,  the  transfer  is  made  as  a 
matter  of  course  and  a  new  certificate  is  issued  in  the  name  of  the 
assignee.  If  the  name  of  the  attorney  to  make  the  transfer  is 
left  blank  in  the  assignment  of  the  surrendered  certificate,  the 
secretary  of  the  corporation  usually  fills  in  his  own  name  and 
then  completes  the  transfer,  thereby  avoiding  the  delay  that 
might  result  if  some  outside  party  were  designated  who  must 
come  in  and  sign  the  transfer  book  before  the  transfer  could  be 
duly  recorded. 

When  the  assignment  on  the  back  of  the  certificate  has  been 
completed  by  the  insertion  of  the  assignee's  name,  the  certificate 


298  CORPORATE  LAW  [Bk.  I- 

is  not  readily  negotiable  and  is  almost  invariably  turned  in  and 
a  new  certificate  taken  out.  If,  however,  conditions  make  it 
necessary  for  the  assignee  to  transfer  the  certificate  originally 
assigned  to  him,  he  may  effect  the  transfer  by  means  of  a  second 
assignment — in  blank  if  desired — written  on  the  back  of  the 
certificate,  or  written  on  a  separate  sheet  and  attached  to  the 
certificate. 

§  352.    Rights  of  Stockholder  of  Record 

As  already  stated,  stock  assigned  by  indorsement  of  the 
certificate,  whether  in  blank  or  complete,  still  stands  on  the 
books  of  the  corporation  in  the  original  owner's  name  until  the 
certificate  is  surrendered  and  the  proper  entries  are  made  on  the 
stock  books  of  the  corporation.  Until  this  is  done  the  original 
owner  is  still  the  stockholder  of  record  and,  while  subject  to  any 
stockholders'  liabilities  accruing  meanwhile,  has,  on  the  other 
hand,  a  legal  right  to  vote  and  to  receive  payment  of  any  divi- 
dends declared  even  though  the  actual  sale  of  his  stock  was  con- 
summated months  before.2  His  right  to  vote  is  absolute,  and 
after  its  exercise  cannot  in  any  way  be  overturned  or  questioned. 
His  right  to  dividends  is  qualified,  as  the  dividends  belong  to  the 
actual  owner  of  the  stock,  i.e.,  the  person  possessing  the  duly 
assigned  stock  certificate,  to  whom  the  holder  of  record  must 
account.  His  responsibility  as  to  any  stockholders'  liability  is, 
as  to  the  corporation,  absolute,  but  for  any  such  payments  he 
has  recourse  on  his  assignee. 

§  353'    Delivery  of  New  Certificate 

Before  delivering  the  new  certificate,  the  secretary  should, 
when  possible,  require  the  party  who  presented  the  old  certificate 
for  transfer — who  may  or  may  not  be  the  assignee — to  sign  a 
receipt  therefor  on  the  stub.  If  the  new  certificate  is  delivered 
by  mail,  it  may  be  registered,  in  which  case  the  stub  in  the  stock 


'Brisbane  v.  Delaware,  etc.,  R.  R.  Co.,  94  N.  Y.  204  (1883);  Cleveland,  etc.,  R.  R.  Co. 
V.  Robbins,  Admr.,  35  O.  St.  483  (1880). 


Ch.  38\  TRANSFER  OF  STOCK  299 

certificate  book,  the  office  copy  of  the  letter  accompanying  the 
certificate,  and  the  returned  registry  receipt,  which  should  be 
attached  to  the  stub,  make  a  sufl&cient  record  of  the  transaction. 
Blank  receipts  are  sometimes  sent  with  the  certificates  in  such 
cases,  to  be  signed  by  the  recipient  and  returned,  and  these 
receipts  when  received  by  the  secretary  are  pasted  on  the  proper 
certificate  stubs. 

§  354.    Sale  of  Part  of  Holding 

Frequently  the  owner  of  stock  wishes  to  sell  or  transfer  only 
a  portion  of  the  stock  represented  by  a  certificate,  and  in  such 
case  the  assignment  on  the  back  of  the  certificate  may  be  filled 
out  according  to  the  facts.  For  instance,  if  Howard  Fielding 
owned  100  shares  of  stock,  all  included  in  a  single  certificate, 
and  wished  to  sell  20  shares  to  James  Wilton,  he  might  fill  out 
the  assignment  as  follows:  "unto  James  Wilton  twenty  shares 
and  Howard  Fielding  eighty  shares,"  or  if  the  secretary  will 
accept  the  somewhat  informal  assignment,  it  might  be  merely 
filled  out  "unto  James  Wilton  twenty  shares,"  it  following  as  a 
matter  of  course  that  if  only  20  shares  are  assigned,  the  balance 
of  the  stock  remains  with  the  assignor. 

The  owner  of  the  100  shares  then  brings  or  sends  in  his 
certificate  to  the  secretary  and  instructs  him  to  make  out  two 
new  certificates — one  for  20  shares  in  the  name  of  the  new  owner, 
the  other  for  80  shares  in  his  own  name.  The  secretary  makes 
the  proper  entries  on  the  stock  book,  cancels  the  old  certificates, 
issues  the  two  new  certificates  in  accordance  with  his  instructions, 
and  delivers  both — unless  he  has  express  instructions  from  the 
original  owner  to  the  contrary — to  this  original  owner,  who  then 
makes  delivery  of  the  20-share  certificate  at  his  convenience. 
The  secretary  must  be  governed  entirely  by  the  instructions  of 
the  assignor  in  delivering  new  certificates,  no  matter  in  whose 
name  these  certificates  may  be  issued,  as  they  are  still  in  fact 
the  property  of  the  original  owner. 

Another  and  usually  preferable  method  when  but  a  portion 


300  CORPORATE  LAW  [Bk.  I- 

of  the  stock  represented  by  a  certificate  is  to  be  transferred,  is 
for  the  original  owner  to  have  the  new  certificates  issued  to  him- 
self. When  this  is  to  be  done,  he  fills  in  his  own  name  as  assignee, 
instructing  the  secretary  to  issue  new  certificates  for  the  proper 
number  of  shares.  In  the  case  instanced  he  would  have  two 
certificates  issued — one  for  20  shares  and  the  other  for  80  shares — 
in  his  own  name.  He  would  then  assign  the  20-share  certificate 
in  blank,  or  in  the  name  of  the  new  owner,  and  deliver  it  if  the 
transaction  is  concluded.  The  new  owner  may  then  bring  in 
and  surrender  this  assigned  certificate  and  take  out  a  new  certifi- 
cate in  his  own  name  at  his  convenience. 

When  this  plan  is  followed,  even  should  the  sale  fail  after 
new  certificates  were  issued,  the  original  owner  still  has  the  stock 
standuig  on  the  books  of  the  corporation  in  his  own  name  and 
both  certificates  made  out  to  him;  whereas  if  the  first  plan  had 
been  followed,  one  of  the  certificates  being  made  out  to  the 
proposed  purchaser,  part  of  his  stock  would  stand  on  the  books 
in  the  transferee's  name,  and  the  real  owner  must  either  secure 
the  assignment  of  this  other  party  as  a  matter  of  courtesy,  or 
otherwise  be  put  to  much  trouble  to  get  the  certificate  back  into 
his  own  name. 

§  355«    Breaking  Up  a  Certificate 

When  a  certificate  is  surrendered  for  reissue  in  one  or  more 
certificates  in  the  original  owner's  name,  the  transfer  may  be 
entered  on  the  transfer  book  as  a  matter  of  record,  but  as  the 
owner's  stock  account  is  not  affected  one  way  or  the  other  by  the 
transaction,  it  should  not  be  posted  therefrom  to  the  stock  book. 
A  memorandum  of  the  facts  should  be  made  in  the  transfer  book 
and  on  the  stubs  of  the  certificates  involved  in  the  reissue,  and 
the  certificate  numbers  in  the  stock  book  must  be  corrected. 

§  356.    Duty  of  Officers  to  Transfer  Stock 

The  secretary  or  officers  of  the  corporation  must  refuse  to 
transfer  or  reissue  stock  until  the  old  certificate  has  been  sur- 


Ch.  38]  TRANSFER  OF  STOCK  301 

rendered  or  until  any  other  proper  requirements  have  been  com- 
phed  with.  When,  however,  all  proper  requirements  have  been 
met,  they  must  make  the  desired  transfer  or  reissue. ^  The 
authenticity  of  the  signature  to  an  assignment  of  a  stock  certifi- 
cate must  be  satisfactorily  established  when  necessary.  In  the 
smaUer  corporations  the  secretary  is  usually  familiar  with  the 
signatures  of  the  stockholders.  The  larger  corporations  some- 
times require  the  signatures  to  be  witnessed  or  guaranteed  by 
some  person  known  to  the  transfer  agent,  or  otherwise  that  they 
.shall  be  formally  acknowledged  before  a  notary  public.  If  there 
is  any  doubt  as  to  the  authenticity  or  correctness  of  the  assign- 
ment or  as  to  the  title  of  the  party  presenting  the  certificate,  or 
as  to  any  other  material  matter,  the  secretary  has  the  right  to 
delay  the  transfer  for  a  reasonable  time  in  order  to  communicate 
with  the  former  holder  or  take  such  other  steps  as  he  may  deem 
expedient.  If  after  due  investigation  there  still  remains  doubt 
as  to  the  propriety  of  the  transfer  or  the  ownership  of  the  certifi- 
cate, or  if  there  be  conflicting  claims,  the  secretary  may  properly 
decline  to  act  until  instructed  by  the  board  of  directors,  and  the 
board,  if  in  doubt,  may  decline  to  take  action  in  the  matter  until 
ordered  thereto  by  some  court  of  competent  jurisdiction. 


'Jones  V.  Terre  Haute,  etc.,  R.  R.  Co.,  57  N.  Y.  196  (1874);  Robinson  v.  National  Bank 
of  New  Berne,  95  N.  Y.  637  (1884). 


i<r] 


rtuit  )K>ii«y!  .^Mn  'Idiii 


,Ai  m.  CHAPTER  XXXIX 

-jmo^  '^"' ""transfer  of  STOCK  (Continued) 

§  357«    Transfer  of  Treasury  Stock 

When  treasury  stock  is  donated  to,  or  otherwise  acquired 
by,  a  corporation,  the  assignment  may  run  to  the  corporation 
direct,  as  "John  Marshall  Company";  to  its  treasurer,  as  "Treas- 
urer of  John  Marshall  Company";  or  to  a  trustee,  as  "John 
H.  McGowan,  Trustee  for  John  Marshall  Company."  The 
certificates  so  assigned  are  canceled  when  received  and  the 
proper  entries  are  made  on  the  transfer  book  and  stock  ledger. 
When  such  stock  is  held  in  the  name  of  the  company  or  even  by 
the  treasurer  of  the  company,  no  new  certificates  need  be  issued 
until  the  stock  is  sold,  the  fact  that  certificates  are  not  issued 
being  noted  on  the  stock  books.  When  a  sale  of  such  stock  is 
made,  the  new  certificates  are  made  out  direct  to  the  purchaser. 
Certificates  might  properly  be  issued  meanwhile  in  the  name  of 
the  company  or  to  the  treasurer  if  desired,  but  such  issue  is 
unnecessary  as  the  data  of  the  transfer  book,  the  entry  on  the 
stock  ledger,  and  the  canceled  certificates  are  quite  sufficient  to 
evidence  the  transaction.  It  is  obvious  that  the  reasons  that 
make  the  certificate  desirable  when  stock  is  held  by  an  individual, 
do  not  apply  when  a  corporation  holds  its  own  stock. 

When  treasury  stock  is  sold,  the  secretary  is  authorized  by 
due  resolution  of  the  board  of  directors  to  issue  the  proper 
certificates.  Such  transfers  are  entered  on  the  stock  books  of 
the  corporation  as  in  case  of  any  other  transfer  of  stock. 
If  certificates  are  not  issued  for  the  stock  while  held  by  the  cor- 
poration, this  fact  should  be  noted  on  the  stock  books.  It  is  not 
necessary  to  issue  certificates  until  the  stock  is  sold. 

302 


Ch.  39]  TRANSFER  OF  STOCK  303 

§  358.    Transfer  Agent  and  Registrar 

A  transfer  agent,  in  the  modern  acceptation  of  the  term,  is 
one  who  supervises  and  certifies  transfers  of  corporate  stock. 
The  extent  of  his  supervision  depends  upon  custom  or  upon  the 
particular  agreement. 

A  transfer  agent  usually  keeps  the  stock  certificate  book  in 
his  custody.  When  a  transfer  is  to  be  made,  the  certificate  of 
stock  duly  assigned  is  surrendered  to  the  transfer  agent,  who 
thereupon  cancels  the  surrendered  certificate,  attaches  it  to  its 
proper  stub,  and  issues  a  new  certificate  in  the  name  of  the  trans- 
feree. This  certificate  is  then  sent  to  the  proper  corporate 
officials  who  affix  their  signatures  and  the  corporate  seal — - 
unless  the  seal  is  also  entrusted  to  the  transfer  agent — make  the 
proper  records  in  the  transfer  and  stock  books,  and  return  the 
signed,  or  signed  and  sealed,  certificate  to  the  transfer  agent. 
The  transfer  agent  thereupon  seals  the  certificate  if  not  already 
sealed,  indorses  it  in  evidence  of  its  due  issue,  delivers  it  to  the 
transferee,  and  the  transaction  is  closed. 

Occasionally  when  a  transfer  agent  is  employed,  the  stock 
certificate  book  is  retained  in  the  custody  of  the  corporation.  In 
such  case  when  a  certificate  is  presented  for  transfer,  it  is  canceled 
by  the  transfer  agent  and  turned  over  to  the  corporation  in 
exchange  for  a  new  certificate  issued  in  the  name  of  the  trans- 
feree. This  certificate  is  indorsed  by  the  transfer  agent  and 
delivered  to  its  owner.  When  the  stock  certificate  book  is  kept 
by  the  corporation,  the  transfer  agent  keeps  an  independent 
record  of  stock  certificates  issued  and  surrendered,  in  order  that 
the  regularity  of  any  particular  transfer  or  issue  may  be  readily 
and  definitely  ascertained. 

A  registrar  is  a  corporate  appointee  who  also  supervises  the 
transfer  of  corporate  stock  but  does  not  usually  carry  his  super- 
vision to  the  same  extent  as  does  the  transfer  agent,  his  function 
being  merely  to  register  stock  as  issued.  He  maintains  a  record 
of  all  stock  certificates  issued  and  of  the  surrender  and  reissue  of 
any  new  certificates  with  thie  names  of  the  parties  to  the  transfer. 


304  CORPORATE  LAW  [Bk.  I- 

If  an  issue  or  transfer  is  to  be  made,  the  registrar  passes  upon  the 
certificates  and  countersigns  them  if  they  are  correctly  issued. 
His  signature  is  evidence  of  due  issuance. 

It  will  be  seen  that  the  duties  of  the  transfer  agent  and  regis- 
trar are  distinct,  and  should  not  be  performed  by  a  single  person 
or  institution.  The  function  of  the  transfer  agent  is  to  insure 
the  proper  issue  of  stock.  The  function  of  the  registrar  is  to 
insure  the  regularity  of  issue  and  to  prevent  overissues.  The 
functions  of  the  two  somewhat  overlap,  as  the  transfer  agent 
would  not  permit  an  overissue  of  stock  nor  would  the  registrar 
sign  stock  improperly  issued. 

It  is  obvious  that  the  work  of  a  transfer  agent  and  registrar 
to  be  effective  must  be  discharged  by  persons  or  institutions  of 
the  highest  character  and  unquestioned  standing.  For  this 
reason  trust  companies  or  banks  are  usually  appointed. 

Speaking  generally,  the  employment  of  transfer  agents  and 
registrars  is  advisable  whenever  transfers  of  stock  are  likely  to 
be  numerous.  The  procedure  involved  is  simple  in  theory  but 
in  practice  involves  much  detailed  work.  Also  it  is  usually 
desirable  that  transfers  be  effected  rapidly  and  accurately.  The 
employment  of  the  proper  transfer  agent  and  registrar,  or 
transfer  agent  alone,  relieves  the  corporate  officials  from  the 
detailed  work  and  responsibility  involved,  reduces  the  possibility 
of  fraud  or  error  in  the  issuance  of  stock  to  a  minimum,  and 
affords  a  general  safety  and  convenience  not  otherwise  secured. 
Stock  exchanges  require  that  the  securities  listed  by  them  shall 
be  issued  through  suitable  transfer  agents  and  registrars. 

§  359*    Lost  and  Stolen  Certificates 

A  stockholder,  so  shown  by  the  books  of  his  company,  is 
entitled  to  every  right  and  privilege  of  a  stockholder  without 
regard  to  the  whereabouts  of  his  certificate.! 

When  certificates  are  lost,  the  owner  usually  desires  to  have 
new  certificates  issued,  not  in  order  to  secure  any  corporate 

•  National  Bank  v.  Watsontown  Bank,  105  U.  S.  217.  222  (1881);  Birmingham  National 
Bank  v.  Roden,  97  Ala.  404  (1892);  Wheeler  v.  Millar,  90  N.  Y.  353  (1883). 


Ch  39]  TRANSFER  OF  STOCK  305 

rights,  but  merely  to  have  his  interest  in  such  shape  that  he  may 
readily  sell,  pledge,  or  otherwise  use  his  stock.  Stockholders 
have  a  general  right  to  certificates2  and,  if  their  certificates  are 
lost,  to  have  them  replaced;  but  before  it  reissues  any  such 
certificates,  the  corporation  on  its  part  has  the  right  to  require 
reasonable  safeguards  for  its  own  protection.^  The  by-laws 
should  outline  the  proper  procedure,  which  must  conform  to  any 
statutory  requirements.* 

A  bond  of  indemnity  is  usually  and  properly  required  before 

a  lost  certificate  is  replaced,  as  it  is  always  possible  that  the 

missing  certificate  may  turn  up  in  the  hands  of  an  innocent 

-purchaser  for  value,  who  might  have  cause  for  damages  against 

:  the  corporation  if  it  refused  to  recognize  his  rights.     It  is  but 

rSeldom  wise  to  reissue  lost  certificates  unless  such  bond  is  given. 

'Only  the  absolute  and  irrecoverable  loss  of  a  certificate,  as  in 

case  of  its  unquestioned  destructipn  by  fixe,  would  justify,  an 

/Unprotected  reissue.  r  >)  -i.-u^nrK^:  tMrf-v/x 

;       When  the  value  of  missing  certificates  is  considerable  and  the 

circumstances  are  doubtful,  it  is  sometimes  best  for  the  directors 

(to  refuse  absolutely  to  replace  the  certificates  until  the  owner 

.  secures  an  order  from  some  court  of  competent  jurisdiction. 

,  When  this  is  done  the  directors  are  relieved  from  all  responsibility 

,.  in  the  matter.     The  officers  of  the  company  should  never  take 

I  the  responsibility  of  reissuing  a  lost  or  stolen  certificate  of  stock 

■  without   express   authorization   from   the   board   of   directors. 

•  Should  they  do  so  and  the  missing  certificate  turn  up  in  such  a 

J  way  that  loss  is  involved,  they  would  be  responsible  to  the 

f, corporation. 

In  case  certificates  are  lost  or  stolen,  the  secretary  of  the 

company  or  its  transfer  agent  should  be  immediately  notified, 

i  and  such  other  steps  be  taken  as  may  be  necessary  to  prevent 

the  negotiation  of  the  missing  certificates.     When  lost  certifi- 


» Buffalo,  etc.,  R.  R.  v.  Dudley,  14  N.  Y.  336.  347  (1856);  Fletcher  v.  McGill,  no  Tnd. 
"395  (1886). 

•See  Book  IV,  Form  249;  also  Guilford  v.  W.  U.  Tel. Co.,  43  Minn.  434  (1890);  Butler  v. 
■  'Glen  Cove,  Starch  Mfg.  Co.,  18  Hun  47  (1879). 
«  See  Book  IV,  Forms  65,  66. 


5o6  CORPORATE  LAW  [Bk.  I- 

cates  are  indorsed  in  blank  and  are  presented  to  the  transfer 
officers  of  the  corporation  before  these  officials  have  been  notified 
of  the  loss,  they  may  make  the  transfer,  and  the  corporation  will 
not  be  liable  to  the  owner  if  the  circumstances  were  such  as  to 
justify  the  belief  that  such  transfer  was  regular  and  in  good  faith. 
If,  however,  the  proper  officials  have  been  warned  of  the  loss, 
or  the  circumstances  were  such  as  to  put  them  on  notice,  they 
could  not  safely  make  such  transfer. 

§  360.    Negotiability  of  Stock  Certificates 

•■'  In  states  where  the  common  law  prevails,  a  stock  certificate 
is  not  perfectly  negotiable  as  are  notes,  drafts,  and  other  forms 
of  negotiable  paper,  but  is  quasi-negotiable,  and  usually  an 
innocent  purchaser  for  value  of  a  properly  indorsed  certificate  is 
protected.5  "Excepting  in  cases  of  certificates  transferred  in 
blank  and  lost  or  stolen  without  negligence  on  the  part  of  the 
owner,  a  bona  fide  purchaser  is  protected  now  in  almost  every 
instance  where  he  would  be  protected  if  he  were  purchasing  a 
promissory  note  or  other  negotiable  instrument. "« 

Thus  a  party  finding  or  stealing  certificates  of  stock,  even 
though  these  certificates  are  indorsed  in  blank,  takes  no  title, 
nor  does  anyone  who  buys  the  lost  or  stolen  certificates  from 
him,  the  title  remaining  in  the  original  owner.'  If,  however, 
a  lost  or  stolen  certificate  is  surrendered  to  the  corporation  and 
a  new  certificate  received  in  its  place — as  might  readily  be  the 
case  if  the  corporate  officials  were  not  promptly  notified  of  the 
loss — any  purchaser  in  good  faith  of  this  new  certificate  takes  a 
clear  title.  The  original  owner  has  then  lost  all  rights  in  the 
matter  save  that  of  bringing  suit  against  those  through  whose 
hands  the  certificate  passed  before  its  reissue  by  the  corporation. 

In  case  of  any  doubt  or  any  dispute  as  to  ownership  of  a 


'  Knox  V.  Eden  Musee  Co.,  148  N.  Y.  441  (1896);  Trust  &  Sav.  Co.  v.  Home  Lumber  Co., 
118  Mo.  447  (1893). 

•  2  Cook  on  Corp.,  {  416;  Real  Estate  Trust  Co.  v.  Bird,  90  Md.  229  (1899);  Jarvis  v. 
Manhattan  Beach  Co.,  148  N.  Y.  652  {1896). 

'  O'Herron  v.  Gray.  168  Mass.  573  (1897);  Hannahs  v.  Hammond  Typewriter  Co.,  158 
App.  Div.  (N.  Y.)  620  (1913);  Barstow  v.  City  Trust  Co.,  216  Mass.  330  (1914)- 


Ch.  39]  TRANSFER  OF  STOCK  307 

certificate,  no  transfer  should  be  made  by  the  corporation  until 
the  true  ownership  has  been  definitely  determined. 

§  361.    The  "Uniform  Transfer  Act"' 

In  order  to  secure  the  greatest  possible  security  to  purchasers 
of  stock,  and  to  facilitate  the  free  transfer  of  shares,  an  act  known 
as  the  "Uniform  Transfer  Act"  has  been,  adopted  with)  only 
slight  variations  in  form  in  New  York,  Pennsylvania,  Massa- 
chusetts, New  Jersey,  and  a  number  of  other  states.  By  this 
act  certificates  of  stock  are  made  negotiable  instruments  subject 
to  the  rules  of  the  law  governing  commercial  paper.  The  step 
is  really  not  a  radical  one,  for,  as  has  been  shown,  the  courts 
have  gone  far  in  cases  under  the  common  law  to  protect  bona 
fide  purchasers.  The  statutes,  of  course,  are  not  extra-terri- 
torial in  their  scope,  and  by  provisions  in  the  acts  themselves 
apply  only  to  certificates  issued  after  their  passage. 

§  362.    Pledges  of  Stock 

The  quasi-negotiability  of  stock,  and  in  many  states  its  full 
negotiability,  renders  its  use  as  a  pledge  or  collateral  security  a 
very  simple  matter,  effected  by  the  mere  indorsement  and  de- 
livery of  the  certificate. 8  The  usual  procedure  is  for  the  pledger 
to  give  his  note  for  the  amount  secured,  the  note  reciting  the 
pledge  of  stock  and  the  terms  under  which  it  is  held.  These 
terms  usually  empower  the  pledgee  to  sell  the  collateral  without 
notice  to  the  pledger.  The  delivery  of  the  stock  as  security  is, 
however,  the  essential  feature  constituting  the  pledge  without 
any  written  contract, »  which  is  necessary  only  as  a  record  and 
proof  of  the  transaction. 

The  pledgee  may  or  may  not,  at  his  option,  have  the  pledged 
stock  transferred  on  the  books  of  the  corporation  to  his  own 


•Christian  v.  Atlantic  &  N.  C.  R.  R.,  133  U.  S.  233  (1890);  Seymour  v.  Hendee,  S4  Fed. 
Rep.  563  (1893);  Atkinson  el  al.  v.  Foster,  134  111.  472  (1890). 

•  Masury  v.  Arkansas  National  Bank,  93  Fed.  Rep.  603,  607  (iSgg);.  Spreckelsv.  Nevada 
Bank,  iisCal.  373  (1896);  Brick  v.  Brick,  98  U.  S.  514  (1878).  /.  ,<i.vnii  nc  .mj  ow  .  oj  .nnj/i 


3o8  CORPORATE  LAW  [Bk.  I- 

name.i"  If  transferred,  the  word  "pledgee"  should  follow  the 
name  of  the  owner  on  the  new  certificates  of  stock  or  otherwise 
the  phrase  "as  collateral  security"  should  appear  on  the  certif- 
icates so  as  to  characterize  definitely  the  nature  of  the  pledgee's 
holding.  A  memorandum  of  the  facts  should  also  appear  in  the 
stock  ledger  against  the  entry  in  both  pledgee's  and  pledger's 
accounts.ii  Such  entries,  if  showing  clearly  the  nature  of  the 
transaction,  relieve  the  pledgee  of  any  corporate  liabilities  in- 
volved in  the  absolute  ownership  of  the  stock. 12  In  some  states 
the  pledgee  is  expressly  relieved  from  these  liabiUties  by  statute.^^ 
When  stock  is  transferred  on  the  books  of  the  company  to  the 
pledgee,  the  voting  right,  as  a  general  rule  and  in  the  absence  of 
any  agreement  to  the  contrary,  follows  the  stock.i*  In  some 
states,  however,  as  in  New  York,  the  owner  of  the  stock  may 
demand  and  receive  a  proxy  from  the  pledgee  upon  paying  any 
necessary  expenses.  In  other  states,  as  New  Jersey,  if  it  appears 
on  the  transfer  books  that  such  stock  has  been  transferred  only 
as  a  pledge,  the  owner  retains  the  right  to  vote  thereon.  Statutes 
protecting  the  voting  rights  of  pledgers  are  found  in  many  states. 
When  stock  is  pledged,  the  pledgee  is  entitled  to  receive  any 
dividends  declared  meanwhile,  and  if  the  stock  has  been  trans- 
ferred to  the  pledgee,  or  if  the  company  has  been  properly  notified 
that  the  stock  is  held  in  pledge,  they  must  be  paid  to  him.is  In 
the  absence  of  notice  or  transfer,  as  the  pledger  remains  the 
owner  of  record  of  the  pledged  stock,  dividends  are  properly  paid 
to  him,  and  the  pledger  and  pledgee  must  then  settle  the  owner- 
ship of  the  dividends  between  themselves.  On  the  termination 
of  the  pledge,  the  pledgee  must  account  for  any  dividends 
received  by  him. 


"  Day  V.  Holmes,  103  Mass.  306  (1869);  Fitchburg  Savings  Bank  v.  Torrey,  134  Mass. 
239  (1883);  Anderson  v.  Philadelphia  Warehouse  Co.,  ill  U.  S.  479  (1884). 

"  2  Cook  on  Corp.,  i  466. 

"  Pauly  V.  State  Loan  &  Trust  Co.,  165  U.  S.  606  (1897);  Tourtelot  v.  Stolteben,  loi  Fed, 
Rep.  362  (1900). 

'•  Barre  National  Bank  v.  Hingham  Manuf.  Co.,  127  Mass.  563  (1879);  Burgess  v.  Selig- 
man,  107  U.  S.  20  (1882). 

'«  Commonwealth  v.  Dalzell,  152  Pa.  St.  217  (1893);  Re  Argus  Printing  Co.,  i  N.  Dakota 
434  (1891);  s.  c,  12  L.  R.  A.  781,  and  note. 

"  Fairbanks  v.  Merchants  National  Bank,  132  111.  120  (1889);  Guarantee  Co.  v.  East 
Rome  Co.,  96  Ga.  511  (1895);  Nat.  Bank  v.  Equitable  Trust  Co.,  227  Fed.  526  (i9iS)-       .^Mtik 


Ch.  39]  TRANSFER  OF  STOCK  309 

§  363.    Rights  of  Pledgee  on  Default 

Upon  default  in  payment  of  the  amount  it  secures,  the 
pledgee  has  the  right  to  sell  pledged  stock.  If  the  note  or  other 
memorandum  of  the  pledge  contains  no  agreement  or  provision 
for  such  sale,  the  pledgee  must  give  the  pledger  due  notice  of 
his  intention  to  sell  the  stock,  and  thereupon  may  sell  the  stock 
at  public  sale  and  apply  the  proceeds  to  the  payment  of  his  debt. 
Notice  must  be  given  the  pledger  a  reasonable  time  before  the 
sale  and  such  notice  must  specify  the  time  and  place  of  sale, 
both  of  which  must  also  be  reasonable.  Two  days'  notice  has 
on  occasion  been  held  sufiicient,i6  and  four  days'  notice  when  the 
parties  lived  in  different  towns.i^ 

When  notice  of  time  and  place  is  waived  by  express  terms  of 
the  pledger's  agreement,  as  is  usually  the  case,  the  pledgee  may 
sell  at  any  time  after  default.  The  sale  must  be  by  public 
auction  unless  otherwise  agreed,  must  be  in  good  faith,  and  an 
endeavor  must  be  made  to  obtain  a  fair  price.  .  The  pledgee 
himself  may  not  bid  the  stock  in,  either  directly  or  indirectly. 
If  he  does,  the  pledger  may  have  the  sale  set  aside.  In  many  of 
the  states  the  whole  matter  of  the  pledge  of  stock  and  its  sale  is 
regulated  by  statute. 

At  any  time  before  sale  the  pledger  may  pay  the  debt  and 
all  interest  and  any  reasonable  expense  involved  in  the  pre- 
liminaries of  the  sale  and  claim  his  stock.  This  stock  need  not 
be  the  particular  shares  pledged  but  merely  an  equal  amount  of 
the  same  stock. 

§  364.    Restrictions  on  Transfers 

Every  stockholder  whose  stock  is  paid  for  in  full  is  entitled 
to  transfer  his  stock  freely.  Even  where  the  stockholders  have 
entered  into  a  contract  to  restrain  the  alienation  of  stock  or  have 
enacted  by-laws  for  the  same  purpose,  the  courts  have  usually 
set  the  restraining  provisions  aside  as  being  contrary  to  public 


"  Edwards  on  Bailments,  |  285. 

n  Guinzburg  v.  Downs  Co.,  i6s  Mass.  467  (1896). 


310  ^^'     CORPORATE  LAW  [Bk.  I- 

.  .  '■■■■■-'''  >~    ^■'■ 

policy. 18    Charter  provisions  restricting  the  transfer  of  stocks 

have,  however,  been  held  valid.i^ 

In  some  states  the  statutes  prescribe  specifically  that  stock 
subscribed  but  not  fully  paid  for  in  accordance  with  the  sub- 
scription agreement  is  not  transferable  save  with  the  consent  of 
the  corporation.  Elsewhere  charter  or  by-law  provisions  may  give 
the  corporation  the  right  to  refuse  to  register  transfers  of  unpaid 
stock.2o  In  the  absence  of  such  provision,  the  right  of  transfer 
is  absolute  and  may  be  enforced  against  the  corporation.21 

At  times  the  restriction  of  stock  transfers  becomes  desirable 
and  various  plans  have  been  attempted  to  effect  this  end.  The 
courts,  however,  defend  this  right  so  strictly  that  its  legal  waiver 
is  difficult.  Perhaps  the  most  successful  method,  when  all  the 
parties  are  in  agreement,  as  to  the  advisability  of  such  restraint 
is  to  form  a  voting  trust  for  a  certain  number  of  years.  All  the 
stock — or  all  the  stock  entering  into  the  agreement — is  placed 
in  the  hands  of  voting  trustees  appointed  under  the  terms  of  the 
voting  trust  agreement  and  is  held  by  them,  withdrawn  from 
sale,  for  the  period  of  the  trust.  Such  arrangements  are  effectual 
and  are  upheld  by  the  courts  in  most  states  if  they  do  not  extend 
for  an  unreasonable  period.22  In  some  states  they  are  expressly 
permitted  by  the  statutes  under  restrictions  as  to  the  term  of 
their  duration, 

'iri  ilU£h  fef i  if 

§  365.    Lien  of  Corporation 

At  common  law  a  corporation  has  no  lien  upon  its  shares  for 
debts  due  to  it  from  its  stockholders.  The  authority  for  any 
lien  which  the  corporation  may  have  must,  therefore,  be  found 
in  the  statutes,  its  charter,  or  its  by-laws.2s    Where  the  lien  is 

"Johnson  v.  Laflin,  103  U.  S.  800,  803  (1880);  Quiner  v.  Marblehead,  etc.,  Co.,  10  Mass. 
476  (1813);  Morris  V.  Hussong  Dyeing  Machine  Co.,  81  N.  J.  Eq.  256  (1913);  Steele  v.  Farmers', 
etc..  Telephone  Assn.,  148  Pac.  Kan.  661  (191S);  Kretzer  v.  Cole  Bros.,  etc.,  Co.,  181  S.  W. 
Mo.    1066  (1916). 

"  Longyear  v.  Hardman,  219  Mass.  405  (1914). 

'»  Barrett  v.  King,  181  Mass.  476  (1902). 

•1  Craig  V.  Hespeira  L.  &  W.  Co.,  113  Cal.  7  (1896);  Kinnan  v.  Sullivan  County  Club, 
26  App.  Div.  (N.  Y.)  213  (1898). 

»  See  Ch.  LVI,  "Voting  Trusts";  also  Brown  v.  Britton,  41  App.  Div.  (N.  Y.)  57  {1899); 
Williams  v.  Montgomery,  148  N.  Y.  519  (1896);  Hey  v.  Dolphin,  92  Hun  (N.  Y.)   230  (1895). 

M  a  Ccx)k  on  Corp.,  {  522;  DriscoU  v.  West  B.  &  C.  M.  Co.,  S9  N  Y.  06  (1874). 


Ch.  39]  TRANSFER  OF  STOCK  311 

given  by  statute  or  charter,  the  lien  is  enforcible  against  the 
stock  into  whosoever  hands  it  may  come  irrespective  of  whether 
the  assignee  has  any  actual  knowledge  of  the  statute  or  charter 
provision.2<  Where  an  attempt  has  been  made  to  create  a  lien 
by  provision  in  the  by-laws,  it  has  generally  been  held  that  the 
stock  is  not  bound  in  the  hands  of  an  assignee  who  took  without 
notice,  25  actual  or  constructive,  of  the  lien  provision. 

In  New  York,  Massachusetts,  Pennsylvania,  New  Jersey, 
and  the  other  states  which  have  adopted  the  law  regulating  the 
transfer  of  stock,  known  as  the  "Uniform  Stock  Transfer  Act," 
there  can  be  no  lien  or  restriction  upon  the  transfer  of  shares  by 
virtue  of  a  by-law  or  otherwise,  unless  the  right  of  the  corporation 
to  such  lien  or  restriction  is  stated  on  the  certificate  of  stock;; i,t>j 


^  Curtice  v.  Bank,  no  Fed.  830  (1901);  United,  etc.,  Co.  v.  Winston,  etc.,  Co.,  104  Fed. 
947  (1912). 

"  DriscoU  V.  West  B.  &  C.  M.  Co..  S9  N.  Y.  96  (1874);  Bankers'  Trust  Co.  v.  McCloy. 
ISO  S.  W.  (Ark.)  205  (1913). 


>l.oodi3i^c»qi<x).  fjfii  ii 


0..  'i.n 

Y--'*      ■■■■'■■- 

i 

■'      '  ' ■    V!  ^i  eaol  10  ily.dJ 


.(Viiiiil  w!>  'C'    i 


CHAPTER  XL 

TRANSFERS  OF  STOCK— RULES 

§  366.    Responsibility  pf  Corporation  as  to  Transfers  .ji 

It  is  the  duty  of  the  corporation  to  record  all  lawful  trans- 
fers; and  if  it  refuses,  the  record  may  be  compelled  by  recourse 
to  the  courts,!  or  the  corporation  may  be  held  liable  in  damages.2 
If  there  is  doubt  as  to  the  identity  of  the  transferee  or  the 
authenticity  of  the  transferrer's  signature,  the  corporation  may 
require  proper  proof  thereof,  and  in  cases  where  two  parties 
claim  the  ownership  of  stock  or  where  the  corporation  has  been 
notified  not  to  register  a  transfer,  the  corporation  may,  if  there 
is  any  real  uncertainty  or  reason  therefor,  decline  to  make  any 
record  on  the  corporate  books  until  the  matter  has  been  settled 
by  the  courts.^ 

The  corporation  is  responsible  if  its  officials  record  a  forged 
transfer.*  It  is  the  duty  of  the  corporate  officials  to  know  the 
stockholders'  signatures,  or  otherwise  to  secure  evidence  of  their 
authenticity  before  making  a  transfer.  For  this  purpose  they 
may  require  the  personal  attendance  of  the  transferrer  or  clear 
proof  that  his  signature  is  genuine. 

In  case  stock  certificates  indorsed  in  blank  are  lost  or  stolen, 
the  corporation  is  not  liable  for  receiving  the  certificates  and 
transferring  the  stock  represented  thereby,  if  the  circumstances 
are  not  suspicious  and  the  transfer  is  made  before  notice  of  the 
theft  or  loss  is  received  by  the  corporation,  s 


iReal  Estate  Trust  Co.  v.  Bird,  90  Md.  229  (1899  ;  Rice  v.  Rockefeller  et  al.,  134  N.  Y. 
174  (1892). 

'  Hine  v.  Commercial  Bank  of  Bay  City,  119  Mich.  448  (1899);  Ralston  v.  Bank  of  Cali- 
fornia, 112  Cal.  208  (1896);  Commercial  Bank,  etc.  v.  Kortright,  22  Wend  (N.  Y.)  348 
(1839). 

»  Tel.  Co.  V.  Davenport,  97  U.  S.  369  (1878);  Athol  Savings  Bank  v.  Bennett,  203  Mass. 
480  (1909);  Amparo  Mining  Co.  v.  Fidelity  Trust  Co.,  75  N.  J.  Eq.  555,  559  (1909)- 

*  Cushman  v.  Thayer,  etc.,  Co.,  76  N.  Y.  365  (1879);  Chicago  Edison  Co.  v.  Fay,  164  111. 
323  (1896). 

'  Mandelbaiun  v.  North  American  Mining  Co.,  4  Mich.  464  (1857);  Dewing  v.  Perdicaries, 
96  U.S.  193  (1877). 

312 


Ch.  4o]  TRANSFER  OF  STOCK— RULES  313 

§  367.    Duties  of  Officers  as  to  Transfers 

The  officers  of  the  company  are  the  custodians  of  its  stock- 
books,  and  it  is  their  duty  to  see  that  all  transfers  of  shares  are 
properly  made,  either  by  the  stockholders  themselves  or  persons 
having  authority  from  them.  If,  upon  the  presentation  of  a  cer- 
tificate for  transfer,  they  are  at  all  doubtful  of  the  identity  of  the 
party  offering  it  with  its  owner,  or  if  not  satisfied  of  the  genuineness 
of  a  power  of  attorney  produced,  they  can  require  the  identity  of 
the  party  in  the  one  case,  and  the  genuineness  of  the  documents  in 
the  other,  to  be  satisfactorily  established  before  allowing  the 
transfer  to  be  made.  In  either  case  they  must  act  upon  their  own 
responsibility.* 

The  record  of  any  proper  transfer,  if  refused,  may  be  com- 
pelled by  either  transferrer  or  transferee. 

§  368.    Who  May  Transfer  Stock 

Any  person  of  full  age  who  has  not  been  adjudged  incompe- 
tent, may  transfer  stock  standing  in  his  own  name.  All  who 
are  duly  authorized  to  represent  others,  as  attorneys,  trustees, 
guardians,  executors,  and  administrators,  may  transfer  stock 
belonging  to  these  others  upon  giving  satisfactory  evidence  of 
their  authority  so  to  do.  Stock  belonging  to  minors  and  others 
incompetent  to  contract  may  be  transferred  only  by  their  legally 
appointed  and  authorized  representatives. 

The  holder  of  unpaid  stock,  i.e.,  stock  upon  which  the  sub- 
scription or  purchase  price  has  not  been  fully  paid,  may  as  a 
rule  transfer  his  stock  without  restriction,  but  in  some  states 
by  statute  provision  such  transfer  is  prohibited  or  may  be  made 
only  by  consent  of  the  corporation. 

-■i;l 

§  369.    To  Whom  Stock  May  Be  Transferred  r 

There  are  but  few  restrictions  as  to  the  transferees  of  stock. 
A  corporation  may,  if  its  officials  see  fit,  refuse  to  transfer  stock 
to  anyone  not  competent  to  assume  the  obligations  of  a  stock- 
holder, such  as  a  minor  or  a  person  of  unsound  mind.    Also  a 

•  Tel.  Co.  V.  Davenport,  97  U.  S.  369  (1878). 


cgi4  "'■  CORPORATE  LAW  [Bk.  I^ 

corporation  when  in  a  failing  condition  may  refuse  to  transfer 
stock  to  an  irresponsible  transferee.  ^  Beyond  these  few  excep- 
tions, stock  may  be  transferred  freely  and  in  the  absence  of 
fraud  the  transfer  is  valid  and  must  be  recorded  by  the  cor- 
poration. 

§  370.    Liability  Involved  in  Transfers 

The  liability  of  unpaid  stock  is  enforced  in  every  state. 
Full-paid  stock,  on  the  other  hand,  involves  no  liability  to  the 
corporation  or  its  creditors  whatsoever,  save  in  the  case  of 
financial  institutions — on  the  stock  of  which  a  further  liability 
is  usually  imposed — and  in  those  states  in  which  by  express 
statutory  provision  liabilities  are  imposed  or  assessments  are 
permitted  on  stock  even  though  full-paid. 

In  those  few  states  where  liabilities  do  or  may  exist  on  full- 
paid  stock,  and  transfers  of  such  stock  are  made  between  parties 
competent  to  contract,  any  liabilities  accruing  before  the  trans- 
fer remain  with  the  transferrer,  but  any  liabilities  accruing 
thereafter  pass  to  the  transferee. 

The  liabilities  of  unpaid  stock  are  affected  by  statute  pro- 
visions in  a  number  of  states,  but  otherwise  are  subject  to  the 
general  rules  that  the  transferrer  is  liable  for  any  calls  or  assess- 
ments already  made  and  which  are  still  unpaid, »  but  the  trans- 
feree is  liable  for  the  amount  that  has  not  yet  been  called. 
••'  ^-'An  exception  to  this  general  rule  obtains  when  a  transfer 
has  been  made  but  has  not  been  recorded  on  the  books  of  the 
corporation.  In  such  case  the  transferrer  is  still  the  owner  of 
record  and  is  therefore  still  liable  for  any  amounts  unpaid  on 
his  transferred  stock  and,  if  calls  are  made  before  the  transfer 
is  recorded,  must  pay  them.  He  may  collect  these  payments, 
if  he  can,  from  the  transferee. 

Another  exception  to  the  general  rule  is  found  when  the 
corporation   has   wrongfully  issued   stock   certificates  marked 


'  2  Cook  on  Corp.,  $S  395.  396. 

*  May  V.  McQuillan,  i2g  Mich.  392  (1902);  Sigua  Iron  Co.  v.  Brown,  171  N.  Y.  488  (1902). 


Ch.  40]  TRANSFER  OF  STOCK— RXJLES  315 

"Full-paid,"  in  which  case  any  bona  fide  purchaser  of  such  cer- 
tificates without  knowledge  of  the  true  character  of  the  stock 
takes  it  free  from  liability  to  the  corporation  and  to  corporate 
creditors  in  case  the  corporation  becomes  insolvent. »  This  is 
also  true  when  a  purchaser  in  good  faith  takes  over  stock  under 
such  circumstances  as  to  lead  him  to  believe  it  is  full-paid.  In 
any  such  case,  so  far  as  the  transferee  is  concerned,  the  stock  is 
held  to  be  full-paid  and  the  corpora tioDj^oir.it^. creditors  cannot 
hold  him  liable.  ';f:h:H  {.n'ti— r  • 

§  371.    Specific  Transfer  Liabilities 

In  the  following  cases  the  rule  as  to  the  liabilities  involved 
in  transfers  of  stock  is  as  set  forth. 

A  married  woman  may  take  stock  in  her  own  name,  in 
practically  every  state  of  the  Union,  and  tajf.j^.,tl)^r£w^th,^yei;y,, 
right  and  responsibility  of  ownership.io      i^f-inti-  r.  V  r-r-frlUi;;?.? 

A  minor  may  receive  a  transfer  of  stock  and  the  corporation 
may  record  it  if  the  corporate  officials  see  fit,  but  as  the  minor 
may  at  will  repudiate  the  whole  transaction,  the  transferrer, 
remains  liable.ii    The  same  rule  holds  as  to  a  transfer  to  a  per-*  • 
son  known  to  be  insolvent,  the  transferrer  not  being  relieved; 
from  liability.i2 

A  transfer  to  an  agent,  attorney,  trustee,  guardian,  adminis-  • 
trator,  or  executor  in  his  own  name,  followed  by  a  statement 
of  the  capacity  in  which  he  acts,  as  "James  H.  McLane,  Agent," 
renders  him  personally  liable  on  the  stock  so  held,i3  except- 
where  expressly  exempted  by  statute. 1*  The  same  is  true  where 
a  transfer  is  made  to  the  treasurer  of  a  corporation  in  his  own 
name,  as  "Henry  James,  Treasurer. "is 

•  Rochestier,  etc.,  Co.  v.  Roe,  7  App.  Div.  (N.  Y.)  366  (1896);  Sprague  v.  National  Bank, 
172  111.  I4J)  (1898);  42  L.  R.  A.  606. 

"•  I  Cook  on  Corp.,  {}  250,  396. 

"  Foster  v.  Chas,  75  Fed.  Rep.  797  (1896);  Foster  v.  Wilson,  75  Fed.  Rep.  797  {1896). 

"  Bowden  v.  Johnson,  107  U.  S.  251  (1882);  Rochester,  etc.,  Co.  v.  Raymond,  158  N.  Y. 
576  (1809). 

"  Wads  worth  v.  Laurie,  164  111.  42  (1896);  Winston  v.  Dorset  Pipe,  etc.,  Co.,  129  111. 
64  (i88q). 

'*  Davis  V.  Essex  Baptist  Society,  44  Conn.  582  (1877);  Lucas  v.  Coe,  86  Fed.  Rep.  97a 
<i898)-  uH  Uj.^i!£''    ■v.    !     .  ■ 

■•  2  Cook  on  Corp.,  {  724,  and  notes.  .(?CHJ)  dot)  .d  ,' ' 


jid  CORPORATE  LAW  (Bk.  I- 

A  transfer  to  two  persons,  as  "George  Howard  and  John 
Mackel,"  makes  them  tenants  in  common  and  each  may  be  held 
for  one-half  of  any  liability  on  such  stock  and  both  must  join 
in  a  transfer.16  A  transfer  to  a  firm,  however,  as  "Howard  & 
Mackel,"  does  not  have  this  effect  but  creates  a  partnership 
holding  and  a  partnership  liability," 

A  transfer  to  an  existing  corporation  authorized  to  hold 
stock,  as  "The  Strathmore  Scale  Company,"  renders  the  as- 
signee corporation  liable  as  is  an  individual  on  the  stock  trans- 
ferred. A  transfer  to  a  membership  corporation  or  unorganized 
association,  as  "Grace  Methodist  Church"  or  the  "Brooklyn 
Decorators'  Union,"  is  of  doubtful  legality,  and,  if  the  matter 
of  liability  is  of  importance,  should  not  be  recorded  by  the 
corporation  until  the  right  of  the  body  to  hold  stock  has  been 
proved.  If  not  authorized  to  hold  stock,  it  cannot  assume  the 
liabilities  of  a  stockholder.  ■ 

A  transfer  to  a  dummy  stockholder,  as  in  case  of  transfer 
to  any  other  agent,  renders  the  dummy  liable  if  he  has  property 
sufficient  to  make  the  liability  effectively  The  party  for  whom 
the  dummy  is  acting  is,  however,  likewise  liable  as  an  undisclosed 
principal.! 9  A  transfer  to  a  pledgee  in  his  own  name  without 
qualification  renders  him  liable.  It  is  otherwise,  however,  if 
the  nature  of  the  transfer  is  shown  by  its  form,  as  "Howard 
Fielding,  Pledgee. "20 

§  372.    Form  of  Transfer 

A  general  form  of  assignment  for  stock  is  always  printed  or 
engraved  upon  the  back  of  each  stock  certificate.  If  there  were 
any  reason  therefor,  stock  might  with  equal  effect  be  transferred 
by  means  of  a  separate  assignment  written  or  printed  and 


«  Markell  v.  Ray,  75  Minn.  138  (1898). 

"  Barton  National  Bank  el  al.  v.  Atkins  et  al.,  72  Vt.  33  (1899) . 
"  Dunn  V.  Howe,  107  Fed.  Rep.  849  (1901). 

'»  Pauly  V.  State,  etc.,  Co.,  16^  U.  S.  606  (1897);  Davis  v.  Stevens,  7  Fed.  Gas.  177  (1879). 
™  Robinson  v.  Siouthem  National  Bank,  180  U.  S.  295  (1901);  Pauly  v.  State  Loan  & 
Trust  Co.,  i6s  U.  S.  606  (1897). 


Ch.  4o]  TRANSFER  OF  STOCK— RULES  317 

attached  to  its  certificate.  In  sticn  case  tne  certificate  should 
be  more  fully  described  and  identified  than  is  the  case  in  the 
usual  form  of  assignment. 

The  signature  to  the  assignment  of  a  stock  certificate  must 
correspond  exactly  with  the  name  on  the  face  of  the  certificate, 
and  should  be  witnessed.  If  the  signature  of  the  transferrer  is 
entirely  unknown  to  the  transfer  officer  or  agent,  it  should  be 
guaranteed  by  some  responsible  party  or  be  acknowledged  before 
a  notary  public. 

If  the  party  signing  a  transfer  of  stock  acts  in  a  representa- 
tive capacity,  a  description  of  the  capacity  in  which  he  signs 
should  be  added  to  the  signature,  as  "Howard  Fielding,  Trustee 
for  Jane  Hathaway."  If  a  certificate,  issued  in  her  maiden 
name,  is  to  be  transferred  by  a  married  woman,  the  signature 
should  be  in  the  following  form:  "(Mrs.)  Alice  H.  Walker, 
formerly  Alice  H.  Ainsley."  Occasionally  a  married  woman 
holding  stock  in  her  maiden  name  wishes  it  transferred  to  the 
name  acquired  by  marriage.  In  such  case  the  signature  to  the 
assignment  is  similar  to  that  just  given  and  the  blank  for  the 
name  of  the  transferee  is  filled  in  as  follows:  "(Mrs.)  Alice  H. 
Walker."  '  •  ^ ''"' 

The  name  of  the  transferee  should  be  written  in  the  proper 
blank  of  the  assignment  form  without  abbreviation,  complimen- 
tary title,  or  suffix,  though  where  the  transferee  is  a  woman, 
the  designation  "(Miss)"  or  "(Mrs.),"  as  the  case  may  be,  is 
frequently  and  properly  placed  before  the  name. 

When  a  transfer  of  stock  is  to  be  received  by  an  agent,  it 
should  be  made  out  in  the  name  of  his  principal,  unless  the 
agent  is  willing  to  assume  any  statutory  liability  on  the  stock 
transferred.  When  stock  is  transferred  by  an  agent  or  one  act- 
ing for  another,  the  name  of  the  principal  should  be  appended 
to  the  assignment  followed  by  the  agent's  name  and  a  statement 
of  the  capacity  in  which  he  signs;  thus,  "Frank  H.  McClelland 
by  Howard  James,  Attorney."  in«T« 


.3,18  CORPORATE  LAW  [Bk.  I-- 

§  373*    Transfers  to  and  by  Agents 

Any  person  competent  to  contract  and  wishing  to  transfer 
stock,  may  transfer  stock  or  receive  the  transfer  of  stock  through 
an  agent.  In  case  of  transfer,  the  agent  or  attorney  in  fact 
should  present  the  certificate  to  be  transferred,  accompanied  by 
his  power  of  attorney  or  a  duly  acknowledged  copy  thereof, 
which  should  be  left  on  file  with  the  transfer  agent  or  officer  of 
the  corporation.  Express  authority  to  transfer  stock  should  be 
given  by  the  power  of  attorney  and,  if  necessary,  evidence 
should  be  furnished  that  the  signature  to  the  power  is  genuine, 
that  the  instrument  is  still  in  force,  and  that  the  party  present- 
ing it  is  the  party  named  therein.21 

In  case  of  transfer  by  an  agent,  it  is  the  duty  of  the  corpora- 
tion to  require  satisfactory  evidence  of  the  agent's  authority. 
Otherwise  in  case  of  a  fraudulent  transfer  the  corporation  is 
liable.22  The  corporation  is  also  liable  if,  with  knowledge  of  the 
facts,  it  recognizes  a  power  of  attorney  executed  by  a  minor, 
an  insane  person,  or  anyone  else  unable  to  contract.23 

In  case  of  transfers  of  stock  to  an  agent,  the  certificates,  as 
stated,  should  be  issued  in  the  principal's  name,  the  agent 
merely  receiving  the  certificates  and  receipting  therefor  for 
account  of  his  principal. 

If  a  certificate  is  indorsed  in  blank  and  entrusted  to  an 
agent,  and  the  agent  assigns  the  stock  fraudulently,  the  stock- 
holder has  no  recourse  save  against  the  agent,  as  his  own  act 
made  it  possible  for  his  agent  to  perpetrate  the  fraud. 2*  The 
rule  is  different,  however,  if  the  agent  transfers  the  stock 
directly  into  his  own  name.  In  such  case,  if  the  corporation 
knew  of  the  agency,  it  is  liable,25  and  the  original  owner  will 
not  be  estopped  from  reclaiming  the  stock. 
'• .".  ■>»'.  •  ■  ■  . 

"  Tel.  Co.  V.  Davenport,  97  U.  S.  369  (1878);  Bayard  v.  Farmers',  etc..  Bank,  52  Pa.  St. 
232  (1866). 

»  Tafft  V.  Presidio,  etc.,  R.  R.  Co.,  84  Gal.  131  (1890);  Tel.  Co.  v.  Davenport,  97  U.  S.  369 
(1878). 

2»  Chew  &  Goldsborough  v.  Bank  Oi  Baltimore,  14  Md.  209  (1859). 

"  P.  R.  R.  Co.'s  Appeal,  86  Pa.  St.  80  (1878);  Elliott  v.  Miller  &  Co.,  158  Fed.    68  (1908). 

"  Tafft  V.  Presidio,  etc.,  R.  R.  Co..  84  Cal.  131  (1890). 


Ch.  4o]  TRANSFER  OF  STOCK— RULES  319 

§  374.    Transfers  to  and  by  Executors  and  Administrators    T£  ■■: 

Before  a  transfer  of  stock  by  an  executor  or  administrator 
is  allowed,  a  certified  copy  of  the  appointment  of  the  party  act- 
ing should  be  filed  with  the  corporation  or  transfer  agent.  Or 
in  case  there  is  a  will,  a  certified  copy  of  this  instrument  should 
be  presented  for  inspection  or  filed  with  the  secretaryze  for  the 
reason  that  it  has  been  repeatedly  held  that  corporations  are 
chargeable  with  notice  of  the  contents  of  the  will.27  Such 
executor  or  administrator  may  transfer  the  stock  directly  from 
the  deceased  party  to  a  purchaser,  or  may  transfer  the  stock 
to  his  own  name  as  administrator  or  executor,28  or  may  pledge 
the  stock  if  this  be  necessary.  The  corporation  should  not, 
however,  permit  him  to  transfer  the  stock  to  his  individual 
name.29  When  there  are  two  or  more  executors  of  an  estate, 
one  alone  may  not  transfer  stock;   all  must  join.^o 

Corporate  officials  recording  transfers  of  executors  or  ad- 
ministrators with  knowledge  that  a  fraud  or  breach  of  official 
duty  is  involved  therein,  are  liable  to  the  estate.  An  adminis- 
trator or  executor  cannot  compel  the  transfer  of  stock  belong- 
ing to  the  estate  when  the  corporation  is  domiciled  in  another 
state.  A  purchaser  of  stock  from  such  an  administrator  or 
executor  can,  however,  compel  the  corporation  to  recognize  his 
right  of  property  in  the  purchased  stock  and  to  issue  to  him 
new  certificates. 

When  a  trust  discharged  by  an  executor  continues  for  a  long 
period,  the  executor  becomes  in  fact  a  trustee  and  his  transfers 
then  become  subject  to  the  rules  governing  trustees."  The 
corporation  must  then  refuse  the  transfer  of  stock  unless  the 
executor  brings  satisfactory  evidence  of  his  right  to  make  such 
transfer. 


"  See  2  Wills,  Estates  and  Trusts  by  T.  Conyngton  et  al.,  pp.  S39.  S40. 

"  Wooten  V.  Railroad,  128  N.  C.  119  (1901);  Marbiiry,  Trustee  v.  Ehlen,  72  Md.  206 
(1890). 

» London,  Paris  &  Am.  Bank  v.  Aronstein,  117  Fed.  Rep.  601  (1902). 

"  I  Cook  on  Corp.t  5  3*9;  London,  Paris  &  Am.  Bank  v.  Aronstein,  117  Fed.  Rep.  601 
(1902);  Chester  Co.,  etc.,  Co.  v.  Securities  Co.,  165  App.  Div.  (N.  YJ  329  (1914)- 

"Bohlen's  Estate.  75  Pa.  St.  304  (1874);  Tunis  v.  Pass.  R.  R.  Co.,  149  Pa.  St.  70  (1892); 
10  Cyc,  p.  594. 

«i  Peck  V.  Bank,  16  R.  L  710  (1890);  2  Cook  on  Corp-.  I  398. 


320  CORPORATE  LAW        .  [Bk.  I- 

§  375*    Transfers  to  and  by  Trustees 

The  corporate  officials  must  refuse  the  transfers  of  a  trustee 
unless  his  authority  is  clearly  established.  His  appointment 
must  be  in  writing  and  expressly  authorize  the  sale  or  transfer 
of  stock.  If  such  instrument  exists  in  due  form,  duly  certified, 
the  trustee  may  compel  transfers  by  the  corporation  when  the 
certificates  of  stock  are  duly  assigned  by  him  in  his  representative 
capacity.  32 

The  corporation  is  responsible  if  it  permits  any  transfer  by 
a  trustee  not  authorized  by  the  trust  instrument.ss  If  there  is 
more  than  one  trustee,  all  must  sign  the  transfer. S4  Trustees 
appointed  by  court  should  show  a  copy  of  the  court  appointment. 

Before  stock  is  purchased  from  a  trustee — ^provided  the  cer- 
tificates of  stock  indicate  that  he  is  a  trustee — the  purchaser 
should  ascertain  whether  the  trustee  is  authorized  to  make  the 
sale.35  "A  certificate  for  shares  of  stock  running  to  *A.  B., 
'Trustee,'  or  to  'A.  B.  in  trust,'  without  disclosing  the  names 
of  the  beneficiaries  or  the  particulars  of  the  trust,  is  notice  to 
a  purchaser  of  shares  that  'A.  B.'  does  not  hold  them  in  his  own 
right,  but  as  a  trustee. "ss 

When  transfers  are  made  to  a  trustee,  his  representative 
capacity  should  be  clearly  indicated  by  reference  in  the  certifi- 
cate to  the  will  or  other  instrument  under  which  the  trusteeship 
was  created,"  and  the  name  of  the  beneficiary  should  be  men- 
tioned when  possible;  thus,  "John  Hayden,  Trustee  for  Howard 
-Waller  under  the  will  of  Horace  Waller." 

§  376.    Transfers  to  and  by  Minors 

A  corporation  may  refuse  to  transfer  stock  to  a  minor  as  he 
is  incapable  of  assuming  the  obligations  of  a  stockholder.ss 

•^  Bird  V.  Chicago,  etc.,  R.  R.,  137  Mass.  428  (1884). 

''  Marbury,  Trustee,  v.  Ehlen  el  al.,  72  Md.  206  ("1890);  Geyser-Marion  Gold-Min.  Co.  v. 
Stark,  106  Fed.  Rep.  558  (1901). 

"  Bohlen's  Estate,  75  Pa.  St.  304,  312  (1874);  Oliver  v.  Governor  &  Co.,  86  L.  T.  Rep.  248 
(1902). 

3*  First  National  Bank  v.  National  Broadway  Bank,  156  N.  Y.  459  (1898);  Shaw  v. 
Spencer  ei  al.,  100  Mass.  382  (1868). 

^  Gerard  v.  McCormick,  130  N.  Y.  261  (1891). 

"  Geyser-Marion  Gold-Min.  Co.  v.  Stark,  106  Fed.  Rep.  558  (1901). 

'^  2  Cook  on  Corp.,  }  3()6. 


Ch.  4o]  TRANSFER  OF  STOCK— RULES  321 

In  case  such  a  transfer  is  made,  the  liability  of  the  transferrer 
as  a  stockholder  of  the  corporation  continues  until  the  minor 
becomes  of  age  and  ratifies  the  transfer.39  Minors  may  receive 
and  hold  stock  in  their  own  names  but  cannot  transfer  stock 
so  held.  Assignments  should  therefore  be  made  to  their  guar- 
dians in  the  following  form:  "Alfred  Carr  (minor)  under  guar- 
dianship of  Henry  B.  Boerum." 

A  minor  is  himself  unable  to  make  a  legal  transfer  of  stock 
even  though  the  stock  is  held  in  his  name,  and  the  corporation 
renders  itself  liable  for  any  resulting  damages  if  it  records  such 
transfer.  The  only  legal  method  of  transferring  a  minor's  stock 
is  therefore  by  assignment  executed  by  a  duly  appointed  guar- 
dian. <<> 

§  377«    Transfers  to  and  by  Guardians 

Certificates  for  stock  owned  by  minors  or  other  persons  not 
competent  to  contract  should  properly  be  issued  in  the  name 
of  the  trustee  or  guardian  of  such  person.  In  most  states  parties 
not  competent  to  contract  cannot  transfer  stock,  and  therefore 
all  transfers  of  stock  belonging  to  such  persons  must  be  made 
by  their  legally  appointed  trustees  or  guardians. 

Usually  the  statutes  require  the  guardian  of  a  minor  to  be 
specially  authorized  by  order  of  a  proper  court  before  he  may 
sell  stock  belonging  to  his  ward,  and  the  corporation  cannot 
safely  record  a  transfer  of  a  minor's  stock  though  made  by  his 
guardian  until  it  ascertains  the  existence  of  such  authority." 
The  guardian  should  therefore  secure  proper  authority  and  file 
a  certified  copy  thereof  with  the  secretary  of  the  corporation 
before  or  at  the  time  the  transfer  is  made. 

When  no  statutes  regulate  the  sale  of  stock  by  guardians,  a 
guardian  may  freely  transfer  stock  without  any  special  court 
authorization,^  though  in  this  case  it  is  safer  for  him  to  obtain 

"  Foster  v.  Wilson  et  al.,  75  Fed.  Rep.  797  (1896). 

«' Smith  V.  Baker,  42  Hun  (N.  Y.)  504  (1886);  White  v.  New  Bedford,  etc.,  Corp.,  178 
Mass.  20  (1901). 

"  Atkinson  v.  Atkinson,' 90  Mass.  is  (1864);  O'Herron  v.  Gray,  168  Mass.  573  (1897). 
o  Lamar  V.  Micou,  112  U.  S.  452  (1884).  '-     -     ■      •    '    •■ 


322  CORPORATE  LAW  [Bk.  I- 

authority  from  the  court  as  a  measure  of  self-prqtj^ption.     A 
guardian  has  no  authority  to  pledge  stock. «      ,  >h|orf>J  - 

§  378.    Transfers  to  and  by  Corporations 

Under  the  common  law,  one  corporation  cannot  hold  stock 
in  another."  In  a  number  of  states,  however,  corporations  are 
by  statute  expressly  authorized  to  hold  stock  of  other  corpora- 
tions, or  may  be  so  authorized  by  inclusion  of  the  power  in  their 
charters.  Even  where  this  is  not  the  case,  the  general  rule  has 
been  relaxed,  and  it  may  now  be  said  in  general  that  a  corpora- 
tion may  become  a  stockholder  in  another  corporation  wherever 
the  stock  is  acquired  in  pursuance  of  a  legitimate  purpose  of 
its  creation.^5  Hence  an  investment  company,  an  insurance 
company,  a  trust  company,  and  others  of  similar  character, 
may  properly  invest  in  and  hold  the  stock  of  other  corporations. 
Also  corporations  may  acquire  stock  by  foreclosure  proceedings 
or  may  take  it  in  order  to  escape  loss,  as  for  instance,  in  settle- 
ment of  a  debt.^6  Also  corporations  are  not  uncommon  in  the 
present  day,  which  are  expressly  authorized  to  hold  stock  in 
other  corporations  and  have  been  organized  for  this  purpose. ■'^ 

In  all  cases  where  the  corporation  properly  holds  stock,  it 
has  all  the  rights  of  a  stockholder  as  to  such  stock,  including  the 
right  to  receive  dividends  and  to  have  its  representatives  vote 
and,  when  duly  elected,  act  as  directors  or  officers  of  the  cor- 
poration by  which  the  stock  was  issued.^s 

As  a  rule  a  corporation  may  buy  its  own  stock  with  its  sur- 
plus profits,  if  not  prohibited  by  statute  and  if  all  its  stock- 
holders acquiesce.^9  It  may  not,  however,,  do  so  except  from 
surplus  profits — unless  expressly  authorized  thereto  by  statute — 

"  O'Herron  v.  Gray,  168  Mass.  573  (1897). 

**  People  V.  Chicago  Gas  Trust  Co.,  130  111.  268  (1889);  De  La  Vergne  Co.  v.  German 
Savings  Inst.,  175  U.  S.  40  (1899). 

<5  Booth  V.  Robinson,  55  Md.  419  (1880) ;  Layng  v.  A.  French  Spring  Co.,  149  Pa.  St. 
308  (1892). 

*»  Robotham  v.- Prudential  Ins.  Co.,  S3  Atl.  Rep.  (N.  J.)  842  (1903). 

"  See  Ch.  LVII,  "Holding  Companies." 

**  Camden,  etc.,  R.  R.  Co.  v.  Elkins,  37  N.  J.  Eq.  273  (1883);  Rogers  v.  Nashville,  etc., 
Ry.  Co.,  91  Fed.  Rep.  299  (1898);  Windmuller  v.  Standard  Distilling,  etc.,  Co.,  114  Fed.  Rep. 
491  (1902);  Oelbermann  v.  New  York,  etc.,  R.  Co-,  77  Hun  332  (1894). 

«'  See  I  Cook  on  Corp.,  5  311;  Lowe  v.  Pioneer  Threshing  Co.,  70  Fed.  Rep.  646  (189s). 


Ch.  40]  TRANSFER  OF  STOCK— RULES  323 

■r    ..TtMl-l-.-l      F,' 

since  such  procedure  impairs  and  practically  amounts  to  an 
illegal  reduction  of  its  capital  stock. so 

Transfers  of  stock  held  by  associations,  societies,  or  cor- 
porations must  be  made  under  the  corporate  seal  by  the  duly 
authorized  officers,  and  must  be  accompanied  by  a  properly 
certified  copy  of  the  resolution  or  by-law  authorizing  the  trans- 
fer. The  certificate  of  authority  should  include  a  designation 
and  statement  of  the  due  election  of  the  officers  who  are  to  act. 
Occasionally  transfer  agents  or  officers  require  an  exemplified 
copy  of  the  minutes  or  by-laws  of  the  organization  before  they 
will  register  such  a  transfer. 

When  stock  is  acquired  by  an  association  or  society  not 
incorporated,  it  is  usually  placed  in  the  hands  of  trustees.    ., 

§  379.    When  Stock  of  Another  Corporation  Is  Acquired    '^ 

When  stock  of  another  corporation  is  acquired  by  a  cor- 
poration authorized  to  hold  such  stock,  the  assignment  may 
run  direct  to  the  corporation  or  to  its  treasurer  or  to  a  trustee 
for  the  corporation,  though  if  the  stock  actually  and  unreservedly 
belongs  to  the  corporation,  there  is  no  reason  why  it  should  not 
be  held  in  the  corporate  name.  The  certificates  for  such  stock, 
assigned  in  blank  or  assigned  direct  to  the  corporation — or  the 
treasurer  or  a  trustee  if  desired — are  turned  over  to  the  treas- 
urer or  other  designated  officer  of  the  transferee  corporation, 
who  presents  the  certificates  for  reissue,  the  new  certificates 
being  taken  in  the  name  of  the  transferee  as  indicated  by  the 

completed  assignments  on  the  back  of  the  certificates. 

i 

§  380.    When  Stock  of  Another  Corporation  Is  Sold 

When  stock  of  another  corporation  is  held  in  the  corporate 
name  and  is  to  be  transferred,  the  corporate  signature  is  affixed 
to  the  assignment  by  the  duly  authorized  officer  or  officers  of 
the  assigning  corporation.  The  corporation  which  issued  the 
stock,  before  registering  the  transfer  on  its  books,  may  and 

'•  McGill  V.  Underwood,  161  App.  Div.  (N.  Y.)  30,  32  (1914). 


324  CORPORATE  LAW  [Bk.  I- 

should  require  proper  evidence  that  these  officers  were  properly 
empowered  to  affix  the  corporate  signature.  This  proof  is  best 
supplied  in  the  form  of  a  certified  copy  of  the  resolution  whereby 
the  transfer  of  the  stock  was  authorized. 

The  procedure  is  much  the  same  where  stock  is  held  in  the 
name  of  the  treasurer  or  a  trustee  for  the  corporation,  save  as 
to  the  signature  to  the  assignment. 

§  381.    Transfers  to  and  by  Partnerships 

A  partnership  may  deal  in  stock  as  freely  as  may  individuals, 
and  if  it  is  a  trading  partnership,  i.e.,  a  partnership  formed  for 
the  purpose  of  buying,  selling,  or  manufacturing,  si  any  member 
of  the  firm  may  sign  the  partnership  name  to  a  transfer  of  stock 
if  this  stock  is  held  in  the  firm  name.52 

The  signatures  of  the  individual  partners  to  the  assignment 
are  not  necessary,  the  firm  name  affixed  by  one  of  the  partners 
being  legally  sufficient.  The  corporation  may  require  evidence, 
when  necessary,  of  the  assigning  partner's  membership  in  the 
firm. 

If  stock  is  issued  to  the  partners  as  individuals,  as  "To  John 
Gray  and  Henry  H.  Harriman,"  they  are  tenants  in  common 
and  both  the  individuals  named  must  join  in  any  transfer.  The 
same  is  true  when  the  stock  is  held  in  the  firm  name  if  the 
partnership  is  not  a  trading  partnership.  Thus,  if  stock  is  held 
by  a  professional  firm,  even  though  in  the  firm  name,  the  part- 
ners must  sign  their  individual  names  to  the  transfer.  In  the 
absence  of  objection,  any  partner  may  vote  on  stock  held  in 
the  firm  name,  but  in  case  of  disagreement  the  stock  cannot  be 
voted.  53 

One  joint  owner  cannot  sell  or  vote  stock  standing  in  the 
names  of  two  or  more  if  the  other  objects,  but  each  name  must 
be  signed  to  its  assignment  or  to  a  proxy.  54 


"  Lee  V.  Bank,  45  Kan.  8  (1890);  11  L.  R.  A.  238. 

"  Comstock  V.  Buchanan,  57  Barb.  127  (1864). 

"  Matter  of  Pioneer  Paper  Co.,  36  How.  Pr.  iii  (1865). 

M  Tunis  V.  R.  R.  Co..  149  Pa.  St.  70  (1892) ;  s.  c.  15  L.  R.  A.  665. 


Ch.  4ol  TRANSFER  OF  STOCK— RULES  325 

§  382.    Summeiry  of  Rules  Regulating  Transfers 

The  following  rules  regulating  transfers  of  stock  are  those 
recognized  by  the  trust  companies  of  New  York  City  and  are 
given  here  as  a  very  clear,  concise  summary  of  the  general  laws 
governing  the  subject. 

1.  The  assignment  of  a  certificate  should  be  executed  by 
the  stockholder  personally  or  by  duly  authorized  attorney.  In 
the  latter  case  the  assigned  certificate  should  be  presented  to 
the  transfer  officials  accompanied  by  the  power  of  attorney 
under  which  the  party  acts,  and  the  original  or  a  notarial  copy 
of  this  power  should  be  left  on  file.  Authority  to  transfer  stock 
should  appear  in  the  power  of  attorney  and,  if  necessary,  the 
authenticity  of  the  signature  and  the  fact  that  the  instrument 
is  still  in  force  must  be  proved. 

2.  The  signature  must  be  witnessed  and  must  correspond 
with  the  name  as  written  on  the  face  of  the  certificate.  Signa- 
tures unknown  to  the  transfer  agent  should  be  guaranteed  by 
some  bank  official  or  acknowledged  before  a  notary  public. 

3.  The  name  and  full  post-office  address  of  the  transferee 
should  be  given  in  full  without  abbreviation  of  any  kind.  The 
space  for  the  name  of  the  attorney  should  be  left  blank.  (The 
address  of  the  transferee  is  not  entered  in  the  assignment  form 
but  may  be  noted  on  the  certificate  or  be  furnished  on  a  slip 
attached  to  the  certificate.) 

4.  The  full  first  name  of  the  transferee  should  be  given. 
If  the  transferee  is  a  woman,  the  prefix  "Mrs."  or  "Miss"  should 
be  used.    No  other  prefixes  and  no  suffixes  should  be  used. 

5.  In  transferring  to  a  married  woman,  use  her  full  Christian 
name — not  that  of  her  husband. 

6.  In  case  a  new  certificate  is  required  because  of  change  of 
name  by  marriage,  the  old  certificate  should  be  signed  "(Mrs.) 
Henrietta  F.  Bowen,  formerly  (Miss)  Henrietta  F.  Francisco," 
while  in  the  space  for  the  name  of  transferee  should  be  placed 
the  name  "(Mrs.)  Henrietta  F.  Bowen." 

7.  Agents,  attorneys,  executors,  administrators,  guardians, 


326  CORPORATE  LAW  [Bk.  I- 

or  trustees  should  not  transfer  stock  to  themselves  directly,  i.e., 
as  individuals. 

8.  Transfers  to  a  minor  should  give  the  guardian's  name; 
thus,  "Frederick  McAllison  (a  minor)  under  guardianship  of, 
John  J.  McCall."  Transfers  to  minors  should  be  avoided  if 
possible.  Transfers  from  a  minor  can  be  made  only  by  a  guar- 
dian appointed  by  the  proper  court,  who  must  exhibit  a  duly^ 
certified  copy  of  appointment.  ...  I      ,. 

q.  A  transfer  by  an  administrator  must  be  within  his  au- 
thority as  evidenced  by  a  copy  of  his  appointment  certified  by 
the  proper  probate  authorities. 

10.  A  transfer  by  an  executor  must  be  accompanied  by  a 
copy  of  the  will  and  appo'ntment,  both  certified  by  the  JiTQba^te, 
authorities.     The  will  is  returned  after  inspection.    ,  •.    ,•  n;,' 

11.  Transfers  should  not  be  made  to  a  trustee,  agent,  or 
attorney  who  is  not  appointed  by  an  instrument  in  writing. 
If  properly  appointed,  the  transfer  must  describe  the  trust  by 
reference  to  the  will  or  other  instrument  creating  it. 

12.  In  transfers  by  trustees — when  more  than  one — all  must 
sign  and  the  transfer  must  be  accompanied  by  a  properly  cer- 
tified copy  of  the  instrument  which  authorizes  the  trustees  to 
sell  or  transfer  such  stock. 

13.  In  transferring  to  a  society  or  institution,  evidence 
should  be  required,  if  necessary,  that  it  has  power  to  hold  and 
transfer  stock. 

14.  Transfers  by  associations,  societies,  or  corporations  must 
be  executed  by  duly  authorized  officers  under  seal  of  the  organi- 
zation, and  must  be  accompanied  by  a  certified  copy  of  the 
authorizing  resolution  or  by-law. 

The  regulations  also  prescribe  generally  that  prompt  notice 
of  any  change  of  address  of  a  stockholder,  stating  the  company 
in  which  the  stock  is  held,  should  be  sent  to  the  transfer  agent 
for  record,  and  that  lost  certificates  should  be  reported  to  the 
transfer  agent  as  soon  as  the  loss  is  discovered,  with  full  descrip- 
tion of  the  missing  certificate. 


CHAPTER  XLI  ^^'^^^^ 
STOCK  TRANSFER  TAXES;  CORPORATE  TAXES 
Stock  Transfer  Taxes 

§  383.    State  Laws 

New  York  State  was  the  first  state  to  impose  a  stock  transfer 
tax,i  and  has  been  followed  by  Pennsylvania2  and  Massachusetts-^ 
In  the  three  states  the  acts  imposing  the  tax  and  the  regulations 
for  their  enforcement  are  substantially  uniform.  Under  each 
act  transfers  of  stock  of  all  domestic  corporations  and  of  all 
.  foreign  corporations  having  transfer  agencies  within  the  state  are 
taxable  at  the  rate  of  two  cents  on  each  $ioo  of  par  value  or 
i  fraction  thereof.  Many  corporations  of  other  states  have 
itransfer  offices  in  New  York,  Boston,  or  Philadelphia.  For  this 
reason  and  for  the  further  reason  that  other  states  may  be  ex- 
pected to  adopt  similar  legislation,  it  seems  not  out  of  place  to 
summarize  the  laws  and  regulations  in  connection  with  the  gen- 
ial topic  of  stock  transfer. 

§384.    Duties  and  Penalties 

ii  ^1  »■ 

It  is  the  duty  of  the  secretary  or  other  ofl&cer  of  the  corpora- 
tion in  charge  of  the  stock  certificate  book,  to  see  in  each  in- 
stance, before  issuing  a  new  certificate,  that  all  requirements  of 
law  have  been  complied  with.  In  the  case  of  the  stamp  transfer 
tax,  this  requires  that  he  see  that  the  proper  stamps  have  been 
;  affixed  and  canceled  and  that  a  record  of  transfers  be  kept  in  such 
form  as  the  law  requires.  In  the  case  of  the  inheritance  tax,  the 
; requirements  differ  under  the  statutes  of  the  different  states;  the 


'  N.  Y.  L.  190S.  Ch.  241. 

'  Pa.,  Act  of  June  4,  191S,  P-  L.  828. 

•  Mass.,  Gen.  Acts,  1915,  Ch.  238. 


337 


328  CORPORATE  LAW  [Bk.  I- 

most  usual  provision  forbidding  the  transfer  until  the  inheritance 
tax  has  been  paid  or  a  waiver  obtained  from  the  state  official 
charged  with  the  collection  of  the  tax.  The  corporation  is  in 
all  cases  made  liable  to  a  penalty  if  the  requirements  of  the  law 
are  not  complied  with. 

§  385.    General  Rulings  as  to  the  State  Tax 

Practically  identical  sets  of  rulings  governing  the  collection 
of  the  tax  have  been  adopted  in  each  state.  These  rulings  are 
in  substance  as  follows: 

1.  The  statute  does  not  apply  to  the  original  issue  of  stock. 

2.  The  transfer  to  and  from  voting  trustees  is  taxable,  also 
the  transfer  of  voting  trust  certificates. 

3.  The  mere  surrender  of  a  certificate  of  stock  for  reissue  in 
smaller  denominations  is  not  taxable;  but  if  reissued  in  part  to 
the  original  owner  and  in  part  to  a  third  party,  it  is  taxable  to 
the  extent  of  the  transfer  to  the  third  party. 

4.  Likewise  the  mere  surrender  of  a  certificate  of  stock  held 
by  a  deceased  person  for  issuance  in  the  name  of  his  executor  or 
administrator  is  not  taxable;  but  all  transfers  made  by  the 
latter,  whether  to  trustees,  legatees,  or  other  persons,  are  taxable. 

5.  While  the  law  has  no  extra-territorial  operation,  neverthe- 
less where  it  appears  that  the  transfer  of  the  stock  on  the  cor- 
porate books  within  the  state  is  essential  to  render  the  transfer 
effectual,  it  subjects  it  to  a  tax  although  in  all  other  respects 
made  without  the  state. 

6.  It  is  the  duty  of  the  person  making  or  effectuating  the 
sale  or  transfer  to  pay  the  required  tax  by  procuring,  affixing, 
and  canceling  the  stamps,  except  that  where  a  sale  or  transfer 
is  shown  only  by  the  books  of  the  corporation,  the  person  making 
the  sale  must  secure,  and  the  corporation  affix,  the  stamps  to  its 
books  and  cancel  them. 

7.  Where  the  sale  or  transfer  is  effected  by  the  deUvery  or 
transfer  of  a  certificate,  the  stamp  must  be  placed  upon  the  sur- 
rendered certificate. 


Ch.  4i]  STOCK  TRANSFER  TAXES  329 

8.  Under  no  circumstances  may  a  stamp  erroneously  at- 
tached to  a  certificate  or  memorandum  be  removed. 

Other  rulings  dealing  with  the  form  of  records  to  be  kept  and 
like  matters  var^  slightly  in  each  state. 

§  386.    Federal  Stamp  Law^ 

■^^•'^iThe  federal  law  imposes  on  an  original  issue  a  stamp  tax  of 
5  cents  on  each  $100  of  par  value;  and  on  all  sales  agreements  to 
sell,  or  memoranda  of  sales,  or  deliveries  of,  or  transfer  of  title 
to,  shares  or  certificates  of  stock,  a  stamp  tax  of  2  cents  on  each 
$  roc  of  par  value  or  fraction  thereof.  This  applies  all  over  the 
United  States. 

The  law  as  to  shares  without  par  value  reads  as  follows  as 
to  original  issues: 

Provided,  That  where  a  certificate  is  issued  without  face  value, 
the  tax  shall  be  5  cents  per  share,  unless  the  actual  value  is  in  excess 
of  $100  per  share,  in  which  case  the  tax  shall  be  5  cents  on  each  $100 
of  actual  value  or  fraction  thereof,  or  unless  the  actual  value  is  less 
than  $100  per  share,  in  which  case  the  tax  shall  be  i  cent  on  each 
$20  of  actual  value,  or  fraction  thereof. 

And  as  to  transfers: 

.  .  .  where  such  shares  are  without  par  or  face  value,  the  tax 
shall  be  2  cents  on  the  transfer  or  sale  or  agreement  to  sell  on  each 
share.  ■   '    ' 

'  Hl'r//  yijl  'ifuri 

If  a  single  $25  certificate  of  par- value  stock  were  issued,  the 
stamp  tax  on  its  original  issue  would  be  5  cents,  the  transfer 
stamp  on  any  later  sale  or  transfer  would  be  2  cents.  If  the  par 
value  of  the  share  were  $175,  it  would  require  10  cents  on  original 
issue  and  4  cents  on  a  transfer.  If  the  certificate  were  for  eight 
shares  aggregating  $200,  the  tax  would  be  10  cents  on  original 
issue  and  4  cents  on  a  transfer. 

In  the  case  of  no-par-value  shares  each  certificate  would 


^Revenue  Act  of  1921.  Title  XI,  Sec.  1107,  Schedule  A,  "Stamp  Taxes." 


330  CORPORATE  LAW  [Bk.  I- 

require  5  cents  in  stamps  for  each  original  issue,  unless  the 
actual  value  of  each  share  were  over  $100,  in  which  case  on 
original  issue  5  cents  would  be  required  for  each  $100  or  fraction 
thereof;  or  unless  the  actual  value  of  each  shajre  were  less  than 
$100,  in  which  case  the  tax  would  be  i  cent  on  each  $20  of  actual 
value  or  fraction  thereof.  That  is,  a  certificate  representing 
no-par-value  shares  of  the  actual  value  of  $520  would  require 
30  cents  in  stamps,  while  one  of  the  value  of  $25  would  require 
2  cents. 

For  transfers  of  no-par- value  shares  a  uniform  rate  of  2 
cents  on  each  share  is  imposed. 

The  stamps  representing  the  tax  imposed  shall  be  attached 
to  the  stock  books  and  not  to  the  certificates  issued. 

§  387.    Penalties  under  Federal  Stamp  Law 

Anyone  liable  to  pay  the  federal  stamp  tax  on  sales  or  trans- 
fers of  capital  stock,  who  makes  any  sale  or  delivery  of  stock 
without  the  proper  stamps  being  affixed,  is  guilty  of  a  misde- 
meanor punishable  by  a  fine  of  not  more  than  $i,oco,  or  by 
imprisonment  for  not  more  than  six  months,  or  both. 

Corporate  Taxes ^ 
§  388.    Capital  Stock  (Excise)  Tax 

It  is  provided  in  the  Federal  Revenue  Act  of  192 1  that: 

1.  Every  domestic  corporation  shall  pay  annually  a  special 
excise  tax  with  respect  to  carrying  on  or  doing  business,  equivalent 
to  $1  for  each  $1,000  of  so  much  of  the  fair  average  value  of  its 
capital  stock  for  the  preceding  year  ending  June  30  as  is  in  excess 
of  $5,000.  In  estimating  the  value  of  capital  stock  the  surplus  and 
undivided  profits  shall  be  included;  .  .  . 

2.  Every  foreign  corporation  shall  pay  annually  a  special  excise 
tax  with  respect  to  carrying  on  or  doing  business  in  the  United 
States,  equivalent  to  $1  for  each  $1,000  of  the  average  amount  of 
capital  employed  in  the  transaction  of  its  business  in  the  United 
States  during  the  preceding  year  ending  June  thirtieth. 


'  See  Montgomery  on  Income  Tax  Proc.     (1922) :   also  Seligmaa's  Essays  on  Taxation. 
Chs.  VI,  VII.  VIII. 


Ch.  41)  CORPORATE  TAXES  .  331 

This  tax  applies  to  all  corporations  carrying  on  business  for 
profit,  and  not  to  the  enumerated  corporations  exempt  from 
paying  an  income  tax.  It  applies  to  all  corporations  and  also 
to  all  associations  for  profit,  and  having  a  capital  stock  divided 
into  shares 

J       It  is  to  be  noted  that  the  tax  is  not  on  the  par  value,  but  on 

the   "fair   average  value."    To   enable   the   Commissioner   of 

Internal  Revenue  to  estimate  the  fair  average  value,  in  cases 

,pf  possible  undervaluation,  corporations  are  required  to  file 

three  exhibits: 

A.  Condensed  balance  sheet. 

B.  Quotations  or  outside  sales  prices  for  past  year. 

C.  The  annual  income  for  a  period  of  five  preceding  years. 

It  is  expected  that  the  return  should  give  as  the  fair  average 
value  the  greatest  value  shown  by  any  of  the  exhibits.  This 
return  must  be  filed  during  July  of  each  year  and  is  an  excise  tax 
to  be  paid  in  advance  for  the  privilege  of  doing  business  for  the 
year  to  come. 

The  failure  to  make  return  in  July  to  the  Commissioner  of 
Internal  Revenue,  unless  good  reason  is  shown,  may  add 
25%  to  the  amount  of  the  tax.  If  a  false  or  fraudulent  return 
is  made,  the  Commissioner  shall  add  50%  to  the  amount.     ,; 

§  389.    Income  Tax 

All  business  and  manufacturing  and  public  utility  corpora- 
tions in  business  for  profit  are  subject  to  the  income  tax  levied 
by  the  general  government.  Under  the  law  as  amended  in  192 1, 
each  corporation  shall  pay  a  tax  of  10%  of  the  net  income  subject 
to  tax  for  1921,  and  i2>^%  for  1922  and  thereafter.  In  addition 
to  this,  each  corporation  up  to  January  i,  1922,  was  subject  to 
the  excess  profits  tax  which  is  considered  in  the  next  section. 

Every  corporation  shall  make  a  return  before  March  15  of 


332  .  CORPORATE  LAW  [Bk.  I- 

each  year,  itemizing  its  gross  income  and  the  allowable  deduc- 
tions and  credits.  Corporations  whose  annual  net  income  is 
below  the  $2,ckdo  exemption  are  nevertheless  required  to  make 
returns. 

The  blanks  for  returns  are  furnished  by  the  collector  in  each 
revenue  district.  To  make  out  the  return  for  a  corporation 
of  any  size  is  a  task  requiring  no  small  measure  of  legal  and 
accounting  skill.  As  a  matter  of  fact  the  effect  of  the  income  and 
excess  profits  taxes  has  been  to  develop  a  new  professional  man, 
the  tax  expert.  It  has  also  developed  many  pretenders,  who 
assume  a  skill  in  evading  taxes  that  they  do  not  possess.  Tax 
returns  should  be  honest  returns,  but  every  man  is  entitled  to 
every  exemption  the  law  allows  and  also  to  shape  his  business 
so  as  to  reduce  his  tax  liabiUty  to  the  minimum.  ,  i      ^ 

§390.    Excess  Profits  Tax  -fifU  fa^ji?>^>y«t1'I 

Behind  the  excess  profits  tax  was  the  idea  that  those  corpora- 
tions that  earned  excessive  profits  should  also  pay  taxes  in 
larger  measure.  The  excess  profits  tax  is  to  be  computed  and 
deducted  from  corporate  income  before  the  normal  tax  is  com- 
puted. 

Corporations  having  net  incomes  of  less  tjia^  .SSjppo  are 
exempt  from  payment  of  excess  profits  taxes.       _  ,4»  ,^ 

To  find  the  income  subject  to  the  excess  profits  tax,  the  net 
income  is  taken  before  the  credits  allowed  for  the  income  tax 
are  deducted,  and  from  this  is  deducted: 

1.  $3,000,  a  specific  deduction. 

2.  8%  of  the  invested  capital. 

The  rate  of  the  excess  profits  tax  is  20%  of  the  amount  of 
the  net  income  in  excess  of  the  two  deductions  "and  not  in 
excess  of  20  per  centum  of  the  invested  capital,  and  40  per 
centum  of  the  amount  of  the  net  income  in  excess  of  20  per 
centum  of  the  invested  capital." 

This  tax  ceases  with  the  year  1 921,  i.e.,  is  applicable  to  192 1 
income  but  not  to  income  arising  in  1922. 


Ch.  41]  CORPORATE  TAXES  ^^3 

§  391.     Local  Property  Taxes 

In  every  state  the  taxes  on  all  property,  both  real  and  per- 
sonal, affect  property  in  corporate  possession,  exactly  as  they 
affect  the  property  of  individuals  or  firms.  A  foreign  corpora- 
tion doing  business  in  a  state  must  pay  taxes  on  any  property 
held  for  its  purposes. 

Each  state  has  its  own  system  of  reporting  property  for  tax- 
ation and  assessing  taxes,  and  corporations  have  only  to  ascer- 
tain what  is  the  local  system  and  comply  with  the  requirements. 
It  may  be  necessary  also  to  pay  both  city  and  county  taxes. 

In  those  states  where  a  license  is  required  for  some  or  all 
businesses  before  commencing  operations,  a  corporation  must 
comply  with  the  law.  In  New  York  business  corporations 
paying  a  state  income  tax  are  exempt  from  the  local  tax  on 
personal  property. 

§  392.     State  Franchise  Taxes 

Franchise  or  license  taxes  are  annual  payments  required  to 
be  made  by  corporations,  for  the  privilege  of  doing  business  under 
the  corporate  form  in  the  particular  state.  In  Michigan  and  a 
few  other  states  there  are  no  franchise  taxes. 

This  kind  of  taxation  varies  greatly  in  amount.  In  Penn- 
sylvania it  is  3^  of  1%  on  actual  values.  In  New  York  it  took 
the  form  of  a  stock  tax  imposed  in  a  complex  plan  on  dividends 
or  on  the  appraised  value  of  the  stock  issued  and  outstanding, 
but  this  is  for  most  corporations  merged  into  the  state  income 
tax.  In  California  it  is  1.2%  .on  actual  values.  In  Missouri 
it  is  .1%.     In  Iowa  it  is  $1. 

In  taxing  no-par-value  stock  or  in  levying  a  franchise  tax 
on  a  corporation  with  no-par- value  stock,  the  usual  rule  is  to 
consider  each  share  as  worth  $100. 

In  Colorado,  for  the  organization  and  license  tax,  no-par 
shares  are  deemed  to  be  of  the  par  value  of  $1.  The  rule  in 
Michigan  is  that  the  value  is  to  be  at  least  $1,  or  the  sale  value 
fixed  by  the  corporation,  or  the  book  value. 


334  CORPORATE  LAW  [Bk.  I- 

In  many  of  the  states  corporations  engaged  in  mining  or 
manufacturing  in  the  state  are  exempt  from  the  payment  of  any 
license  fee  or  franchise  tax.  Sometimes  it  is  specified  that  more 
than  50%  of  the  capital  must  be  so  used  to  secure  exemption  from 
franchise  tax. 

§  393.    State  Income  Taxes 

Only  a  few  states  have  imposed  an  income  tax  on  corporations 
as  yet.     It  yields  a  large  revenue,  and  is  likely  to  become  general. 

In  New  York  the  income  tax  is  4^%  on  the  net  corporate 
income.  After  January  i,  1922,  the  federal  tax  on  corporate 
incomes  will  be  12^%,  so  that  corporations  doing  business  in 
New  York  will  pay  17%  income  tax. 

In  New  York  the  net  income  on  which  the  income  tax  is 
calculated  "is  presumably  the  same  as  the  entire  net  income  upon 
which  such  corporation  is  required  to  pay  a  tax  to  the  United 
States." 

In  Massachusetts  the  excise  taxes  are  moderate,  but  in 
addition  there  is  a  tax  of  2^%  of  that  part  of  its  net  in- 
come derived  from  business  carried  on  within  the  commonwealth. 
As  in  New  York,  the  income  report  made  to  the  federal  govern- 
ment is  taken  as  the  basis  of  taxation. 

The  Massachusetts  law  is  comprehensive  and  provides  for 
many  details  of  procedure.  The  tax  paid  is  divided,  the  state 
government  retaining  one-sixth,  and  the  remaining  five-sixth 
being  distributed  among  the  cities  and  towns  in  which  the  cor- 
poration maintains  offices,  stores,  or  factories. 

A  foreign  corporation  doing  business  in  Massachusetts  pays 
the  same  rate  of  excise  and  income  taxes  on  that  p)ortipn  of  its 
capital  employed  in  the  state  as  is  levied  on  domestic  corporations. 

In  North  Carolina  an  income  tax  is  laid  of  3%  on  the  total 
net  income  of  domestic  corporations.  Foreign  corporations 
are  taxed  proportionately  at  the  same  rate  on  the  business  done 
or  property  held  in  the  state.  In  some  other  states  corpora- 
tions are  compelled  to  pay  income  taxes. 


Part  IX — Meetings  and  Records 


CHAPTER  XLII 

ANNUAL  MEETING  OF  STOCKHOLDERS 

§  394.    The  Annual  Meeting 

The  annual  meeting  of  stockholders  is  prescribed  by  statute 
in  most  states,  and  elsewhere  is  required  by  the  charter  or  by- 
laws of  the  corporation.  It  is  the  only  usual  regular  meeting  of 
stockholders.  If  other  meetings  are  necessary,  they  are 
"special  meetings"  and  called  as  required. 

Stockholders'  meetings  must  be  held  within  the  state  of  in- 
corporation. In  many  states  the  statutes  so  provide.  Else- 
where it  is  a  matter  of  common  law,i  save  in  some  few  instances, 
as  in  Delaware,  West  Virginia,  and  South  Dakota,  where  the 
statutes  expressly  provide  that  stockholders'  meetings  may  be 
held  out  of  the  state.  The  principal  office  of  the  company 
within  the  state  is  the  customary  and  most  appropriate  place 
for  stockholders'  meetings  and  in  many  states  is  the  place 
designated  by  statute. 

The  by-laws  usually  prescribe  the  details  of  the  annual 
meeting,  such  as  the  time  and  place,  the  notice  required,  the 
number  necessary  to  constitute  a  quorum,  the  time  of  closing 
books,  the  officers  of  the  meeting,  and  the  order  of  business. 
By-law  provisions  also  usually  regulate  the  use  of  proxies, 
method  of  casting  votes,  and  the  employment  of  inspectors  or 
tellers  at  elections  of  directors. 

Whenever  there  is  any  probability  of  the  proceedings  of  the 

» Ormsby  v.  Vermont  Mining  Co.,  56  N.  Y.  623  (1874)  • 

335 


336  CORPORATE  LAW  [Bk.  I- 

annual  meeting  being  attacked,  or  when  there  are  any  dispute, 
or  differences  of  opinion  among  the  stockholders  of  a  corporations 
every  formality  in  connection  with  the  annual  meeting  should 
be  carefully  observed.  Under  other  circumstances  such  close 
observance,  though  always  advisable,  is  not  so  essential.  If 
the  proceedings  are  characterized  by  good  faith  and  are  a  fair 
expression  of  the  sense  of  those  present,  "mere  irregularities  in 
the  manner  of  conducting  the  business  are  immaterial. "2 

§  395*    Closing  Transfer  Books 

The  corporate  calendars  should  show  the  exact  date  prior 
to  the  annual  meeting  on  which  the  transfer  books  are  to  be 
closed  to  transfers.  The  object  of  thus  closing  the  books  is  to 
obviate  any  uncertainty  as  to  who  is  entitled  to  receive  notice 
of  and  to  vote  at  the  annual  meeting. 

§  396.    Notice  of  Annual  Meeting 

Notice  of  the  annual  meeting  is  usually  prescribed  by  the 
by-laws  and  in  some  few  states  is  required  by  statute.  Such 
notice  is  not,  however,  of  the  same  vital  importance  as  in  the 
case  of  special  meetings,  since  the  time  and  place  of  the  annual 
meeting  are  specified  in  the  by-laws  and  are  supposed  to  be 
familiar  to  the  stockholders.  For  this  reason  failure  to  send 
out  notice  of  its  time  and  place  as  required  by  the  by-lav/s, 
while  a  very  serious  breach  of  duty  on  the  part  of  the  secretary 
is  not  ordinarily  held  to  invalidate  the  proceedings  of  the  meet- 
ing, save  as  to  any  unusual  or  specially  important  business 
considered  thereat.^  Where  notice  is  prescribed  by  statute, 
however,  the  provision  of  the  statute  must  be  compUed  with 
unless  waived  by  all  the  stockholders. 

The  notice  of  the  annual  meeting  should  specify  not  only  its 
time  and  place,  but  also  its  objects.     This  is  not  always  legally 

'  2  Cook  on  Corp.,  i  606. 

»  See  Book  IV   Form  267. 

*  Morawetz,  S  482;  Warner  v.  Mower,  11  Vt.  38s  (1839);  Sampson  v.  Steam  Mill,  36  Me. 
"8  (1853) ;  Morrill  v.  Little  Falls  Mfg.  Co.,  S3  Minn.  37i  (1893)-  For  forms  of  notice,  see  Book 
iV  Ch.  XII  "Notices  of  Meetings." 


Ch.  42 j  ANNUAL  MEETING  OF  STOCKHOLDERS  337 

necessary  but  is  an  advisable  precaution,  particularly  when  busi- 
ness of  special  importance  is  to  be  considered  thereat.  ''Where 
unusual  business  is  to  be  transacted,  even  at  a  regular  meeting, 
the  notice  of  that  meeting  should  state  the  unusual  business. "s 
In  Pennsylvania  it  has  even  been  held  that  important  amend- 
ments of  the  by-laws  cannot  be  legally  effected  at  the  annual 
meeting  unless  previously  notified  to  the  stockholders. s  In  the 
larger  corporations  the  by-laws  frequently  provide  specifically 
that  any  failure  or  irregularity  in  the  notice  of  the  annual  meet- 
ing shall  not  affect  its  validity  or  the  validity  of  any  of  its  pro- 
ceedings. 

Written  notice  of  the  annual  meeting  mailed  to  the  stock- 
holders of  record  is  usually  prescribed.  This  notice  should  be 
signed  with  the  official  signature  of  the  secretary  or  other  cor- 
porate officer  authorized  thereto, ^  and  should  be  mailed,  postage 
paid,  on  the  date  specified  in  the  by-laws — which  ranges  widely 
from  5  to  60  days  or  more  before  the  date  of  the  meeting — to  the 
address  of  each  stockholder  as  shown  by  the  books  of  the  com- 
pany. A  copy  of  the  notice  with  date  of  sending  indorsed 
thereon,  should  be  preserved  by  the  secretary  as  evidence  that 
proper  notice  of  the  meeting  has  been  given. 

Publication  of  the  notice  of  an  annual  meeting  is  in  some 
states  required  by  statute,  and  in  all  states  is  customary  among 
the  larger  corporations.  It  is,  however,  a  most  uncertain  and 
inadequate  method  of  notification  and  should  be  used  only  in 
connection  with  notice  by  mail.  Copies  of  the  papers  in  which 
the  publication  notice  appears  should  be  preserved  by  the 
secretary  as  proof  of  due  publication;  or  if  preferred,  a  copy  of 
the  notice  may  be  made  and  an  affidavit  of  the  publisher  or  of 
the  secretary  certifying  to  its  due  publication  be  attached. « 

The  notice  of  the  annual  meeting  usually  states  the  dates 
for  the  closing  and  reopening  of  the  transfer  books. 


..•2  Cook  on  Corp.,  {  S9S- 

•  Bagley  v.  Reno,  201  Pa.  St.  78  (1902). 
'  Johnson  v.  Jones  23  N.  J.  Eq.  216  (1872). 
'See  Book  IV,  Forms  121-124. 


338  CORPORATE  LAW  [Bk.  I- 

§  397.    Preparations  for  Annual  Meeting 

It  is  the  secretary's  duty  to  see  that  all  stationery,  blanks, 
and  materials  and  any  of  the  corporate  books  or  documents  in 
his  keeping  that  may  be  needed  at  the  meeting  are  at  hand  or 
readily  accessible  at  the  proper  time.  His  preparations  will  also 
usually  include: 

1.  Order  of  Business. — Unless  the  presiding  officer  is  very 
familiar  with  the  regular  order  of  business  as  given  in  the  by- 
laws of  the  company,  a  copy  should  be  prepared  by  the  secretary 
in  convenient  form  for  reference  and  be  handed  to  the  chairman 
at  or  before  the  time  he  takes  charge  of  the  meeting.  9 

The  object  of  the  formal  order  of  business  is  to  insure  the 
systematic  and  orderly  conduct  of  meetings  and  of  the  business 
of  such  meetings.  The  order  prescribed  is,  however,  directory, 
not  mandatory  as  are  most  of  the  by-law  regulations,  and  may 
therefore  be  suspended  at  any  meeting  in  whole  or  in  part, 
either  by  a  majority  vote  of  those  present  or  by  their  mere 
assent.  10 

2.  List  of  Stockholders.— Under  the  laws  of  New  Jersey 
and  some  other  states,  an  alphabetical  list  of  the  stockholders 
entitled  to  vote  at  the  annual  meeting  must  be  prepared  by  the 
secretary,  be  presented  at  the  meeting,  and  be  kept  'there  for 
the  inspection  of  any  stockholder.  The  requirement  is  a  reason- 
able one,  and  a  similar  list  will  be  found  a  convenience  in  any 
state.     Its  preparation  is  frequently  made  a  by-law  requirement. 

This  Hst  of  stockholders  is  made  out  from  the  stock  books 
after  they  are  closed  to  transfers,  and  gives  the  names  and 
addresses  of  the  stockholders  and  the  amount  of  stock  held  by 
each.  It  must  be  remembered,  however,  that  the  company's 
stock  books  are  the  final  authority  in  any  such  matters  and 
should  be  at  hand  for  reference  in  case  the  accuracy  of  the  list  is 
impugned." 


»  See  Book  IV,  Form  6s  (by-laws,  Art.  II,  i  6);  also  Form  66  (by-laws.  Art.  II.  i  9). 
"  Matter  of  Wheeler,  2  Abb.  Pr.  (N.  S.)  361  (1866);  Matter  of  Mohawk,  etc.,  R.  R.  Co., 
19  Wend.  I3S  (1838). 

•'  Johnston  v.  Jones,  23  N.  J.  Eq.  216  (1872) ;  Downing  v.  Potts,  23  N.  J.  L.  66  (1851). 


Ch.  42]  ANNUAL  MEETING  OF  STOCKHOLDERS  339 

In  the  smaller  corporations  the  secretary  will  in  addition 
find  an  alphabetical  list  of  the  stockholders  of  much  convenience 
for  his  own  use.  This  list  should  be  arranged  with  columns  in 
which  may  be  noted  those  present  in  person  or  by  proxy,  those 
absent,  and  the  amount  of  stock  held  by  each. 12 

3.  Outline  Minutes. — These  will  be  found  convenient  for 
the  ,use  of  the  secretary.  Properly  prepared,  they  cover  all 
routine  business,  so  that  a  few  short  pencil  notes  will  usually 
dispose  of  these  matters,  leaving  the  secretary  free  to  attend  to 
any  new  or  special  business  that  may  demand  his  services. i3 

§  398.    Officers  of  Meetings 

No  fixed  rule  prevails  as  to  officers  of  stockholders'  meetings. 
The  regular  officers  of  the  company  usually  serve,  but  not  unless 
authorized  thereto  by  the  charter  or  by-laws.  If  no  such  pro- 
vision exists,  the  stockholders  elect  or  appoint  the  officers  of 
their  own  meetings.  As  a  rule,  the  secretary  so  appointed 
should  be  the  secretary  of  the  company.  To  appoint  a  secretary 
not  familiar  with  the  records,  the  personnel,  and  the  general 
condition  of  the  company,  is  apt  to  cause  delay  and  confusion 
and  is  but  seldom  advisable. 

When  the  regular  officers  are  designated,  the  president  will 
take  charge  of  the  meeting  as  a  matter  of  course,  or  in  his  absence 
the  vice-president  takes  the  chair.  If  both  are  absent,  the 
treasurer  might  act  as  presiding  officer.  If  the  treasurer  is  also 
absent,  the  secretary  might  very  properly  ask  someone  present 
to  call  the  meeting  to  order,  who  will  then  preside  until  a  more 
permanent  chairman  is  selected,  or  the  secretary  might  act 
temporarily  himself.  If  so,  he  should  not  preside  longer  than  is 
necessary  for  the  appointment  of  a  chairman.  He  cannot  act 
as  president  and  secretary  at  the  same  time,  and  his  more 
important  duty  is  to  record  the  proceedings  of  the  meeting.  In 
the  absence  of  all  the  regular  officers  from  the  meeting,  the 


"  See  Book  IV,  Form  160. 
"  See  Book  IV.  Form  161. 


34©  CORPORATE  LAW  [Bk.  I- 

stockholders  appoint  a  chairman  and  a  secretary  pro  tern,  who 
serve  for  that  meeting. 

§  399'    Opening  the  Meeting 

Usually,  as  stated,  the  by-laws  provide  that  the  president 
and  secretary  of  the  company  shall  officiate  at  stockholders' 
meetings.  In  such  case,  at  the  appointed  time  and  place  the 
president,  or  in  his  absence  the  next  ranking  officer  present, 
requests  the  meeting  to  come  to  order;  and  the  secretary,  if  he 
has  not  already  done  so,  furnishes  the  presiding  officer  with  a 
copy  of  the  order  of  business  and  presents  a  list  of  the  stock- 
holders of  the  company  which  remains  open  during  the  meeting 
for  the  inspection  of  those  present. 

§  400.    Roll-Call 

In  the  smaller  corporations,  the  presiding  officer  after  calhng 
the  meeting  to  order  requests  the  secretary  to  call  the  roll. 
Practice  varies  as  to  the  precise  manner  of  roll-call.  Usually 
the  secretary  employs  an  alphabetical  list  prepared  for  the  pur- 
pose and,  calling  the  names  if  he  is  not  personally  acquainted 
with  all  the  stockholders,  notes  thereon  those  present  either  in 
person  or  by  proxy,  and  any  absentees. 1* 

In  the  larger  corporations  tliis  plan  is  not  practicable.  When 
the  list  of  stockholders  runs  far  up  in  the  hundreds  or  thousands, 
an  actual  call  of  roll  is  obviously  impossible.  Instead,  the  chair- 
man first  requests  the  stockholders  present  in  person  to  report 
to  the  secretary.  As  each  reports,  reference  is  made  to  the  secre- 
tary's list  of  stockholders,  and  if  the  person  reporting  is  found 
thereon,  his  name  and  the  amount  of  stock  he  holds  are  recorded. 
The  chairman  then  calls  for  those  who  represent  stockholders 
by  proxy.  These  also  report,  each  giving  the  name  of  the 
stockholder  and  the  number  of  shares  he  represents,  handing  in 
his  proxy  or,  after  exhibiting  the  original,  a  certified  copy  thereof, 
as  evidence  of  his  right  to  vote.     The  statements  are  verified 

"  See  Book  IV,  Form  i6o. 


Ch.  42]  ANNUAL  MEETING  OF  STOCKHOLDERS  341 

in  each  case,  and  the  names  of  both  principal  and  proxy  and  the 
stock  represented  are  duly  noted.  In  this  way  the  number  of 
shares  represented  and  entitled  to  vote  at  the  meeting  is  arrived 
at  accurately  and  expeditiously. 

After  the  secretary  has  completed  the  roll-call  or  annotation 
of  stockholders  present,  he  announces  to  the  chairman  the  total 
number  of  shares  outstanding  entitled  to  vote,  the  number  neces- 
sary to  constitute  a  quorum,  the  number  represented  at  the 
meeting,  in  person  and  by  proxy,  and,  if  such  is  the  fact,  that 
they  constitute  a  quorum. 

If  a  quorum  is  present,  the  presiding  officer  announces  the 
fact  and  states  that  the  meeting  will  proceed  to  business.  If  a 
quorum  is  not  present  and  no  other  stockholders  can  be  secured, 
the  meeting  may  take  either  one  of  two  courses.  It  may 
adjourn  sine  die,  which  defers  the  election  of  directors  indefin- 
itely and  leaves  the  existing  board  to  hold  over  until  the  next 
annual  meeting  or  until  a  special  meeting  is  called  for  the 
election  of  directors;  or  the  meeting  may  adjourn  from  day  to 
day  or,  if  the  charter  or  by-laws  so  permit,  to  any  desired  future 
date,  when  if  a  quorum  is  secured  the  meeting  may  be  held. 

The  important  point  to  be  determined  at  roll-call  is  the 
amount  of  stock  represented.  The  number  of  persons  present 
is  immaterial.  One  man,  by  stock  ownership  or  proxies,  or  by 
both,  might  represent  the  entire  outstanding  stock  of  the  com- 
pany, and  such  meeting,  if  properly  conducted,  is  legal  in  this 
country. 15  In  England  it  has  been  held  that  one  person  cannot 
hold  a  meeting.16  In  either  country,  however,  the  party  in  con- 
trol could  avoid  all  question  and  satisfy  every  requirement  by 
giving  proxies  for  one  or  more  shares  of  stock  to  convenient 
parties  thus  qualified  to  participate  with  him  in  the  meeting. 

§  401.    Proxies 

A  proxy  is  a  special  power  of  attorney  executed  by  a  stock- 
holder of  the  corporation  and  authorizing  some  specified  person 

"  Morrill  v.  Little  Falls  Mfg.  Co.,  53  Minn.  371  (1893);  see  note  21  L.  R.  A.  174. 

"  Sharp  V.  Dawes,  2  Q.  B.  D.  26  (1876);  In  re  Sanitary  Carbon  Co.,  12  W.  N.  223  (1877). 


342  CORPORATE  LAW  [Bk.  I 

to  represent  him  at  one  or  more  stockholders'  meetings  of  that 
corporation.  A  party  who  holds  and  exercises  the  powers  of  a 
proxy  is  said  to  act  as  a  proxy.  Any  person  competent  to  act  as 
an  agent  may  act  as  a  proxy. i^ 

The  right  to  vote  by  proxy  is  not  a  common  law  right.  It 
cannot  therefore  be  exercised  unless  conferred  either  by  con- 
stitutional provision  as  in  the  case  in  some  states,  by  statute 
provision  as  is  the  case  in  many  states,  or  otherwise  by  charter 
or  by-law  provisions. 

In  the  majority  of  states  the  statutes  prescribe  that  voting 
at  stockholders'  meetings  may  be  either  in  person  or  by  proxy. 
In  some  states  the  statutes  are  merely  permissive,  allowing 
voting  by  proxy  if  provision  therefor  is  made  by  charter  or  by- 
laws. Variations  or  restrictions  of  the  usual  right  to  vote  by 
proxy  are  found  in  many  states.  Thus  in  New  Hampshire  no 
person  may  vote  as  proxy,  or  as  principal  and  proxy,  for  shares 
exceeding  one-eighth  of  the  whole  capital  stock.  In  Maine  a 
general  power  of  attorney  authorizing  the  voting  of  stock  is  good 
until  it  expires  or  is  revoked,  but  a  proxy  must  have  been 
executed  within  thirty  days  preceding  the  day  of  meeting.  In 
Pennsylvania  a  proxy  must  have  been  executed  within  two 
months  of  the  date  of  meeting;  in  Massachusetts  within  six 
months;  in  New  York,  California,  and  Connecticut  within 
eleven  months;  in  Minnesota  within  one  year;  in  New  Jersey, 
Delaware,  North  Carolina,  and  Porto  Rico  within  three  years; 
and  in  New  Mexico  within  five  years. 

The  original,  or  a  duplicate  or  certified  copy  of  every  proxy 
should  be  filed  with  the  secretary  of  the  meeting  at  which  the 
powers  conferred  by  the  proxy  are  to  be  exercised,  and  should 
be  preserved  by  him  in  case  the  validity  of  the  meeting  or  any 
of  its  proceedings  should  be  questioned.  If  the  proxy  is  a 
continuing  one,  it  should  be  filed  at  the  first  meeting  at  which 
its  powers  are  exercised  but  need  not  be  filed  at  subsequent 
meetings. 

"  See  Book  IV,  Forms  127-133;  also  People's  Bank  v.  Superior  Court,  104  Cal.  649  (1894); 
Re  Lighthall  Mfg.  Co.,  47  Hun  258  (1888). 


Ch.  42]  ANNUAL  MEETING  OF  STOCKHOLDERS  343 

§402.     Quorum  t^  >a  >oo-?q 

A  quorum  at  stockholders'  meetings  is  the  number  of  shares 
of  stock  which  must  be  represented — or  the  number  of  members 
which  must  be  present — to  duly  constitute  the  meeting  and 
enable  the  legal  transaction  of  business.  In  some  of  the  states 
the  statutes  provide  that  at  least  a  majority  of  the  outstanding 
stock  must  be  present  in  order  to  constitute  a  quorum.  Else- 
where a  similar  provision  is  usually  inserted  in  the  charter  or 
by-laws  of  the  particular  corporation.  If  no  regulating  provi- 
sions exist,  the  common  law  prevails,  under  which  those  present 
at  a  duly  assembled  stockholders'  meeting  are  entitled  to  act, 
no  matter  whether  they  represent  a  majority  of  the  outstanding 
stock  or  otherwise.  "The  law  is  clear  that  those  stockholders 
who  attend  a  duly  called  stockholders'  meeting  may  transact 
the  business  of  that  meeting,  although  a  majority  in  interest  or 
in  number  of  the  stockholders  are  not  present. "is 

In  the  absence  of  conflicting  statutes,  the  stock  necessary  to 
constitute  a  quorum  may  be  fixed  at  any  amount  desired.  The 
usual  and  best  practice  requires  a  majority  of  all  the  outstanding 
stock.  A  smaller  quorum  is  sometimes  prescribed  but  is  not 
always  safe.  A  majority  of  a  legal  quorum  may  always  act. 
Hence,  if  less  than  a  majority  constitutes  a  quorum,  it  is  entirely 
possible  that  matters  of  the  greatest  importance  to  the  cor- 
poration will  be  decided  by  less  than  one-fourth  of  the  outstand- 
ing stock. 

It  may  be  noted  that  the  statutes  of  a  few  states — New 
York  among  them — reaffirm  the  common  law  as  to  a  quorum 
in  the  case  of  meetings  for  the  election  of  directors. 19  In  these 
states  the  stockholders,  meeting  at  the  duly  appointed  time  and 
place  for  the  election  of  directors,  have  power  to  act  regardless 
of  the  amount  of  stock  they  represent,  that  is,  whether  or  no  a 
quorum  is  present.20 


"  Cook  on  Corp.,  I  607;  Morrill  v.  Little  Falls  Mfg.  Co.,  S3  Minn.  371  (1893). 

"  Stock  Corp.  Law  (N.  Y.) ,  f  25. 

'"See  I  170;  also  Matter  of  Rapid  Transit  Ferry,  15  App.  Div.  (N.  Y.)  530  (1897). 


344  CORPORATE  LAW  [Bk.  I- 

§  403.    Proof  of  Notice 

After  the  presence  of  a  quorum  has  been  ascertained,  the 
secretary,  in  response  to  a  request  from  the  chair,  should  submit 
proof  that  due  notice  of  the  meeting  has  been  given.  For  this 
purpose  a  copy  of  the  notice  should  be  exhibited,  with  the 
secretary's  certificate  as  to  its  due  service  attached.  If  greater 
formality  is  desired,  the  secretary's  certificate  might  appear  in 
the  form  of  an  affidavit.  When  less  formality  is  deemed  suffi- 
cient, the  secretary  merely  presents  a  copy  of  the  notice  with  a 
statement  that  it  has  been  sent  out  as  required  by  by-laws.21 

If  notice  by  publication  has  been  given,  the  secretary  should 
exhibit  copies  of  the  papers  containing  the  notice,  or  copies  of 
the  notice  with  the  affidavit  of  the  publisher  or  of  the  secretary 
himself  as  to  its  publication.  If  the  formality  of  an  affidavit  is 
deemed  unnecessary,  the  secretary's  certification,  or  even  his 
mere  statement,  as  to  the  facts  of  publication  will  usually  suffice. 

§  404.    Reading  of  Minutes  22 

The  presiding  officer  next  calls  for  the  reading  of  any  unap- 
proved minutes.  The  secretary  in  response  reads  the  minutes  of 
the  annual  meeting  held  the  preceding  year,  also  the  minutes  of 
any  special  meeting  or  meetings  of  the  stockholders  held  during 
the  year.  Occasionally  it  will  happen  that  the  reading  of  the 
minutes  at  the  preceding  annual  meeting  has  been  passed  or  the 
minutes  of  preceding  meetings  have  not  been  approved  at  such 
meeting,  and  the  secretary  will  then  go  back  still  further,  pre- 
senting all  minutes  of  stockholders'  meetings  that  have  not  been 
read  and  approved  at  some  succeeding  meeting. 

At  the  close  of  the  reading  of  each  set  of  minutes  or,  if  pre- 
ferred, at  the  close  of  the  reading  of  all  unapproved  minutes,  the 
chairman  may  announce:  "If  there  are  no  objections,  the 
minutes  as  read  will  stand  approved";  or  a  motion  may  be 
passed  that  "the  minutes  be  approved  as  read." 


"'  See  Book  IV,  Forms  221-223, 
22  See  Book  IV,  Form  168. 


Ch.  42]  ANNUAL  MEETING  OF  STOCKHOLDERS  345 

If  errors  are  discovered,  the  minutes  may  be  corrected  at  once 
or  when  the  reading  of  the  particular  minutes  is  concluded,  or 
at  any  time  previous  to  their  approval.  If  the  errors  are  obvious 
or  immaterial,  the  presiding  officer  may,  in  the  absence  of 
objection,  merely  direct  the  secretary  to  make  the  corrections. 
If  there  is  any  question  as  to  an  alleged  error  or  if  the  matters 
are  important,  the  correction  of  the  minutes  is  best  effected  by 
motion.  If  the  motion  prevails,  the  minutes  must  be  amended 
accordingly  and  are  then  "approved  as  corrected,"  usually  by 
order  of  the  president  or  chairman;  otherwise  by  formal  motion. 

The  minutes  of  an  annual  or  special  meeting  cannot  be 
approved  at  a  special  meeting  of  stockholders  unless  so  specified 
in  the  call  for  such  meeting.  Minutes  of  a  directors'  meeting 
are  never  read  at  a  stockholders'  meeting,  except  for  purposes 
of  information  or  to  obtain  the  stockholders'  ratification  of  acts 
recorded  in  the  minutes. 

The  reading  of  the  minutes  may  be  dispensed  with,  if  desired, 
either  by  formal  motion  or,  in 'the  absence  of  objection,  by  mere 
announcement  of  the  chairman. 

§  405.    Annual  Reports  23 

Under  the  usual  order  of  business  the  annual  reports  of 
officers  and  committees  follow  the  reading  of  minutes.  The 
president's  report  is  the  first  official  report  to  be  presented. 
Following  this  usually  comes  the  treasurer's  report,  and  if  other 
officers  have  reports  to  make  or  if  the  board  of  directors  or  any 
committees  have  reports  to  submit,  they  are  in  order  at  this 
time. 

Before  a  report  presented  at  the  annual  meeting  is  formally 
received,  it  is  discussed  if  necessary  and  any  desired  questions 
asked  and  answered  concerning  it.  A  motion  is  then  made  that 
the  report  be  received  and  filed,  or  otherwise  disposed  of  as  may 
be  necessary;  or  in  the  absence  of  objection,  its  proper  disposition 
may  be  eff'ected  by  order  of  the  chairman.     If  any  report  proves 


'•See  Book  IV.  Ch.  XXVII,  "Reports." 


346  CORPORATE  LAW  (Bk.  I- 

to  be  incomplete,  erroneous,  or  otherwise  objectionable,  a  motion 
may  be  made  to  return  such  report  for  correction  or  for  revision, 
or  it  might  even  be  rejected  absolutely,  such  rejection  serving 
as  an  emphatic  rebuke  to  the  official  or  committee  by  whom  the 
report  was  made. 

As  reports  are  ordered  received,  the  secretary,  unless  it  is 
expressly  otherwise  ordered,  takes  charge  of  and  preserves  them 
for  future  reference.  Reports  of  special  importance  are  some- 
times ordered  spread  upon  the  minutes,  or  entered  in  the  minute 
book  immediately  following  the  minutes  of  the  meeting. 

§  406.    Election  of  Directors 

In  the  larger  corporations  the  annual  election  of  directors 
is  the  most  important  event  in  the  corporate  calendar,  deciding 
the  management  and  the  general  policy  of  the  company  for  the 
ensuing  year.  In  small  or  close  corporations,  on  the  other  hand, 
the  election  of  directors  is  frequently  omitted,  the  directors  then 
in  office  holding  over  for  another  year  or  until  their  successors 
are  elected.  There  is  no  legal  objection  to  this  practice  when 
all  the  stockholders  acquiesce. 

Voting  for  election  of  directors  should  be  by  ballot.'*  In 
perhaps  the  majority  of  the  states  the  statutes  require  this 
method  to  be  followed.  The  election  is  usually  conducted  by 
inspectors  or  tellers,  in  some  states  as  a  matter  of  statutory  re- 
quirement; elsewhere  as  a  matter  of  by-law  provision  or  merely 
of  convenience.  These  inspectors  or  tellers,  usually  two  in 
number,  may  be  stockholders  or  otherwise,  as  seems  best  to  the 
meeting,  but  candidates  who  are  to  be  voted  upon  at  the  election 
should  not  be  appointed.  The  inspectors  take  entire  charge  of 
the  election.  At  its  close  they  announce  the  results,  or  otherwise 
hand  their  report  to  the  chairman  of  the  meeting,  who  reads  the 
results  from  the  inspectors'  report.  The  report  is  then  handed 
to  the  secretary  for  preservation  or  for  such  other  disposition 
as  may  be  prescribed. 


««  See  Book  IV.  Forms  166.  167. 


Ch.  42]  ANNUAL  MEETING  OF  STOCKHOLDERS  347 

In  the  larger  corporations  the  formalities  of  an  election  of 
directors  are  usually  strictly  observed.  In  the  smaller  corpora- 
tions such  elections  are  frequently  conducted  very  informally. 
Where  there  is  entire  agreement,  the  board  is  sometimes  selected 
by  conference,  and  the  secretary — authorized  thereto  by  motion 
— casts  the  single  ballot  of  the  meeting  for  the  parties  named. 

Unless  otherwise  provided  by  statute  or  the  charter  or  by- 
laws of  the  corporation,  a  majority  of  the  votes  cast  at  an 
election  of  directors  held  at  a  duly  constituted  meeting  elects,25 
even  though  these  are  not  a  majority  in  interest  of  all  those  pres- 
ent at  the  meeting.  In  other  words,  stockholders  who  do  not 
vote  carmot  have  their  votes  counted  in  the  negative. 2fi  The 
charter  or  by-laws  may,  however,  in  the  absence  of  any  con- 
flicting statutes,  modify  this  rule  by  providing  that  the  votes  of 
a  majority  of  those  present  at  the  meeting,  or  of  a  majority  or 
any  other  desired  proportion  of  the  outstanding  stock,  shall  be 
necessary  to  elect. 

If  less  than  the  full  number  of  directors  to  be  elected  receive 
the  majority  or  plurality  vote  necessary  to  elect,  those  receiving 
the  required  majority  or  plurality  vote  are  elected  and  another 
ballot  or  another  election  may  be  held  to  elect  the  remainder.27 
It  may  be  noted  that  unless  the  statutes,  charter,  or  by-laws 
provide  that  a  plurality  of  votes  elect,  a  majority  of  all  the  votes 
cast  is  necessary  to  an  election.28  After  the  ballot  has  been 
counted  or  announced,  it  is  too  late  to  receive  additional  votes. 

§  407.    Voting  at  Elections 

If  the  statutes  do  not  prescribe  the  method  of  voting  at 
elections  of  directors,  it  may  be  by  any  desired  method  that  will 
fairly  indicate  the  will  of  those  entitled  to  vote. 

The  stock  books  of  the  corporation  which  show  the  transfer 
and  ownership  of  stock  are  in  most  states  the  final  and  decisive 


"  2  Coo'<  on  Corp.,  i  608. 

»  State  V.  Green,  37  O.  St.  227  {i88r);  Smith  v.  Proctor,  130  N.  Y.  319  (1891). 

"  Wright  V.  Commonwealth,  109  Pa.  St.  560  (1885). 

"  I  Thompson  on  Corp.,  {  846;  2  Cook  on  Corp.,  {  608. 


348  CORPORATE  LAW  (Bk.  I~ 

evidence  as  to  who  is  entitled  to  vote  at  corporate  elections.  If 
the  corporation  keeps  no  other  stock  book  than  a  stock  certificate 
book,  this  wUl  be  sufficient  if  it  shows  the  stock  transfers  and 
ownership.  A  stockholder  cannot  be  kept  from  voting  on 
account  of  the  loss  or  absence  of  his  stock  certificate ;  nor  can  he 
be  denied  the  voting  right  because  his  stock  is  not  fully  paid, 
unless  it  is  expressly  so  provided  by  the  statutes  of  the  state  or 
the  charter  of  the  corporation.29  A  by-law  provision  restricting 
the  voting  right  is  not  ordinarily  effective.  A  corporation  can- 
not vote  on  its  own  stock,  whether  held  in  the  name  of  the 
corporation  or  a  trustee  for  the  corporation.  Any  sale  or  issue 
of  stock  made  by  the  directors  to  control  an  election  can  usually 
be  stopped  by  injunction,  or  the  courts  may  be  invoked  to  set 
the  election  aside. 

The  inspectors,  tellers,  or  other  officers  conducting  an  election 
have  no  authority  to  refuse  the  vote  of  any  stockholder  of  record, 
nor  the  right  to  receive  the  vote  of  anyone  who  is  not  a  stock- 
holder of  record.  Even  when  grounds  for  so  doing  exist,  the 
courts  alone  can  go  behind  the  corporate  records  and  enjoin 
stockholders  of  record  from  voting,  or  set  aside  an  election 
carried  by  the  vote  of  such  stock.  The  secretary  or  chairman 
of  the  meeting  has  no  authority  to  decide  who  may  vote,  the 
matter  resting  with  the  tellers  or  other  persons  conducting  the 
election,  who  must  be  governed  by  the  stock  books  of  the 
corporation. 

Under  the  general  rule  in  regard  to  voting  at  elections,  a 
stockholder  is  entitled  to  one  vote  for  each  director  to  be  elected, 
for  each  share  of  stock  standing  in  his  name  on  the  books  of  the 
corporation.3  0  If  there  are  any  variations  of  this  usual  rule, 
such  as  cumulative  voting,  classified  voting,  or  restriction  of 
voting  to  one  class  of  stock,  such  variation  should  be  stated  as 
clearly  as  possible  in  the  charter  or  by-laws  of  the  corporation 


"  Downing  v.  Potts,  23  N.  J.  L.  66  (1851);  People  v.  Albany,  etc.,  R.  R.,  55  Barb.  (N.  Y. 
386  (1869);  Am.  etc.,  Co.  v.  State  Board,  56  N.  J.  L.  389  (1894). 


344,  386  (1869);  Am.  etc  .  _  _- 
•"  2  Cook  on  Corp.,  i  609 


Ch.  42]  ANNUAL  MEETING  OF  STOCKHOLDERS  349 

and  must,  as  a  matter  of  course,  conform  to  the  requirements 
of  any  state  statutes  on  the  subject. 

§  408.    Cumulative  Voting 

The  usual  method  of  voting  for  directors  results  in  the  elec- 
tion of  the  entire  board  of  directors  by  those  holding  a  majority 
of  the  stock.  The  cumulative  system  of  voting  is  a  modification 
of  this  usual  method  whereby  representation  on  the  board  may 
be  secured  by  the  minority.  Under  it,  while  each  share  still  has 
as  many  votes  as  there  are  directors  to  be  elected,  and  these 
votes  may  be  cast  one  for  each  candidate  as  before,  all  of  these 
votes,  if  so  desired,  may  be  cast  for  one  candidate  or  may  be 
divided  among  any  or  all  of  the  candidates  a?  the  stockholder 
sees  fit.  Thus  if  five  directors  are  to  be  elected,  a  stockholder 
owning  one  share  of  stock  may,  under  the  cumulative  system, 
cast  one  vote  for  each  of  five  candidates  or,  if  he  prefers,  may  cast 
five  votes  for  one  candidate,  or  two  votes  for  one  and  three  for 
another,  or  divide  his  five  votes  among  the  candidates  in  any 
other  way  he  sees  fit. 

The  practical  result  of  this  modification  of  the  usual  system 
is  to  insure  minority  representation  whenever  the  minority 
holding  of  stock  is  at  all  material. ^i 

§  409.    Other  Business 

The  consideration  of  any  unfinished  business  follows  the 
election  of  directors.  This  includes  any  matters  which  were 
under  consideration  but  not  disposed  of  at  any  prior  stock- 
holders' meetings,  whether  regular  or  special.  Matters  referred 
to  committees  for  consideration  or  investigation  or  report  come 
under  this  head  and  may  be  acted  upon  at  this  time. 

The  secretary  usually  brings  up  any  matters  of  unfinished 
business,  but  the  stockholders  or  the  chairman  himself  may 
properly  call  them  to  the  attention  of  the  meeting. 


"  This  subject  is  treated  more  fully  in  Ch.  VLIII,  "Protection  of  Minority  Stockholders." 


3  so  CORPORATE  LAW  [Bk.  I- 

If  there  is  no  unfinished  business,  or  otherwise  upon  its 
disposal,  the  presiding  officer  passes  on  to  the  next  order  of  busi- 
ness and  inquires  if  there  is  any  new  business  to  be  brought 
before  the  meeting.  Under  this  head  come  any  matters  requiring 
the  attention  of  the  meeting  not  before  considered.  These 
may  be  brought  up  either  by  the  officials  of  the  meeting  or  by 
any  of  the  stockholders  present. 

§  410.    Adjournment 

After  the  disposal  of  any  new  business  brought  before  the 
meeting,  adjournment  is  in  order.  This  may  be  by  motion. 
Usually,  however,  when  this  point  is  reached  the  chairman 
inquires  if  there  is  any  other  business  before  the  meeting  and, 
if  no  response  is  received,  declares  the  meeting  adjourned.  Such 
adjournment  is  sine  die,  i.e.,  final. 

If  the  business  of  the  meeting  cannot  be  completed  at  the 
one  session,  or  if  any  other  reasons  render  its  continuation  desir- 
able, it  is  not  adjourned  sine  die,  but  to  such  convenient  future 
date  as  may  be  decided  upon.  An  adjournment  of  this  kind  is 
usually  by  motion,  but  if  it  is  obviously  desirable  or  advisable, 
the  chairman  might  properly  adjourn  the  meeting  himself, 
merely  announcing:  "If  there  is  no  objection,  the  meeting  stands 
adjourned  until  ..." 

Adjournment  may  be  made  only  by  consent  of  a  majority  of 
those  present,  and  the  chairman  has  no  power  to  declare  a  meet- 
ing adjourned  in  defiance  of  this  majority.  If  he  does  so  not- 
withstanding, any  stockholder  may  demand  a  vote,  and,  if  this 
vote  is  against  adjournment  or  if  the  chairman  should  decline 
to  put  the  matter  to  vote,  a  majority  of  the  stockholders  may 
remain  and  continue  the  meeting,  electing  a  new  chairman  if 
necessary,  and  even  adjourning  to  another  room. 32 

If  the  meeting  adjourns  to  a  date  certain,  the  adjourned 
meeting  is  regarded  as  a  continuation  of  the  original  meeting 
and  need  not  therefore  be  again  notified  to  the  stockholders.     If 

"  State  V.  Cronan,  23  Nev.  437  (1897). 


Ch.  42]  ANNUAL  MEETING  OF  STOCKHOLDERS  351 

the  adjournment  is  for  more  than  a  few  days,  however,  it  is 
always  proper  for  the  secretary  to  send  out  notice  of  the  ad- 
journed meeting  a  reasonable  time  before  it  convenes. 

As  an  adjourned  meeting  is,  from  a  legal  standpoint,  merely 
a  continuation  of  the  original  meeting,  the  same  officers  preside 
and  any  business  that  might  have  been  transacted  at  the  first 
meeting  may  be  acted  upon  at  its  adjournment,  or  at  any 
adjournment  from  an  adjourned  meeting.** 

§  411.     Signing  Minutes 

As  soon  after  the  meeting  as  convenient  and  while  its  details 
are  fresh  in  his  mind,  the  secretary  should  write  up  its  proceed- 
ings in  the  minute  book  and  sign  them  with  his  name  and  official 
designation.  The  presiding  officer  also  usually  affixes  his  sig- 
nature. 

The  minutes  are  the  legal  evidence  of  the  proceedings  of  the 
meeting,  and  this  double  signature  is  of  advantage  in  event  of 
any  dispute  as  to  the  accuracy  of  the  record.** 


"  People  V.  Batchelor,  22  N.  Y.  128  (i860);  Staats  v.  Borough  of  Washington,  44  N.  J.  L. 
60s,  611  (1882). 

"See  Book  IV,  Ch.  XVI,  "Minutes  of  Corporate  Meetings." 


CHAPTER  XLIII 
SPECIAL  MEETINGS  OF  STOCKHOLDERS 

§  412.    Special  or  Called  Meetings 

"Special"  or  "called"  meetings  are  held  when  matters  de- 
manding the  attention  of  the  stockholders  arise  in  the  interim 
between  annual  meetings.  As  in  the  case  of  annual  meetings, 
special  meetings  of  stockholders  must  be  held  within  the  state 
in  which  the  corporation  was  organized,  and  usually  at  the 
principal  office  of  the  corporation,  unless  otherwise  expressly- 
permitted  by  statute  or  charter  provision.  Statutory  provisions 
regarding  special  meetings  which  are  found  in  a  number  of  states, 
mainly  relate  to  the  call  or  notice  required. 

Special  meetings  differ  from  the  annual  meeting  in  the  fol- 
lowing important  details: 

1.  They  must  be  authorized  by  a  more  or  less  formal  call. 

2.  Notice  of  the  time,  of  the  place,  and  of  all  business  to 

be   transacted  at  the  meeting  must  be  given  each 
stockholder  of  record. 

3.  No  other  business  save  that  so  notified  may  be  trans- 

acted at  the  meeting. 

The  formalities  of  special  meetings  must  be  strictly  observed, 
or  action  taken  thereat  may  be  invalidated.  They  may,  how- 
ever, be  waived  by  consent  of  every  interested  party,  either 
formally  expressed  in  writing,  or  indicated  by  their  presence  at, 
and  participation  or  acquiescence  in,  the  meeting.^ 

§  413.    Call  for  Meeting 

The  time  and  place  of  special  meetings  cannot,  from  the 
nature  of  the  case,  be  prescribed  by  the  by-laws,  and  hence 


»  See  Book  IV,  Form  ids. 

352 


Ch.  43]  SPECIAL  MEETINGS  OF  STOCKHOLDERS  353 

each  meeting  must  be  formally  called  as  the  necessity  arises. 
The  manner  of  this  call  is  sometimes  prescribed  by  statute  or 
charter  but  is  usually  left  for  the  by-laws.  If  neither  the  stat- 
utes, charter,  nor  by-laws  prescribe  the  manner  of  calling  special 
meetings  of  stockholders,  the  directors  may  always  do  so  by 
resolution,2  or  the  stockholders  may  unite  in  calling  a  meeting, 
which,  provided  the  number  joining  in  the  call  represents  a  fair 
proportion  of  the  outstanding  stock  and  the  time  and  place  is 
reasonable,  will  be  lega.1. 

Ordinarily  the  by-laws  provide  that  special  meetings  may 
be  called  in  any  one  of  four  ways: 

1.  By  written  call  signed  by  the  president. 

2.  By  resolution  of  the  directors. 

3.  By  written  call  signed  by  two  or  more  directors. 

4.  By  written  or  published  call  subscribed  by  a  specified 

number  of  stockholders,  or  a  certain  proportion  of 
the  outstanding  stock,  usually  ranging  from  one-third 
to  a  majority.3 

The  call  and  notice  for  a  special  meeting  must  state  its  time, 
place,  and  purpose.'*  These  essentials  every  stockholder  is  en- 
titled to  know,  and  the  omission  of  any  one  might  invalidate 
the  entire  action  of  the  meeting.  No  business  except  that  which 
has  been  specified  in  the  call  and  in  the  notice  which  follows  the 
call,  can  be  legally  transacted  at  a  special  meeting.^  To  end  the  call 
or  notice,  as  is  frequently  done,  with  some  general  phrase,  such 
as  "and  all  other  matters  that  may  come  before  such  meeting," 
does  not  add  to  the  scope  of  the  meeting  in  any  way  and  does 
not  in  itself  legally  authorize  the  consideration  of  anything. « 

Where  a  company  with  but  few  stockholders  is  to  be  assem- 
bled in  special  meeting,  time  may  be  saved  by  employment  of 
the  combined  call  and  waiver  of  notice.    This  requires  the  sig- 


'  Commonwealth  v.  Smith,  45  Pa.  St.  S9  (1863);  Cassell  v.  Lexington,  etc.,  Co.,  9  S.  W. 
Rep.  502  (1888). 

•  See  Book  IV,  Ch.  XI,  "Calls  and  Waivers  for  Special  Meetings." 

•  2  Cook  on  Corp.,  {  S9S. 

>  Clark  &  Marshall  on  Corp.,  {  647. 

•  I  Morawetz  on  Corp.,  {  482;  People's  Ins.  Co.  v.  Wcstcott,  80  Mass.  440  (i860). 


354  CORPORATE  LAW  [Bk.  I- 

nature  of  every  stockholder  to  make  it  effective,  but  the  meet- 
ing so  authorized  may  be  held  at  once,  and,  if  so  agreed,  any 
business  within  the  powers  of  the  stockholders  may  be  trans- 
acted "thereat.  A  provision  in  a  duly  signed  call  and  waiver 
for  the  "transaction  at  such  meeting  of  any  and  all  business 
pertaining  to  the  affairs  of  the  company"  is  effective,  since 
everyone  interested  has  agreed  thereto. ^ 

The  first  meeting  of  stockholders  is  merely  a  form  of  special 
meeting  and  is  usually  assembled  by  call  and  waiver  signed  by 
all  those  entitled  to  be  present. 

§  414.    Notice  of  Special  Meeting 

The  call  for  a  special  meeting  must  not  be  confused  with  the 
notice  of  such  a  meeting.  The  call  is  the  written  authority  or 
instructions,  usually  handed  or  sent  to  the  secretary,  pursuant 
to  which  the  meeting  is  to  be  assembled.  The  notice,  on  the 
other  hand,  is  the  actual  statement  of  the  time,  place,  and  pur- 
poses of  the  meeting,  sent  out  to  the  stockholders,  usually  by 
the  secretary,  in  obedience  to  the  instructions  of  the  call  and 
in  accordance  with  its  terms. «  If  there  is  any  material  differ- 
ence as  to  these  between  the  call  and  the  notice,  the  meeting  is 
invalidated  thereby.  The  time  means  both  the  day  and  the 
hour.  No  business  other  than  that  specified  in  the  notice  may 
be  transacted  at  a  special  meeting.  If  one  single  stockholder 
is  not  properly  notified,  he  may  be  able  to  set  the  entire  pro- 
ceedings of  the  meeting  aside. ^ 

When,  as  is  usually  the  case,  notice  of  a  special  meeting 
must  be  sent  by  mail  to  the  "last  known  address"  of  each  stock- 
holder, or  to  his  "address  as  it  appears  on  the  books  of  the 
corporation,"  the  secretary  must  be  prepared  to  make  aflEidavit, 
if  necessary,  that  this  has  been  done.  If  no  special  method  of 
service  or  publication  is  prescribed  by  the  statutes,  the  by-laws, 


»  2  Cook  on  Corp.,  I  599. 

'  I  Morawetz  on  Corp.,  §  482. 

»  See  Book  IV,  Ch.  XII,  "Notices  of  Meetings.' 


Ch.  43]  SPECIAL  MEETINGS  OF  STOCKHOLDERS  355 

or  other  corporate  regulation,  the  secretary  must  himself  or  by- 
deputy  give  personal  notice  by  placing  a  copy  of  the  notice  in 
the  hands  of  each  stockholder. i"  If  no  time  is  prescribed,  notice 
must  be  served  a  "reasonable  time  before  the  meeting."ii  When 
notice  is  requested  to  be  given  a  certain  number  of  days  before 
the  meeting,  the  time  should  be  counted  exclusive  of  the  day 
of  notice  and  the  day  of  meeting,  though  in  New  York  by 
statute  provision  but  one  of  these  days  need  be  excluded. 

If  the  secretary  refuses  to  give  proper  notice  of  a  special 
meeting  after  it  has  been  duly  called,  anyone  interested  may 
send  out  the  notice,  and  such  notice,  if  in  due  form  and  properly 
served  on  each  stockholder,  will  be  effectual. 

§  415.    Consent  Meetings 

Special  meetings  of  stockholders  may  be  assembled  at  any 
time  without  the  usual  call  and  notice  if  all  interested  sign  a 
formal  waiver  thereof.12  Also,  if  without  any  such  waiver  all 
the  stockholders  assemble  in  meeting,  no  matter  how  called  or 
whether  called  at  all,  it  is  termed  a  "consent  meeting,"  and,  all 
present  acquiescing,  any  business  within  the  stockholders'  powers 
may  be  transacted  thereat.is  Those  present  and  participating 
in  such  meeting  are  thereby  estopped  from  later  objection  to  any 
informality  of  call  or  notice,  and,  as  all  concerned  are  present, 
no  one  is  left  who  has  a  right  to  object. 

When  consent  meetings  are  held,  it  is  important  that  the 
minutes  shall  show  the  presence  of  every  stpckholder.  Also  if 
the  action  taken  is  important,  it  is  always  advisable  that  every 
person  present  shall  either  sign  the  minutes,  which  is  the  most 
effective  evidence  of  attendance  and  acquiescence,  or  otherwise 
sign  a  waiver  of  the  formalities. 

In  a  small  or  close  corporation  consent  meetings  can  be 


">Stebbins  et  al.,  Admrs.  v.  Merritt  et  al.,  64  Mass.  27  (1852);  Tuttle  v.  Mich.  Air  Line 
R.  R.  Co.,  35  Mich.  247  (1877). 

"  Re  Long  Island  Railroad,  19  Wend.  (N.  Y.)  37  (1837);  Covert  v.  Rogers,  38  Mich. 
363  (1878). 

"  3  Clark  &  Marshall  on  Corp.,  $  647,  note  278. 

"  Handley  v.  Stutz,  139  U.  S.  417  (1890);  In  re  Griffing  Iron  Co.,  63  N.  J.  L.  168  (1898); 
afifd.,  63  N.  J.  L.  357  (1899). 


3S6  CORPORATE  LAW  [Bk.  I- 

readily  assembled  and  are  the  rule  when  special  meetings  are 
necessary.  In  the  larger  corporations  such  meetings  are  in 
most  cases  obviously  impossible.  In  New  York  and  a  few 
other  states  such  "consent  meetings"  are  recognized  by  statute 
law.    Elsewhere  such  a  meeting  is  valid  under  the  common  law. 

§  416.    Opening  Formalities 

The  procedure  for  opening  a  special  meeting  is  the  same  as 
in  the  case  of  the  annual  meeting. i^  The  alphabetical  list  of 
stockholders  required  by  statute  in  some  of  the  states  at  the 
annual  meeting  of  stockholders,  is  not  required  at  special  meet- 
ings unless  directors  are  to  be  elected. 

The  proof  of  proper  call  and  notice  of  the  meeting  follows 
the  roll-call.  The  secretary  should  present  the  original  duly 
signed  call;  also  a  copy  of  the  notice  sent  out  pursuant  to  the 
call,  with  his  certificate  attached  showing  that  the  notice  was 
properly  addressed  and  mailed  to  each  stockholder  the  neces- 
sary number  of  days  before  the  date  of  the  meeting.  The  call 
and  notice  may  be  ordered  received  and  filed  as  in  the  case  of 
a  regular  meeting,  or,  as  the  validity  of  the  meeting  is  dependent 
upon  its  due  assembling  evidenced  by  the  call  and  notice,  they 
may  very  properly  be  ordered  spread  upon  the  minutes. 

If  the  meeting  has  been  assembled  by  call  and  waiver  signed 
by  all  the  stockholders  of  the  company,  this  instrument  should 
be  presented  to  the  meeting  and  may  be  properly  included  by 
the  secretary  in  his  minutes  without  instruction. 

§  417.     Special  Business 

Minutes  of  previous  stockholders'  meetings  cannot  properly 
be  approved  at  a  special  meeting,  unless  so  provided  in  the 
call  and  notice  or  other  authorization  of  the  meeting,  nor  can 
any  other  business  be  transacted  save  that  so  specified. 15  Hence 
the  particular  business  for  which  the  meeting  was  called  should 

"  See  i  399- 

"Warner  v.  Mower,  ii  Vt.  385  (1839);  People's  Mut.  Ins.  Co.  v.  Westcott,  80  Mass. 
'y^o  (i860);  Atlantic  De  Laine  Co.  v.  Mason,  s  R.  I.  463  (1858). 


Ch.  43]  SPECIAL  MEETINGS  OF  STOCKHOLDERS  357 

be  taken  up  at  once.  The  presiding  officer,  or  at  his  request 
someone  present,  states  the  purposes  of  the  meeting  and  makes 
such  explanations  as  may  be  necessary.  Or  the  presiding  officer 
may  call  upon  the  secretary  to  read  the  notice  of  the  meeting 
in  which  its  purposes  are  set  forth  and  then  call  upon  someone 
familiar  with  the  matter  to  explain  it  to  the  stockholders. 
After  such  statement  and  explanation  and  any  desired  discus- 
sion, someone  interested  usually  presents  and  moves  the  adop- 
tion of  a  resolution  covering  the  matter.  The  meeting  may 
then,  at  its  discretion,  dispose  of  this  resolution  in  any  parlia- 
mentary way. 

§  418.    Adjournment 

As  already  stated,  no  business  of  any  kind  may  be  transacted 
at  a  special  meeting  save  that  specifically  authorized.  As  soon, 
therefore,  as  the  particular  business  for  which  the  meeting  was 
called  is  disposed  of,  nothing  is  left  but  adjournment.  This 
may  be  by  motion,  or,  if  no  one  objects,  the  president  may 
merely  state  that  "no  further  business  being  before  the  meeting, 
it  stands  adjourned." 

A  special  meeting  may  be  adjourned  to  another  day  just  as 
may  an  annual  meeting,  and  at  the  adjourned  meeting  any 
business  set  forth  in  the  notice  for  the  original  meeting  may  be 
considered.  New  business  cannot,  however,  be  introduced  or 
considered.  No  notice  of  an  adjourned  meeting  is  necessarily 
sent  to  stockholders. 


CHAPTER  XLIV 

MEETINGS  OF  DIRECTORS 

§  419.    Time  of  Meeting 

The  by-laws  usually  set  forth  the  general  details  of  directors' 
meetings.  The  board  itself  may  provide  for  any  details  not 
already  prescribed  by  some  competent  authority. 

Special  meetings  of  directors  are  called  when  the  necessity 
arises.  Regular  meetings  are  held  at  specified  times — commonly 
once  a  month — usually  fixed  by  the  by-laws.  In  the  smaller 
corporations  with  boards  consisting  of  a  few  members  easily 
assembled  in  special  mSeting,  and  also  in  the  larger  corporations 
whose  affairs  are  conducted  mainly  by  standing  committees, 
regular  board  meetings  once  a  quarter,  or  even  at  longer  intervals, 
are  usually  sufiicient. 

§  420.    Place  of  Meeting 

The  usual  place  for  meetings  of  directors  is  the  principal 
office  of  the  corporation  in  the  state  of  its  creation.  Directors' 
meetings  may,  however,  be  held  elsewhere,  either  within  the 
state,!  or  without  the  state  in  the  absence  of  prohibition,2  if 
properly  authorized  by  the  charter,  the  by-laws,  or  by  due 
resolution  of  the  directors.  If  prohibited  by  statutes,  charter, 
or  by-laws,  meetings  outside  the  state  are  void,  and  their  actions 
of  no  effect.^ 

In  a  majority  of  the  states  the  statutes  provide  that  directors' 
meetings  may  be  held  outside  the  state  if  ■  authorized  in  some 
specified  manner — usually  by  the  by-laws,  in  some  states  by 


1  Corbett  v.  Woodward,  s  Sawy.  403  (1879);  Ashley  Wire  Co.  v.  111.  Steel  Co.,  164  111. 
149  (1896). 

^  3  Cook  on  Corp.,  {  713a;  Saltmarsh  v.  Spaulding,  147  Mass.  224  (1888). 

•  Brockway  v.  Gadsden,  etc.,  Co.,  102  Ala.  620  (1893);  Union  Nat.  Bk.  v.  State  Bank,  155 
Mo.  95  (1899). 

358 


Ch.  44]  MEETINGS  OF  DIRECTORS  359 

the  charter,  in  others  by  either,  but  in  one  or  two  states  by 
mere  resolution  of  the  directors.  In  New  York  meetings  of 
directors  may  be  held  outside  the  state  unless  otherwise  expressly 
provided  in  the  charter  or  by-laws.^  Other  provisions  affecting 
directors'  meetings  outside  the  state  are  found  in  a  number  of 
states. 

In  the  absence  of  any  statutory  provision  on  the  subject,  it 
is  generally  held  that  directors  may  hold  meetings  and  transact 
business  outside  the  state  of  incorporation,  s  In  New  York  a 
contrary  ruling  was  made,  but  it  is  now  provided  by  statute 
that  if  meetings  of  the  board  of  directors  of  a  corporation  organ- 
ized under  the  Business  Corporation  Law  are  to  be  held  only 
within  the  state,  the  certificate  of  incorporation  or  by-laws  must 
so  provide. 6  Of  course,  if  prohibited  by  statute,  meetings  of 
the  board  of  directors  cannot  be  held  outside  the  state,  and 
action  taken  at  such  meetings  will  be  void.' 

Permission  for  directors'  meetings  outside  the  state  is  given 
by  the  statutes  of  several  of  the  states  besides  New  York,  and, 
used  under  proper  regulations  as  to  place  and  notice,  such 
meetings  are  at  times  of  much  advantage.  When  directors  are 
especially  authorized  to  meet  outside  of  the  state  there  is  of 
course  no  question  as  to  the  legality  of  their  actions  at  such 
meetings.  8 

§  421,    Purposes  of  Meetings 

At  duly  assembled  regular  meetings  of  directors,  any  busi- 
ness within  the  power  of  the  board  may  be  transacted.  At 
special  meetings,  unless  otherwise  agreed  by  every  member  of 
the  board,  only  such  business  may  be  acted  upon  as  is  set  forth 
in  the  call  and  notice  of  the  meeting.  If,  however,  the  notice 
of  a  special  meeting  does  not  specify  its  purposes,  any  ordinary 


♦  N.  Y.  Bus.  Corp.  Law,  |  a. 

'  Handley  v.  Stutz,  139  U.  S.  417  (1891);  Boatmen's  Bank  v.  Gillespie,  209  Mo.  217,  256 
(1908). 

•  N.  Y.  Bus.  Corp.  Law,  |  2. 

'  Hilles  V.  Parrish,  14  N.  J.  Eq.  380  (1862);  Place  v.  People,  192  111.  160  (1901). 
"^Saltmarsh   v.  Soaulding,  147  Mass.  224  (1888);  Ormsby  v.  Copper  Co.,  s6  N.  Y.  623 
(1874}. 


360  CORPORATE  LAW  [Bk.  I- 

business  affairs  of  the  corporation  may  be  transacted  thereat, 
unless  the  by-laws  specifically  provide  that  only  such  business 
as  has  been  duly  notified  may  be  transacted  at  special  meetings 
of  the  board. 

§  422.    Assembling  Meetings 

The  time  and  place  of  regular  meetings  are  usually  prescribed 
in  the  by-laws,  are  supposed  to  be  known  to  the  directors,  and 
do  not  depend  for  their  legality  upon  calls,  waivers,  or  notices. ^ 
Notices  are,  it  is  true,  generally  provided  for  in  the  by-laws, 
but  this  is  a  practical  measure  to  insure  the  attendance  of  direc- 
tors, and  is  not  in  compliance  with  legal  requirements.  To  pre- 
vent any  question  on  this  point,  However,  the  by-laws  of  the 
larger  corporations  customarily  provide  that  failure  to  send  out 
notice  of  a  regular  meeting  shall  not  affect  its  legality  nor  the 
legality  of  any  action  taken  thereat. 

Special  meetings,  on  the  other  hand,  are  assembled  as  the 
necessity  arises,  must  be  called  by  proper  authority,  and  must 
be  formally  notified. to  every  member  of  the  board,  unless  these 
formalities  are  duly  waived.  Accordingly  special  meetings  of 
the  board  are  assembled  by  means  of  the  call  followed  by  notice, 
or  by  means  of  a  combined  call  and  waiver  of  notice.  Or  if  all 
the  members  of  the  board  can  be  gotten  together,  a  special 
meeting  may  by  agreement  be  held  at  any  time  and  without 
formality.  These  methods  of  assembling  meetings  of  directors 
are  discussed  in  the  sections  which  follow. 

§  423.    Call  for  Special  Meetings 

The  call  for  a  special  meeting  of  directors  is  the  formal  in- 
strument which  authorizes  its  assembling,  specifying  its  time, 
place,  and  purposes,  and  usually  directing  or  otherwise  obligat- 
ing the  secretary  to  notify  such  meeting  to  the  members  of  the 
board.  10 


•  Whitehead  v.  Rubber  Co.,  52  N.  J.  Eq.  78,  82  (1893);  Western  Imp.  Co.  v.  Bank,  103 
Iowa  4SS  (1897);  Atlantic,  etc.,  Co.  v.  Sanders,  36  N.  H.  252  (1858). 

'!>  See  Book  IV,  Ch.  XI.  "Calls  and  Waivers  for  Special  Meetings." 


Ch.  44]  MEETINGS  OF  DIRECTORS  361 

In  some  few  states  the  statutes  prescribe  by  whom  special 
meetings  of  directors  may  be  called.  In  the  majority  of  the 
states  the  matter  is  left  entirely  for  by-law  regulation.  These 
almost  invariably  empower  the  president  to  call  special  meetings, 
usually  alone,  but  sometimes  in  conjunction  with  some  other 
officer.  Usually  they  provide  that  two  or  more  of  the  directors 
may  call  such  meetings.  Occasionally  a  certain  proportion  in 
interest  of  the  stockholders  are  authorized  thereto.  Whether 
so  specified  in  the  by-laws  or  not,  special  meetings  of  directors 
may  always  be  called  by  due  resolution  of  the  board.  Consent 
meetings  are  assembled  informally. 

The  call  for  a  special  meeting  of  directors  by  whomsoever 
issued,  to  be  legally  effective,  must  always  specify  the  time  of 
meeting  and  its  place,  and  if  business  of  special  importance  is 
to  be  considered  this  must  also  be  set  forth. 

The  place  is  usually — though  not  necessarily  unless  so 
.specified  by  statute  or  by-laws — the  principal  office  of  the 
corporation  within  the  state  of  incorporation. n  In  the  absence 
of  conflicting  provisions,  special  meetings  may  be  called  to 
meet  at  any  reasonable  place  in  the  discretion  of  the  party  or 
parties  issuing  the  call. 

The  time  at  which  the  meeting  is  to  be  held  must  be  reason- 
able, and  must  be  definitely  stated,  both  day  and  hour  being 
given.  The  particular  business  to  be  transacted  must  be  specified 
with  reasonable  detail,  and  ordinarily  no  other  business  may  be 
transacted  at  such  special  meeting. 

§  424.    Notice  of  Special  Meetings 

When  a  call  in  due  form  for  a  special  meeting  of  directors  is 
handed  to  the  secretary,  it  is  his  duty  to  send  out  notices  of  the 
meeting  thereby  authorized.  These  notice's  are  sent  in  such 
manner — usually  by  mail  or  telegraph — and  at  such  time  before 
the  meeting  as  is  prescribed  by  the  by-laws,  or  otherwise  as 

"  See  J  420. 


362  CORPORATE  LAW  [Bk.  I- 

will  under  ordinary  conditions  permit  the  attendance  of  all  the 
members  of  the  board.12 

The  by-laws  also  frequently  prescribe  that  no  business  save 
that  specifically  set  forth  in  the  call  and  notice  shall  be  con- 
sidered or  acted  upon  at  such  special  meetings.  If  not  so  pre- 
scribed, a  notice  specifying  time  and  place,  but  not  the  business 
to  be  transacted,  is  sufficient  to  authorize  all  ordinary  corporate 
business.13  It  is  otherwise  if  important  or  unusual  business  is 
to  be  transacted  at  the  special  meeting.  In  a  Pennsylvania 
case  the  notice  read:  "To  hear  report  of  Treasurer  and  such 
other  business  as  may  be  brought  before  the  meeting."  A  quo- 
rum of  the  directors  met  and  authorized  an  important  lease. 
This  the  courts  set  aside. 1* 

When  the  by-laws  do  not  prescribe  the  specific  details  of 
notice,  both  its  time  and  manner  must  be  reasonable.  Just 
what  constitutes  reasonable  notice  of  special  meetings  of  direc- 
tors is  a  matter  on  which  judicial  decisions  vary,  and  should 
therefore  be  settled  by  express  by-law  provision. 

It  is  always  presumed  that  notice  duly  mailed  with  postage 
prepaid  to  the  last  known  address  of  each  member  of  the  board 
is  received  by  the  party  addressed.  It  is,  however,  usually 
provided  in  the  by-laws  that  notice  given  in  this  manner  shall 
be  sufficient.  When  this  is  done,  it  is  immaterial  whether  or 
not  the  notice  is  actually  received. is  Notice  by  postal  card  is 
sufficient  when  this  method  of  notification  is  customary.  Any 
irregularity  in  call  or  notice  may  be  cured  by  a  ratification  of 
the  special  meeting  or  of  the  business  transacted  thereat  at  a 
subsequent  regular  meeting  of  the  board,  or,  if  all  the  members 
are  present  at  and  participate  in  a  special  meeting,  this  in  itself 
cures  any  defect  in  call  or  notice. i«    Unless  cured  in  some  way, 

'-  See  Book  IV,  Forms  125,  126;  also  People  v.  Albany  Medical  College,  26  Hun  (N.  Y.) 

f48  (1882);  Ashley  Wire  Co.  v.  Illinois  Steel  Co.,  164  111.  149  (1896);  Stockton,  etc.,  Works  v. 
[ouser,  109  Cal.  i  (1895). 

"  Jn  re  Argus  Co.,  138  N.  Y.  557  (1893);  Ashley  Wire  Co.  v.  Illinois  Steel  Co.,  164  111.  149 
(1896). 

"  Mercantile  Library  Hall  Co.  v.  Pittsburg,  etc.,  Assoc,  173  Pa.  St.  30  (1896). 
"  Ashley  Wire  Co.  v.  Illinois  Steel  Co.,  164  111.  149,  159  (1896);  Haj  v.  Amer.  Bottle  Co., 
183  111.  App.  636,  641  (1913). 

"Minneapolis  Times  Co.  v.  Nimocks,  53  Minn.  381  (1893);  Chase  v.  Tuttle,  55  Conn. 
45S  (1888). 


Ch.  44]  MEETINGS  OF  DIRECTORS  363 

failure  to  give  notice  to  any  one  director  invalidates  the  action 
of  a  special  meeting.i'' 

§  425.     Call  and  Waiver  of  Notice 

The  call  and  waiver  of  notice  of  a  special  meeting  of  directors 
is  merely  a  call  for  the  meeting  combined  with  a  waiver  of  the 
usual  formalities  of  notice.  This  must  be  signed  by  every 
member  of  the  board,  but  when  so  signed  authorizes  a  meeting 
to  be  held  at  the  time  and  place,  and  for  the  transaction  of  the 
business  specified  therein.  Whenever  the  members  of  the  board 
are  readily  accessible,  the  call  and  waiver  is  the  preferable 
method  of  assembling  special  meetings.is 

§  426.    Opening  Directors'  Meetings 

At  the  time  appointed  for  the  meeting,  the  president  of  the 
corporation — or  the  chairman  of  the  board,  if  such  official  exists 
— or  in  his  absence  the  vice-president,  calls  the  meeting  to  order. 
Should  these  officers  be  absent,  the  next  ranking  officer  of  the 
corporation,  if  a  member  of  the  board,  presides.  Should  such 
officer  be  the  secretary,  he  should  merely  call  the  meeting  to 
order,  and  then  request  some  other  member  of  the  board  to  act 
as  chairman,  or,  if  objection  is  made,  the  appointment  should 
be  effected  by  motion. 

If  no  ofiicer  of  the  corporation  who  is  also  a  member  of  the 
board  is  present,  it  is  proper  for  any  member  of  the  board  in 
attendance  to  call  the  meeting  to  order,  and  in  the  absence  of 
objection  ask  someone  to  act  as  chairman.  If  there  is  objection, 
the  appointment  should  be  made  by  means  of  a  motion. 

No  formal  roll-call  of  a  directors'  meeting  is  usual,  the  sec- 
retary merely  noting  the  names  of  those  present,  which  names 
are  later  entered  on  the  minutes.  If  there  is  no  quorum,  business 
may  not  be  transacted  at  that  session,  but  the  meeting  may 
adjourn  from  day  to  day,  if  desired,  until  a  quonmi  is  secured. 


"People  V.  Batchelor.  22  N.  Y.  128  (i860);  Relley  v.  Campbell,  134  Gal.  175  (1901): 
Broughton  v.  Jones,  120  Mich.  462  (1899);  Hill  v.  Coal  Co.,  119  Mo.  9  (1893). 
"See  Book  IV,  Forms  116,  117. 


3iS4  CORPORATE  LAW  [Bk  I- 

Formal  submission  of  proof  of  notice  of  a  directors'  regular 
meeting  is  not  necessary  unless  called  for  by  the  president  or 
some  member  of  the  board.  The  secretary  should,  however, 
preserve  a  copy  of  the  notice  sent  out  and  indorse  upon  it  the 
fact  that  it  was  duly  mailed  on  the  date  given  thereon  to  the 
last  known  address  of  each  member  of  the  board. 

In  the  case  of  special  meetings  of  directors  the  call  and 
notice,  or  call  and  waiver  of  notice  as  the  case  may  be,  should 
be  submitted  to  the  meeting  and  be  entered  on  the  minutes  in 
full  with  a  statement  of  the  circumstances.  The  matter  is  of 
importance,  as  the  due  call  of  the  meeting  with  sufficient  notice 
to  each  member  is  absolutely  essential  to  its  legality. 

At  a  regular  meeting  of  directors  the  order  of  business  as 
set  forth  in  the  by-laws  is  followed,  unless  set  aside  by  formal 
motion  or  unanimous  consent.  At  a  special  meeting  it  is  but 
seldom  applicable. 

§  427.     Quorum 

The  number  required  for  a  quorum  at  directors'  meetings 
should  be  fixed  by  the  charter  or  by-laws.i^  In  New  York  this 
cannot  be  a  number  less  than  one-third  of  the  full^o  membership 
of  the  board.  Where  there  is  no  provision  in  the  charter  or 
by-laws,  the  common  law  prevails,  and  a  majority  of  the  whole 
board  is  necessary  for  a  quorum. 2  A  majority  of  the  board  in 
this  connection  is  a  majority  of  the  whole  number  constituting 
the  board,  and  not  of  some  reduced  number  resulting  from 
vacancies  or  removals. 22  A  majority  of  a  quorum  can  decide 
any  question  properly  brought  before  the  meeting.23 

Directors  cannot  vote  by  proxy  at  directors'  meetings,  but 
must  be  personally  present  in  order  to  act  thereat.24    No  legal 


'•  Hoyt  V.  Thompson's  Ex... 19  N.  Y.  207  (1859);  Craig  Medicine  Co.  v.  Merchants'  Bank, 
59  Hun  (N.  Y.)  561  (1891). 

"  N.  Y.  Gen.  Corp.  Law,  {  34. 

SI  Wells  V.  Rubber  Co.,  19  N.  J.  Eq.  402  (1869). 

«  Moore  V.  Rector,  4  Abbott's  N.  Cas.  (N.  Y.)  51  (1873). 

»  N.  Y.  Gen.  Corp.  Law,  $  43;  Wells  v.  Rubber  Co.,  19  N.  J.  Eq.  402  (1869);  Foster  v- 
Mill  Co.,  92  Mo.  79  (1887). 

M  Perry  v.  Oil  Co.,  93  Ala.  364  (1890);  State  v.  Perkins,  90  Mo.  App.  603  (1901). 


Ch.  44]  MEETINGS  OF  DIRECTORS  365 

authority  exists  for  permitting  directors  to  vote  or  to  be  con- 
sidered as  present  when  merely  connected  by  telephone,  nor  for 
permitting  an  absent  member  to  sign  the  minutes  of  the  direc- 
tors' meeting  and  be  counted  present,  though  any  action  so 
taken  may  be  validated  by  action  at  a  subsequent  meeting 
where  a  quorum  is  really  present. 

A  director  cannot  legally  vote  at  directors'  meetings  on  a 
matter  in  which  he  is  personally  interested,  nor  is  such  action 
usually  valid  if  he  is  jounted  to  make  a  quorum  when  such  a 
question  is  put  to  vote.2s 

§  428.    Reading  the  Minutes 

As  a  matter  of  due  parliamentary  procedure,  any  unapproved 
minutes  of  preceding  directors'  meetings  should  be  read  and 
approved  or  be  otherwise  disposed  of  at  a  regular  meeting  of 
directors  before  any  other  business  is  considered.  If,  however, 
time  is  pressing,  the  president  sometimes  directs  that  the  read- 
ing of  the  minutes  be  dispensed  with,  or  the  same  end  is  accom- 
plished by  formal  motion. 

The  minutes  of  stockholders'  meetings  are  never  read  at 
directors'  meetings  imless  as  a  matter  of  information  or  by 
special  request,  nor  if  read  would  their  approval  by  the  board 
be  of  any  legal  effect.  The  minutes  of  any  preceding  board 
meeting  should  not  be  approved  at  a  special  meeting  unless  the 
approval  of  such  minutes  was  specifically  mentioned  as  one  of 
the  purposes  of  the  meeting.26 

§  429.    Reports 

At  a  regular  meeting,  after  disposal  of  the  minutes,  the 
president  takes  up  the  next  order  of  business  and  calls  for  re- 
ports from  officers  first,  and  then  from  committees,  if  any  are  to 
report.  When  a  report  is  made  it  may  be  disposed  of  by  motion, 
or,  if  there  are  no  objections,  the  president  himself  may  direct 


"Curtin  v.  Salmon  River  Co.,  130  Cal.  34s  (1900);  Miller  v.  Crown  Perfumery  Co.,  57 
Misc.  (N.  Y.)  383  (1908);  Jacobson  v.  Brooklyn  Lumber  Co.,  184  N.  Y.  152  (1906). 
»•  See  I  438. 


366  CORPORATE  LAW  [Bk.  I- 

that  the  report  be  received  and  filed.  A  verbal  report  does  not 
require  any  formal  disposal,  the  secretary  reporting  its  sub- 
stance in  the  minutes  as  a  matter  of  course. 

§  430.    Unfinished  and  New  Business 

The  business  of  a  special  meeting  is,  as  a  rule,  all  new  busi- 
ness. It  is  set  forth  in  both  the  call  and  notice,  and  may  be 
presented  by  the  presiding  officer,  or  he  may  call  on  the  secretary 
or  some  member  of  the  board  for  its  introduction. 

At  regular  meetings  of  directors  it  usually  rests  with  the 
secretary  to  bring  up  any  matters  of  unfinished  business.  New 
matters  requiring  attention  are  brought  up  by  the  president  or 
by  any  member  interested. 

The  election  of  officers  does  not  appear  upon  the  regular 
order  of  business,  as  it  takes  place  but  once  a  year.  It  therefore 
comes  under  the  head  of  "New  Business,"  and  at  the  proper 
meeting  may  be  taken  up  at  any  suitable  time  when  new  busi- 
ness is  under  consideration.  Usually  the  by-laws  provide  that 
the  election  of  officers  shall  be  held  at  the  first  directors'  meeting 
after  the  annual  meeting  of  stockholders. 

Officers  are  usually  elected  by  ballot,  though  in  the  absence 
of  express  provision  the  board  may  follow  any  method  that 
will  secure  a  fair  expression  of  the  wishes  of  its  members. 

When  the  board  is  agreed  as  to  who  are  to  be  elected,  time 
is  frequently  saved  by  instructing  the  secretary  to  cast  the 
single  ballot  of  the  meeting  for  the  recited  list  of  officers.  Or 
a  mere  motion  unanimously  carried  that  the  named  persons  be 
respectively  appointed  to  the  specified  offices,  is  legally  suffi- 
cient. The  election  of  officers  by  the  board  is  sometimes  held 
to  be  more  in  the  nature  of  an  appointment  than  of  an  election. 27 

Unless  otherwise  specified  by  the  by-laws  or  prevented  by 
conditions,  the  officers-elect  may  at  once  begin  the  discharge 
of  the  duties  of  their  respective  offices.    Frequently  the  newly 


"  state  V.  Kupferle,  44  Mo.  154  (1869). 


Ch.  44]  MEETINGS  OF  DIRECTORS  367 

elected  president  and  secretary  take  charge  of  the  meeting  im- 
mediately after  the  result  of  the  election  has  been  announced. 
A  person  cannot  be  made  an  officer  against  his  will.28  Ac- 
ceptance of  the  position  to  which  an  officer-elect  has  been  ap- 
pointed is  therefore  necessary.  This  may  either  be  expressed, 
or  be  indicated  by  the  performance  of  the  duties  of  his  office, 
or  even  by  his  failure  to  decline  the  office  when  properly  notified 
of  his  election  thereto.29 

§  431.    Adjournment 

When  the  business  of  a  meeting  has  been  finished,  or  when 
for  any  reason  the  board  cannot  longer  continue  in  session,  an 
adjournment  should  be  taken,  either  sine  die,  which  terminates 
the  meeting  absolutely,  or,  if  important  business  is  left  un- 
finished, to  some  specified  future  date. 

A  meeting  adjourned  to  some  future  time  is  on  reassembling 
legally  regarded  as  a  continuation  of  the  original  meeting,  may 
transact  any  business  that  could  have  been  transacted  at  the 
original  meeting,  and  does  not  necessarily  require  any  notifica- 
tion to  the  members  of  the  board. ^o 

§  432.    Procedure  at  Meetings  of  Standing  Committee 

The  general  rules  governing  the  meetings  of  a  standing  com- 
mittee are  the  same  as  those  for  meetings  of  the  board. si  Special 
meetings  must  be  duly  notified  to  every  member  of  the  committee 
unless  waived  by  formal  agreement  or  by  the  presence  of  every 
member  at  the  meeting.  Actions  taken  at  meetings  of  the  com- 
mittee should  be  expressed  by  means  of  duly  adopted  motions 
or  resolutions,  and  careful  minutes  of  all  proceedings  should  be 
kept  in  a  minute  book  provided  for  the  purpose,  and  not  in  the 
minute  book  of  the  directors.    The  committee  proceedings  should 


"Blake  v.  Bayley,  82  Mass.  S3i  (i860). 

"  Danville,  etc.,  Co.  v.  Brown,  90  Va.  340  {1893);  Lockwood  v.  Nat.  Bank,  9  R.  I.  308 
(1869). 

"Smith  V.  Law,  21  N.  Y.  296  (i860);  Western  Imp.  Co.  v.  Bank,  103  Iowa  455  (1897)- 

«  Met.  Tel.  Co.  v.  Domestic  Tel.  Co.,  44  N.  J.  Eq.  568  (1888);  McNeil  v.  Chamber  of 
G)mmerce,  154  Mass.  277  (1891). 


368  CORPORATE  LAW  (Bk.  I- 

from  time  to  time  be  reported  to  the  board,  either  by  direct  re- 
port or  by  submission  of  the  committee  minutes. 

Unless  otherwise  expressly  provided,  the  majority  of  any 
standing  committee  constitutes  a  quorum,  and  a  majority  of 
that  quorum  has  power  to  act.  32 


»  Burleigh  v.  Ford,  6i  N.  H.  360  {1881);  State  v.  Jersey  City,  27  N.  J.  L.  493  (i8s9); 
McNeil  V.  Boston  Chamber  of  Com.,  154  Mass.  277  (1891). 


CHAPTER  XLV 

MINUTES  OF  MEETINGS 

§  433.    The  Corporate  Books 

The  financial  records  of  a  corporation  are  much  the  same  as 
those  of  a  firm  or  individual.  Some  of  their  entries  and  accounts 
are  peculiar  to  the  corporation  but  the  books  do  not''dififer  from 
those  of  any  other  form  of  business  organization.! 

The  more  important  books  of  record  peculiar  to  the  corpora- 
tion are  the  minute  book,  the  stock  certificate  book,  the  transfer 
book,  and  the  stock  book  and  stock  ledger,  all  of  which  are  kept 
by  the  secretary  of  the  corporation.  . 

§  434.    The  Minute  Book 

The  minute  book  of  a  corporation  properly  kept  is  legal 
evidence  of  the  proceedings  of  its  stockholders'  and  directors' 
meetings.  The  secretary  is  its  custodian  and  its  entries  should 
be  made  by  him  alone.  Any  director  has  the  right  to  inspect 
this  book  at  any  suitable  time.  A  stockholder  usually  does  not 
have  this  right. 

The  minute  book  is  ordinarily  a  blank  book  of  the  style 
termed  "record"  by  stationers.  It  may  be  had  at  any  price 
from  plainly  bound  books  at  $1  or  less,  up  to  elaborately  bound 
and  specially  printed  books  costing  from  $5  to  $25  or  even  more. 
A  reasonably  good  and  substantially  bound  book  is  always  to  be 
desired. 

The  minute  book  varies  in  size  and  general  form  according 
to  the  taste  or  requirements  of  the  secretary.  A  common  and 
convenient  form  is  8^  x  13  inches.     Sometimes  the  book  is 


'  See  I  445;  also  Book  III,  "Corporate  Accounting." 

369 


370  CORPORATE  LAW  [Bk.  I- 

specially  made,  of  a  size  and  style  to  match  the  other  corporate 
records.  For  a  small  corporation  with  few  meetings,  a  book 
containing  loo  pages  will  usually  be  found  amply  sufficient. 

When  the  minutes  are  kept  in  a  substantially  bound  volume 
with  longhand  entries  succeeding  each  other  in  regular  order, 
later  additions  or  insertions  are  difficult  if  not  impossible,  and 
the  evidence  of  the  minutes  as  to  proceedings  at  the  company's 
meetings  is  difficult  to  controvert. 

Minutes  are,  however,  not  infrequently  written  with  the 
typewriter  on  sheets  of  thin  paper,  which  are  then  pasted  in  the 
minute  book.  Also  at  times  loose-leaf  minute  books  are  em- 
ployed, in  which  the  pages  may  be  removed  and,  after  the 
minutes  are  written  upon  them,  be  reinserted  in  the  book.  When 
either  of  these  plans  is  followed,  substitutions  and  alterations  in 
the  minutes  may  be  made  with  comparative  ease  and  their  value 
as  evidence  is  diminished.     • 

To  avoid  this  objection  to  the  convenient  loose-leaf  minute 
book,  each  page  is  sometimes  water-marked  with  its  proper 
number  in  such  manner  that  substitution  is  extremely  difficult 
and  practically  impossible.  The  same  end  is  sometimes  accom- 
plished by  the  inscription  of  the  president's  and  secretary's 
signatures  or  initials  on  each  page,  making  substitution  without 
the  participation  of  these  officials  impossible.  It  is  obvious 
that  this  latter  method  of  verification  may  also  be  effectively 
employed  when  minutes  are  pasted  into  the  minute  book. 

§  435'     Contents  of  Minute  Book 

A  copy  of  the  company's  charter  or  certificate  of  incorpora- 
tion is  usually  entered  on  the  first  pages  of  the  minute  book. 
This  may  be  a  copy  certified  by  the  secretary  of  state,  bound  or 
pasted  into  the  book,  or,  equally  sufficient,  a  careful  and  legible 
copy  written  in  the  book  by  the  secretary,  or,  if  written  on 
separate  sheets,  bound  or  pasted  into  the  minute  book.  If  the 
copy  is  made  by  him,  the  secretary  usually  certifies  to  its  cor- 
rectness. 


Ch.  4S]  MINUTES  OF  MEETINGS  371 

Following  the  charter  come  the  by-laws  of  the  company, 
These  begin  at  the  top  of  the  next  right-hand  page  and  should 
also  be  a  careful  and  legible  copy,  or  a  copy  bound  or  pasted  in, 
followed  by  the  secretary's  certificate  as  to  the  accuracy  of  the 
transcription. 

A  few  pages  immediately  following  the  by-laws  should  be 
left  blank  for  the  entry  of  any  amendments.  Then  follow  the 
minutes  of  the  first  meeting  of  stockholders,  closely  followed  by 
the  proceedings  of  the  first  meeting  of  directors,  and  thereafter 
the  minutes  of  stockholders'  and  directors'  meetings  in  due  se- 
quence as  held,  each  with  its  distinctive  heading.  Each  meeting 
should  begin  at  the  top  of  its  proper  page  and  no  blank  pages 
should  be  left  between  the  records  of  the  different  meetings. 

In  the  larger  corporations  separate  minute  books  are  pro- 
vided for  stockholders'  and  directors'  minutes  and  also  for  the 
minutes  of  standing  committees.  In  the  smaller  corporations  a 
single  minute  book  will  usually  suffice. 

§  436.    Form  and  Subject  Matter  of  Minutes 

The  secretary  should  spare  no  pains  to  secure  accuracy  in  his 
minutes,  since  they  are  the  legal  evidence  of  the  proceedings  of 
the  meetings  recorded  and  the  authority  for  any  action  of  the 
officers  required  thereby. 

The  minutes  given  in  the  latter  part  of  this  work  are  in  con- 
ventional form.  This  has  the  advantage  of  brevity.  Any  clear 
statement  of  the  proceedings  is,  however,  legally  sufficient, 
though  a  reasonably  close  adherence  to  the  conventional  arrange- 
ment is  desirable. 2 

It  is  usual  to  enter  on  the  minutes  of  directors'  meetings  the 
names  of  those  present.  Save  in  the  case  of  very  small  corpora- 
tions, it  is  not  customary  nor  necessary  to  enter  on  the  minutes 
the  names  of  stockholders  present  at  a  stockholders'  meeting. 
The  secretary  should,  however,  check  off  on  his  alphabetical 


»  See  Book  IV,  Ch.  XVI,  "Minutes  of  Corporate  Meetings."       >  Jl  i)Ot>' 


372  CORPORATE  LAW  [Bk.  I- 

list  those  in  attendance  and  thus  preserve  a  record  of  the  stock- 
holders present  at  meetings. 

During  the  progress  of  meetings,  letters,  reports,  and  other 
instruments  are  frequently  presented.  When  of  importance,  the 
secretary  is  usually  instructed  to  enter  these  upon  the  minutes. 
If  not  instructed,  he  may  use  his  discretion.  If  the  matters  to 
which  they  relate  are  important,  they  should  usually  be  spread 
upon  the  minutes,  i.e.,  entered  in  full.  Generally,  however,  it  is 
sufficient  if  the  instruments  be  filed  and  preserved,  such  reference 
being  made  to  them  in  the  minutes  as  the  conditions  may 
demand. 

When  reports  or  other  instruments  are  ordered  spread  upon 
the  minutes,  the  secretary  may  usually  exercise  his  discretion  as 
to  whether  they  shall  be  included  in  the  body  of  the  minutes  or 
follow  immediately  after  them.  If,  however,  the  motion  or  order 
directs  that  the  instrument  follow  the  minutes,  or  that  it  appear 
in  the  body  of  the  minutes,  the  secretary  should  comply  with  the 
letter  of  his  instructions. 

§  437.     Recording  the  Proceedings 

The  corporate  minutes  are  a  record  of  the  transactions  of 
corporate  meetings — a  record  of  what  is  done,  not  of  what  is 
said;  and  the  record  should  usually  be  as  concise  and  accurate  as 
possible. 

If  a  motion  or  resolution  is  passed  upon  at  a  meeting,  no 
matter  whether  adopted  or  rejected,  its  disposition  should  be 
recorded,  but,  speaking  generally,  the  debate  and  discussion 
should  not  be  set  down,  nor  are  the  names  of  the  parties  by  whom 
minor  motions  or  resolutions  are  made  or  seconded  of  sufficient 
importance  to  be  entered,  nor  need  any  record  be  made  of 
those  voting  for  or  against  any  such  matter. 

It  may  be  said  further  that  when  the  presiding  officer  decides 
that  a  motion  or  a  resolution  is  properly  before  the  meeting  and 
puts  it  to  vote,  the  fact  that  the  names  of  the  parties  who  moved 
and  seconded  it  or  who  voted  for  or  against  it  are  ndt  recorded. 


Ch.  45]  MINUTES  OF  MEETINGS  373 

does  not  affect  the  force  of  the  corporate  action.  If,  however,  a 
motion  or  a  resolution  is  of  importance,  or  is  contested,  or  of 
such  a  nature  that  it  may  thereafter  be  of  importance  to  know 
by  whom  the  matter  was  introduced  and  by  whom  it  was  favored 
and  opposed,  the  record  should  be  made  in  full. 

It  sometimes  happens  that  a  stockholder  or  a  member  oppos- 
ing some  proposed  action  wishes  his  objections  or  protest  recorded 
in  the  minutes.  If  his  objections  are  pertinent  and  not  too 
lengthy,  this  should  usually  be  permitted,  but  the  secretary 
should  not  enter  any  such  objections  upon  his  record  unless  so 
directed  by  a  vote  of  the  meeting  or  by  unopposed  direction  of 
the  presiding  officer. 

The  objecting  member  sometimes  files  his  protest  in  writing 
and  in  such  case  the  document  should  be  received  and  filed  in 
the  usual  course  of  business,  and  this  fact  be  noted  in  the  minutes. 
In  some  cases  it  is  necessary  for  a  member  of  the  board  to  have 
the  dissent  to  proposed  action  noted  in  order  to  avoid  liability. 
In  such  case  he  has  a  right  to  demand  its  entry  upon  the  minutes, 
and,  if  refused,  may  force  its  entry  by  proper  legal  procedure. 

Motions  are  not  usually  entered  verbatim.  It  is  sufficient 
if  their  sense  is  preserved.  Resolutions  are,  however,  more  for- 
mal and  should  usually  be  entered  in  the  exact  form  in  which 
they  are  adopted. »  The  presiding  officer  of  the  meeting  may 
always  require  resolutions  and  important  motions  to  be  reduced 
to  writing  before  consideration,  and  if  he  does  this  the  work  of 
the  secretary  is  greatly  lightened. 

All  papers  presented  to  or  used  at  meetings  should  be  filed 
for  future  reference  in  the  custody  of  the  secretary,  unless  other- 
wise ordered. 

Notes  of  the  proceedings  are  taken  as  the  meeting  progresses, 
and  these  should  be  written  up  in  permanent  form  as  soon  after 
the  meeting  as  possible  while  the  events  are  fresh  in  the  secre- 
tary's mind.  Should  he  delay  the  final  entry  of  his  record  unduly, 
doubt  may  arise  as  to  whether   the  secretary's   notes,  or   the 

»  See  Book  IV,  Ch.  XIV,  "Motions  and  Resolutions." 


574  CORPORATE  LAW  [Bk.  I- 

record  of  the  minute  book  is  the  original  entry,  and  if  it  should 
be  held  that  the  formal  minutes  are  not  the  original  entry,  their 
value  as  evidence  is  destroyed.  If  minutes  are  used  as  evidence, 
the  secretary  will  be  asked  when  he  wrote  up  his  final  record. 
As  soon  as  the  minutes  are  duly  entered  in  the  minute  book, 
they  should  be  signed  with  the  official  signatures  of  the  secretary 
and  the  presiding  officer  of  the  meeting,  the  secretary  usually 
signing  at  the  right  and  the  presiding  officer  at  the  left. 

§  438.    Approval  and  Amendment  of  Minutes 

Minutes  should  be  approved  by  the  body  whose  proceedings 
they  record.  The  approval  of  stockholders'  minutes  by  the 
board  of  directors  is  absolutely  ineffective,  as  is  also  the  approval 
of  directors'  minutes  by  the  stockholders,  save  by  way  of  indorse- 
ment or  ratification  of  the  directors'  action  recorded  therein.        . . 

The  minutes  of  a  stockholders'  annual  or  special  meeting 
cannot  be  approved  at  a  subsequent  special  meeting  unless  such 
approval  is  noted  in  the  call  and  notice ;  but  the  minutes  of  any 
preceding  stockholders'  meetings,  whether  annual  or  special, 
may  always  be  approved  at  the  stockholders'  annual  meeting. 
Likewise  the  approval  of  the  minutes  of  a  directors'  regular  or 
special  meeting  at  a  subsequent  special  meeting  is  effective  if 
such  approval  was  duly  notified  as  one  of  the  purposes  of  the 
meeting;  while  any  unapproved  minutes  of  directors'  meetings 
may  always  be  approved  at  a  regular  meeting  of  directors. 

The  minutes  of  a  stockholders'  meeting  are  usually  not  passed 
upon  until  the  following  annual  meeting,  when  all  unapproved 
minutes  should  be  read  and,  if  no  objections  are  offered,  ap- 
proved. Directors'  minutes  likewise  are  usually  approved  only 
at  regular  meetings.  The  approval  of  minutes  relieves  the  secre- 
tary of  all  direct  responsibility  for  the  accuracy  of  their  record  and 
also  serves  as  a  ratification  of  the  proceedings  recorded  therein.* 
./  When  minutes  are  approved,  no  record  need  be  made  save 
the  statement  in  the  minutes  of  the  meeting  then  in  progress 

*  Delano  v.  Trustees,  138  Mass.  63  (1884);  County  Court  v.  Ry.  Co.  35  Fed.  Rep.  161 
(1888). 


Ch.  45]  MINUTES  OF  MEETINGS  375 

that  the  minutes  of  the  previous  meeting  or  meetings,  giving 
their  dates,  were  read  and  approved.  Usually,  however,  for 
convenience  the  secretary  also  notes  at  the  bottom  of  each  set 
of  approved  minutes  the  proper  facts,  as  "Approved  at  the 
annual  meeting  of  stockholders  held  January  10,  191 7." 

If  corrections  of  minutes  are  ordered,  the  minutes  of  the 
meeting  then  in  session  should  show  exactly  what  corrections 
were  directed  and  in  what  minutes.  In  the  corrected  minutes 
the  alteration  should  appear  in  red  and  a  marginal  note  should 
give  the  date  of  the  meeting  at  which  such  correction  was 
directed.  Red  lines  may  be  drawn  through  any  part  ordered 
stricken  out  and  any  correction  be  interlined,  but  no  erasure 
should  be  made  in  any  case,  as  the  corrected  minutes  should 
show  both  the  error  and  the  correction. 

Sometimes  it  happens  that  those  present  at  a  meeting  decide, 
contrary  to  the  facts,  that  the  secretary  has  made  errors  in  his 
record  of  a  preceding  meeting,  and  move  that  a  portion  of  the 
minutes  be  stricken  out  or  corrected.  Whether  right  or  wrong, 
if  the  majority  of  those  present  at  the  meeting  vote  in 
favor  of  the  motion,  the  secretary  must  carry  it  into  effect.  In 
such  case  he  should  draw  red  lines  through  the  part  ordered 
stricken  out  and  interline  in  red  any  matter  ordered  inserted,  and 
make  the  proper  entry  in  the  margin  of  the  minutes.  This  then 
shows  the  whole  matter — that  the  record  was  made  in  one  way, 
and  was  at  a  later  date  ordered  changed.  The  minutes  of  the 
meeting  at  which  such  change  was  ordered  should  also  give  a 
complete  statement  of  the  matter. 

§  439.    "Cut  and  Dried"  Minutes 

The  annual  meeting  of  stockholders  is  frequently  held  in  a 
locality  distant  from  the  residence  of  the  parties  really  in  interest, 
as  for  instance  the  meetings  of  the  non-resident  corporations  of 
New  Jersey,  Maine,  and  many  other  states,  which  must  be  held 
within  the  state  of  incorporation.  Also  there  are  many  cor- 
porations in  which  the  whole  or  the  greater  part  of  the  stock  is 


376  CORPORATE  LAW  [Bk.  I- 

held  by  combinations  and  the  subordinate  corporations  hold 
only  such  meetings  as  are  essential  to  maintain  their  legal 
existence.  In  these  and  in  many  other  cases  the  only  necessity 
for  meetings  is  to  give  the  proper  legal  expression  to  matters  that 
are  already  determined,  and  it  is  possible  to  write  out  the  entire 
minutes  in  advance. 

The  proceedings  at  such  meetings  are  simple.  A  controlling 
interest,  usually  in  the  shape  of  proxies,  is  sent  or  taken  to  the 
place  of  meeting.  If  the  regular  officers  are  not  present  or  are 
not  authorized  to  act,  officials  for  the  meeting  are  appointed  at 
the  time  by  those  holding  these  proxies.  The  prepared  minutes 
are  then  read  and  agreed  to,  the  meeting  is  adjourned,  and  the 
accepted  minutes,  signed  by  the  officials  who  acted  at  the  meet- 
ing, are  returned  to  the  secretary  of  the  company  and  preserved 
in  his  minute  book.s 


'  For  detailed  account  of  such  a  meeting,  see  Book  II,  S  30. 


Part  X— The  Treasurer 


CHAPTER  XLVI 

TREASURER'S  DUTIES  AND  POWERS 

§  440.    General 

The  duties,  powers,  and  liabilities  of  the  treasurer  as  one  of 
the  officers  and  directors  of  the  corporation  will  be  found  in 
earlier  chapters  dealing  generally  with  the  duties  and  liabilities 
of  the  officers  and  directors.  The  present  chapter  and  those 
following  deal  with  those  duties  and  liabilities  which  belong 
more  particularly  to  the  office  of  treasurer  alone. 

§  441.    The  Treasurer's  Primary  Duty 

The  treasurer  is  the  official  custodian  of  the  corporate  funds,i 
and  his  primary  duty  is  to  receive  them,  care  for  them,  and 
disburse  them.  Other  duties  assigned  to  him  are  usually  in 
some  way  connected  with  or  related  to  this  primary  duty. 

§  442.    The  Treasurer's  Authority 

The  by-laws  are  almost  invariably  the  source  from  which 
come  both  the  powers  and  the  duties  of  the  treasurer.  Statutes 
rarely  specify  his  duties.  In  New  Jersey,  Pennsylvania,  and  a 
few  other  states  the  treasurer  is  required  by  statute  to  give  a 
bond,  and  in  Pennsylvania  the  treasurer  must  keep  the  moneys 
of  the  corporation  in  a  separate  book  account  to  his  credit  as 
treasurer;  but,  broadly  speaking,  the  whole  matter  of  the  treas- 
urer's duties  is  left  to  the  discretion  of  the  corporation.    In  New 


1  Laurel  Springs  Land  Co.  v.  Fougeray,  57  N.  J.  Eq.  318  (1898). 

377 


378  •  CORPORATE  LAW  [Bk.I- 

York,  New  Jersey,  and  some  other  states  where  the  statutes 
permit  special  charter  provisions,  the  treasurer's  duties  may  be 
specified  therein,  but  such  regulations  properly  belong  in  the 
by-laws  and  are  almost  invariably  found  there. 

In  the  care  and  management  of  the  corporate  funds  and  for 
the  discharge  of  any  duties  connected  therewith,  the  treasurer 
is  the  active  agent  of  the  corporation,  and  of  its  governing  body, 
the  board  of  iirectors.  He  is  therefore  subject  to  the  direction 
of  this  board  in  all  such  matters,  except  in  so  far  as  his  powers 
and  duties  have  already  been  prescribed  by  higher  authority. 

If  no  provision  as  to  the  powers  and  duties  of  the  treasurer 
are  found  in  the  charter  or  by-laws  of  the  corporation,  the 
directors,  as  an  incident  of  their  general  control  of  the  corporate 
affairs,  are  fully  competent  to  determine  these  powers  and  duties 
and  to  authorize  him  to  do  whatever  is  required. 

The  treasurer  is  expected  to  inform  himself  as  to  the  powers 
and  duties  pertaining  to  his  office  and  must  look  for  his  authority, 
first,  in  the  charter  and  by-laws,  and  second,  in  the  resolutions 
of  the  board  of  directors.    ,  , 

§443.    By-Law  Provisions^  ..mq  j-i-; 

By-law  provisions  relating  to  the  treasurer  diflfer  in  each 
corporation,  but  the  following  by-law  extract  presents  an  excel- 
lent synopsis  of  the  usual  duties  of  the  treasurer: 

Section  5.    'The  Treasurer 

The  Treasurer  shall  have  the  custody  of  and  he  responsible  for 
all  moneys  and  securities  of  the  Company;  shall  keep  full  and 
accurate  records  and  accounts  in  books  belonging  to  the  Company, 
showing  the  transactions  of  the  Company,  its  accounts,  liabilities, 
and  financial  condition,  and  shall  see  that  all  expenditures  are  duly 
authorized  and  are  evidenced  by  proper  receipts  and  vouchers. 
He  shall  deposit,  in  the  name  of  the  Company,  in  such  depositary 
or  depositaries  as  are  approved  by  the  Directors,  all  moneys  that 
may  come  into  his  hands  for  the  Company  account.  His  books  and 
accounts  shall  be  open  at  all  times  during  business  hours  to  the 
inspection  of  any  Director  of  the  Company. 


Ch.  46]  TREASURER'S  DUTIES  AND  POWERS  379 

The  Treasurer  shall  also  indorse  for  collection  or  deposit  all  bills, 
notes,  checks,  and  other  negotiable  instruments  of  the  Company; 
shaU  pay  out  money  as  may  be  necessary  in  the  transactions  of 
the  Company,  either  by  special  or  general  direction  of  the  Board  of 
Directors,  and  on  checks  signed  by  the  President  and  himself,  and 
shaU  generally,  together  with  the  President,  have  supervision  of 
the  finances  of  the  Company. 

He  shaU  also  make  a  full  report  of  the  financial  condition  of  the 
Company  for  the  annual  meeting  of  the  stockholders,  and  shall 
make  such  other  reports  and  statements  as  may  be  required  of  him 
by  the  Board  of  Directors  or  by  the  laws  of  the  State.^ 

He  shall  give  bond  in  the  sum  of  Five  Thousand  Dollars,  with 
sureties  satisfactory  to  the  Board  of  Directors,  for  the  faithful 
performance  of  his  duties  and  for  the  restoration  to  the  Company, 
in  event  of  his  death,  resignation,  or  removal  from  office,  of  all 
books,  papers,  vouchers,  money,  and  other  property  belonging  to 
the  Company  that  may  have  come  into  his  custody.  He  shall 
receive  such  compensation,  not  exceeding  Five  Thousand  Dollars 
per  annum,  as  may  be  fixed  by  the  Board  of  Directors. 

By  these  provisions  the  treasurer  is  given  entire  custody 
and  charge  of  the  corporate  moneys  and  securities,  though  not 
of  the  general  property  belonging  to  the  company.  These  pro- 
visions could  be  extended  to  cover  other  property,  if  desired. 

In  the  by-laws  of  the  larger  corporations  it  is  usually  though 
not  invariably  the  case  that  the  pow^ers  and  duties  of  the  treas- 
urer are  specified  in  much  detail.  The  following  provision,  de- 
fining the  powers  and  duties  of  the  treasurer,  is  taken  from  the 
by-laws  of  the  United  States  Steel  Corporation: 

Section  7.  Powers  and  Duties  of  Treasurer.  The  treasurer 
shall  have  custody  of  all  the  funds  and  securities  of  the  Company 
which  may  have  come  into  his  hands;  when  necessary  or  proper  he 
shall  indorse  on  behalf  of  the  Company,  for  collection,  checks, 
notes,  and  other  obligations,  and  shall  deposit  the  same  to  the 
credit  of  the  Company  in  such  bank  or  banks  or  depositary  as  the 
Board  of  Directors  or  the  Finance  Committee  may  designate;  he 
shall  sign  all  receipts  and  vouchers  for  payments  made  to  the 
Company;  jointly  with  such  other  officer  as  may  be  designated  by 


•For  a  form  of  treasurer's  report,  see  Book  IV,  Forms  264,  26&< »:»   i'^iijirllr:  •)' 


380  CORPORATE  LAV/  >  [Bk.  I- 

the  Finance  Committee,  he  shall  sign  all  checks  made  by  the 
Company,  and  shall  pay  out  and  dispose  of  the  same  under  the 
direction  of  the  Board  or  of  the  Finance  Committee ;  he  shall  sign 
with  the  president,  or  such  other  person  or  persons  as  may  be 
designated  for  the  purpose  by  the  Board  of  Directors  or  the  Finance 
Committee,  all  bills  of  exchange  and  promissory  notes  of  the  Com- 
pany; he  may  sign,  with  the  president  or  a  vice-president,  all 
certificates  of  shares  in  the  capital  stock;  whenever  required  by 
the  Board  of  Directors  or  by  the  Finance  Committee,  he  shall 
render  a  statement  of  his  cash  account;  he  shall  enter  regularly,  in 
books  of  the  Company,  to  be  kept  by  him  for  the  purpose,  full  and 
accurate  account  of  all  moneys  received  and  paid  by  him  on  ac- 
count of  the  Company;  he  shall,  at  all  reasonable  times,  exhibit  his 
books  and  accounts  to  any  director  of  the  Company  upon  applica- 
tion at  the  office  of  the  Company  during  business  hours;  and  he 
shall  perform  all  acts  incident  to  the  position  of  treasurer,  subject 
to  the  control  of  the  Board  of  Directors  or  of  the  Finance  Committee. 
He  shall  give  a  bond  for  the  faithful  discharge  of  his  duties  in 
such  sum  as  the  Board  of  Directors  or  the  Finance  Committee  may 
require. 

As  will  be  noted,  the  treasurer  is  subordinated  to  the  board 
of  directors  and  to  the  finance  committee.  In  the  present  in- 
stance he  is  still  further  held  in  check  by  another  by-law  pro- 
vision subjecting  him  to  removal  without  cause  at  the  pleasure 
of  the  directors.  Under  such  circumstances,  it  is  not  probable 
that  the  treasurer  will  lightly  oppose  the  wishes  or  instructions 
of  the  directors. 

In  the  same  by-laws,  provision  is  made  for  assistant  treasurers 
as  follows: 

Section  8.  Assistant  Treasurers.  The  Board  of  Directors  or 
the  Finance  Committee  may  appoint  an  assistant  treasurer  or  more 
than  one  assistant  treasurer.  Each  assistant  treasurer  shall  have 
such  pow^ers  and  shall  perform  such  duties  as  may  be  assigned  to 
him  by  the  Board  of  Directors,  or  by  the  Finance  Committee. 

The  by-law  provisions  relating  to  the  treasurer  are  simpler 
in  the  smaller  corporations.    The  following  are  usual  provisions; 


Ch.  46]  TREASURER'S  DUTIES  AND  POWERS  381 

The  Treasurer  shall  have  the  custody  of  all  moneys  and  securi- 
ties of  the  Company,  and  shall  keep  regular  books  of  account  and 
balance  the  same  each  month.  He  shall  sign  or  countersign  such 
instruments  as  require  his  signature,  and  shall  perform  all  other 
duties  incident  to  his  office  or  that  are  properly  required  of  him  by 
the  Board  of  Directors. 

The  Moneys  of  the  Company  shall  be  deposited  in  the  name  of 
the  Company  in  such  bank  or  trust  company  as  the  Board  of 
Directors  shall  designate,  and  shall  be  drawn  only  by  check  signed 
by  the  Treasurer  and  countersigned  by  the  President  of  the 
Company. 

§  444.    Directors'  Resolutions 

The  directors  ordinarily  cannot  change  the  provisions  of  the 
by-laws  as  to  the  powers  and  duties  of  the  treasurer;  but  they 
are  generally  required,  as  in  the  examples  of  by-laws  given  in  the 
preceding  section,  to  supplement  them  by  designating  the  de- 
positary of  the  corporate  funds,  and  by  prescribing  any  other 
working  details  which  may  be  necessary  and  do  not  conflict 
with  the  by-law  provisions. 

In  a  few  states  the  directors  either  have  power  under  the 
statute  to  make  and  alter  the  by-laws,  or  may  be  given  such 
power  in  the  certificate  of  incorporation  itself.  When  this  is  the 
case  the  directors  are  enabled  thereby  to  exercise  complete  and 
unquestioned  control  over  the  corporate  officials. 

§  445.    Books  of  Account 

The  treasurer  has,  as  a  matter  of  course,  charge  of  the  cor- 
porate books  of  account.3  In  the  smaller  corporations  he  is 
usually  either  acting  bookkeeper  or  has  direct  control  of  the 
books  of  account  and  keeps  his  own  special  books  as  well.  A 
knowledge  of  bookkeeping  and  of  the  financial  duties  connected 
with  his  office  is  then  a  necessary  qualification.  In  the  larger 
corporations  the  treasurer's  duties  do  not  usually  include  the 
details  of  accounting.     These  devolve  upon  subordinate  em- 


•  See  Book  III,  Ch.  I,  "The  Corporate  Records  and  Accounts." 


382  CORPORATE  LAW  [Bk.  I- 

ployees,  or  are  perhaps  relegated  to  an  accounting  department, 
leaving  the  treasurer  free  to  devote  his  attention  to  the  general 
overseeing  and  management  of  the  corporate  finances  and  finan- 
cial affairs. 

In  many  of  the  larger  corporations  the  actua^  duties  of  the 
treasurer  are  nominal,  the  usual  duties  of  that  official  being 
assigned  to  other  officers  or  employees  of  the  corporation.  The 
treasurer  is  then,  as  a  rule,  selected  because  of  his  financial 
responsibility  or  connections,  or  for  other  reasons  that  make 
his  election  desirable. 

§  440.    Assumption  of  Official  Duties  \ 

The  procedure  and  formalities  when  the  newly  elected  treas- 
urer assumes  the  duties  of  his  office  are  simple.  Usually  he  is 
required  to  give  bond,  and  this  must  be  done  in  accordance  with 
the  requirements  of  the  particular  corporation  before  he  may 
enter  upon  the  duties  of  his  office.  As  soon,  however,  as  he  has 
qualified  for  his  position  by  giving  a  satisfactory  bond  and 
complying  with  any  other  requirements  of  the  corporation,  he 
is  ready  and  entitled  to  take  possession  of  his  office  and  begin 
the  discharge  of  his  ofl&cial  duties. 

The  retiring  treasurer,  on  the  other  hand,  retains  his  position 
as  treasurer  of  the  corporation  and  has  authority  to  perform 
all  its  usual  duties  until  the  treasurer-elect  has  qualified  and 
assumed  the  duties  of  his  office.  Then,  however,  the  authority 
of  the  retiring  treasurer  immediately  terminates,  he  is  no  longer 
competent  to  exercise  any  of  the  functions  of  the  ofl&ce,  and, 
unless  otherwise  instructed  by  the  board,  must  at  once  turn 
over  to  the  new  official  all  corporate  property  in  liis  custody, 
including  the  books  of  account. 

The  retiring  treasurer,  in  preparation  for  the  surrender  of 
his  office,  usually  closes  his  books  and  prepares  a  balance  she&t, 
giving  a  more  or  less  complete  statement  of  the  general  financial 
condition  of  the  corporation.  Also  an  audit  of  his  accounts  is 
desirable,  particularly  when  the  corporate  assets  are  material. 


Ch.  46]  TREASURER'S  DUTIES  AND  POWERS  383 

The  audit  of  the  retiring  treasurer's  books  relieves  the  in- 
coming treasurer  from  any  responsibility  as  to  their  condition. 
He  takes  them  as  they  are,  but  must  assure  himself  that  the 
corporate  funds  and  other  property  turned  over  to  him  by  the 
retiring  treasurer  accord  with  the  books.  If  he  does  not,  his 
negligence  in  the  matter  may  render  him  liable  for  any  resulting 
loss  to  the  corporation.  ■..•! 

The  incoming  treasurer  should  at  once  notify  the  deposi- 
taries in  which  the  corporate  funds  are  held,  of  his  election  and 
assumption  of  office.  If  the  corporate  funds  have  been  deposited 
in  the  name  of  the  treasurer  of  the  corporation,  it  will  be  neces- 
sary for  them  to  be  transferred  to  the  treasurer-elect  by  check 
of  the  retiring  official.  If,  however,  the  funds  are  deposited  in 
the  corporate  name,  no  such  transfer  is  necessary.  There  is 
then  no  change  in  their  ownership  but  merely  a  change  in  the 
officer  by  whom  checks  are  drawn,  and  proper  certification  to 
the  bank  of  this  change  is  all  that  is  required.*  Should  the  out- 
going treasurer  refuse  to  turn  over  to  the  treasurer-elect  any 
property  which  belongs  to  the  corporation,  the  directors,  or 
even  the  treasurer  himself,  may  bring  suit  for  its  recovery.  As 
a  matter  of  course,  the  treasurer  should  give  his  predecessor  a 
receipt  for  the  corporate  property  turned  over. 

§  447.    Formalities  on  Giving  Up  Office 

When  the  treasurer  relinquishes,  or  is  ousted  from,  his  posi- 
tion, all  properties  of  the  company  in  his  possession,  including 
the  books  of  account,  should  be  surrendered  to  his  successor  or 
to  such  other  party  as  may  be  designated  by  the  board  of  direc- 
tors. The  incoming  treasurer  is  the  usual  and  proper  party  to 
whom  such  property  is  delivered.  The  retiring  treasurer  should 
be  given  receipts  for  all  properties  turned  ©ver. 

The  corporate  accounts  are  always  the  property  of  the  cor- 
poration. Sometimes  in  the  smaller  corporations  the  books  in 
which  these  accounts  are  kept  have  been  purchased  by  the 

«S«e  Book  IV,  Form  227. 


384  CORPORATE  LAW  (Bk.  I- 

treasurer  personally  and  the  question  as  to  their  ownership 
then  arises.  As  a  matter  of  law,  the  treasurer  must  surrender 
the  books  in  which  the  accounts  are  kept  although  these  books 
have  been  purchased  with  his  personal  funds.  He  is  entitled 
in  such  case  to  payment  for  the  books,  but  he  cannot  withhold 
them  as  a  means  of  enforcing  this  payment  or  on  the  plea  that 
they  are  his.s 

In  order  to  prevent  any  complications  on  this  score,  it  is 
sometimes  provided  in  the  by-laws  that  the  accounts  of  the 
company  shall  be  kept  only  in  books  that  are  the  property  of 
the  corporation. 


*  State  V.  Goll,  33  N.  J.  L.  385  (1867);  High  on  Extraordinary  Legal  Remedlec,  I  306. 


CHAPTER  XLVII 

TREASURER'S    RELATION    TO    OTHER    CORPORATE 
AUTHORITIES 

§  448.    To  the  Stockholders 

The  treasurer  is  the  agent  of  the  corporation  but  under  the 
usual  corporate  arrangements  his  direct  responsibility  is  to  the 
board  of  directors,  not  to  the  stockholders.  In  practice  the 
treasurer  usually  has  no  official  connection  with  the  stockholders, 
save  perhaps  when  an  annual  or  an  occasional  special  report  is 
to  be  made,  when  dividends  are  to  be  paid,  or  amounts  due  from 
the  stockholders  to  the  corporation  are  to  be  collected.  He  is 
not  under  their  supervision  and  owes  them  no  direct  duty.  He 
must  obey  their  instructions  as  expressed  in  the  by-laws  of  the 
corporation,  but  this  is  the  limit  of  their  usual  authority.  Should 
they  attempt  to  compel  his  action  by  direct  motion  or  resolution, 
they  exceed  their  power  and  the  treasurer  is  under  no  legal 
obligation  to  obey. 

As  stated  in  an  early  case,  "The  individual  members  of  the 
corporation,  whether  they  should  all  join,  orpach  act  separately 
have  no  right  or  power  to  intermeddle  with  the  property  or  con- 
cerns of  the  bank,  or  call  any  officer,  agent  or  servant  to  account, 
or  discharge  them  from  any  liability.  "1 

§  449.    To  the  Board  of  Directors 

Speaking  generally,  the  treasurer  is  directly  responsible  to  the 
directors  and  must  obey  their  instructions.  Occasionally,  how- 
ever, the  charter  gives  him  certain  specified  powers  and  almost 
invariably  the  by-laws  define  his  authority  and  prescribe  his 


J  Smith  V.  Hurd,  la  Mete.  (Mass.)  371,  385  (1847). 

38s 


386  CORPORATE  LAW  [Bk.  I- 

duties  in  detail.  It  is  then  beyond  the  power  of  the  directors  to 
disturb  him  in  the  exercise  of  the  authority  and  the  performance 
of  the  duties  prescribed  by  these  higher  corporate  authorities. 

For  instance,  the  charter  may  provide  that  the  treasurer  shall 
be,  ex  oflScio,  a  member  of  the  finance  committee.  If  so,  the 
directors  cannot  deny  him  this  right  so  long  as  the  charter  pro- 
vision remains  unchanged.  Or  the  by-laws  may,  as  is  usual, 
assign  the  custody  of  the  corporate  funds  to  the  treasurer. 
Should  the  directors,  in  defiance  of  this  by-law  provision,  instruct 
the  treasurer  to  surrender  the  corporate  funds  to  the  custody  of 
some  other  officer  of  the  company,  they  would,  save  perhaps  in 
case  of  some  special  emergency,  exceed  their  authority  and  the 
treasurer  need  not  obey  their  instructions.  On  the  contrary, 
should  he  obey  them  and  should  loss  result  to  the  company  as  a 
consequence,  the  treasurer  himself  might  be  held  responsible. 

The  treasurer  must,  however,  obey  all  such  proper  instruc- 
tions of  the  directors  as  are  not  in  conflict  with  charter  or  by-law 
provisions,  or  are  intended  to  supplement  and  make  them  effec- 
tive. In  all  such  matters  the  directors  are  entirely  within  the 
scope  of  their  powers  and  their  instructions  are  as  binding  upon 
the  treasurer  as  are  the  by-laws  themselves. 

Sometimes  also  the  directors  are  given  express  authority  to 
modify,  repeal,  or  amend  the  by-laws,  and  their  power  over  the 
official  acts  of  the  treasurer  is  then  practically  complete.  When 
this  is  the  case,  statutory  and  charter  provisions  alone  are  su- 
perior to  their  authority. 

It  may  be  added,  however,  that  the  powers  discussed  are  the 
powers  of  the  board  of  directors  and  not  of  the  individual 
directors  composing  the  board.  These  individual  directors  have 
certain  powers  of  their  own.  Thus,  without  special  authoriza- 
tion thereto,  any  member  of  the  board  of  directors  may  inspect 
the  corporate  books  at  any  reasonable  time — save  for  purposes 
hostile  to  the  corporation2 — and  may  examine  at  his  discretion 
into  the  acts  of  the  treasurer  or  of  any  other  corporate  official, 

2  Heminway  v.  Heminway,  58  Conn.  443  (1890);  People  v.  Central  Fish  Co.,  117  App. 
Div.  (N,  Y.)  77  (1907). 


Ch.  47]  TREASURER'S  RELATION  TO  OTHERS  387 

though  he  cannot  delegate  this  official  right  to  an  audit  company. 3 
Also  as  an  individual  director,  he  may  make  such  suggestions  to 
the  corporate  officials  as  he  sees  fit  and  such  suggestions  will 
naturally  have  weight. 

The  individual  director  has  not,  however,  any  power  to  en- 
force compliance  with  his  suggestions,  nor  has  he  the  right  to 
change,  censure,  suspend,  remove,  or  even  direct  an  officer  of  the 
corporation,  such  rights  and  powers  inhering  only  in  the  board 
collectively.  A  director  may  be  specially  authorized  by  the 
board  to  do  any  of  these  things  and  will  then  have  all  necessary 
power  for  its  performance,  but  he  has  no  such  authority  by  mere 
virtue  of  his  board  membership. 

The  treasurer  reports  to  the  directors  and,  as  already  stated, 
is  governed  by  their  instructions  in  all  matters  not  specifically 
covered  by  charter  or  by-law  provisions.  The  relations  between 
the  treasurer  and  the  board  of  directors  are  therefore  very  close 
and  are  usually  harmonious.  Both  are  supposed  to  have  the 
financial  welfare  of  the  corporation  at  heart  and  to  be  working 
together  to  advance  it,  and  it  is  but  rarely  that  the  exact  measure 
of  the  board's  authority  over  the  treasurer,  or  of  the  treasurer's 
independence  of  the  board,  comes  into  question. 

§  450.    To  the  Finance  Committee 

Nominally  the  finance  committee  is  subject  to  the  board  of 
directors.  It  is,  however,  always  composed  of  members  of  the 
board  and  generally  of  its  best  financiers,  and  the  directors  are 
usually  and  wisely  quite  content  to  leave  the  financial  manage- 
ment of  the  corporation  entirely  in  its  hands.  The  finance  com- 
mittee is  then  practically  the  board  of  directors  so  far  as  the 
finances  of  the  corporation  are  concerned.  The  committee  will 
naturally  report  to  the  directors  at  frequent  intervals,  but  its 
reports,  acts,  and  recommendations  are  usually  sure  of  approval 
in  advance.     In  practice,  a  finance  committee  possessing  the 


'People  V.  Borgstede,  169  App.  Div.  (N.'Y.)  421  (1915);  People  v.  Throop,  12  Wend. 
(N.  Y.)  183  (1834). 


388  CORPORATE  LAW  ^k.  I- 

confidence  of  the  board  will  direct  the  financial  affairs  of  the 
corporation  from  year's  end  to  year's  end  without  interference. 
The  allegiance,  co-operation,  and  obedience  the  treasurer 
ordinarily  owes  to  the  directors  is  then  transferred  to  this  com- 
mittee. 

If  the  treasurer  is  a  member  of  the  board  of  directors,  he  is 
usually  also  a  member,  ex  officio,  of  the  finance  committee  and 
participates  in  its  proceedings.  If,  however,  he  is  not  a  director, 
he  cannot  be  made  an  active  member  of  the  committee.  This  is, 
as  already  stated,  because  the  committee  exercises  discretionary 
powers  belonging  to  the  board,  which  cannot  be  legally  conferred 
upon  a  committee  composed  in  whole  or  in  part  of  members  who 
are  not  directors. 

If  the  treasurer  is  a  member  of  the  finance  committee,  and 
particularly  if  he  is  of  some  financial  ability  and  standing  himself, 
the  direct  and  entire  charge  of  the  financial  affairs  of  the  corpora- 
tion is  apt  to  be  left  in  his  hands,  the  remainder  of  the  committee 
acting  merely  in  an  advisory  capacity.  Even  where  the  treasurer 
is  not  a  member  of  the  committee,  the  financial  matters  of  the 
corporation  are  still  as  a  rule  left  largely  to  his  care.  In  such 
case  he  reports  frequently  and  informally  to  the  committee, 
either  receiving  authority  for  the  particular  act  or  policy  under 
discussion,  or  approval  of  his  actions  in  matters  which  have 
already  been  consummated. 

When  the  treasurer  has  not  sufficient  experience  and  ability 
to  conduct  the  general  financial  affairs  of  the  company  to  this 
extent,  he  works  in  close  accord  with  the  members  of  the  finance 
committee,  carrying  out  their  instructions,  consulting  with  them 
frequently,  and  at  all  times  referring  to  them  matters  of  impor- 
tance, or  such  as  may  be  beyond  his  immediate  authority,  ability, 
or  control. 

Since  the  finance  committee  practically  takes  the  place  of 
the  board  of  directors  so  far  as  the  corporate  finances  are  con- 
cerned, it  usually  and  naturally  has  all  the  authority  of  the  board 
itself  over  the  treasurer.     The  matter  is,  however,  one  that  may 


Ch.  47]  TREASURER'S  RELATION  TO  OTHERS  389 

be  determined  absolutely  by  the  charter  or  by-laws.  These 
usually  and  properly  prescribe  that  the  treasurer  shall  report  to, 
and  be  controlled  by,  the  finance  committee. 

The  following  by-law  provisions  define  with  much  clearness 
the  usual  scope  and  powers  of  the  finance  committee  and  its 
authority  over  the  treasurer.  They  are  found  under  the  head  of 
"Standing  Committees"  in  the  by-laws  quoted  from  in  the  pre- 
ceding chapter: 

The  Finance  Committee  shall  have  general  and  special  charge 
and  control  of  all  financial  affairs  of  the  Company,  and  shall  have 
and  exercise  all  of  the  powers  of  the  Board  of  Directors  in  such 
financial  matters  when  the  latter  is  not  in  session.  The  Treasurer 
and  the  Auditor  of  the  Company  shall  be  under  the  direct  control 
and  supervision  of  the  Finance  Committee. 

The  Finance  Committee  shaU  fix  all  salaries  and  compensation 
paid  or  payable  to  officials  of  the  Company,  except  as  otherwise 
provided  in  these  by-laws  or  fixed  by  resolution  of  the  Board  of 
Directors. 

It  will  be  noted  that  the  financial  affairs  of  the  company  are 
placed  unreservedly  in  the  hands  of  the  committee  in  the  interim 
between  board  meetings;  also  that  the  treasurer  is  expressly 
subordinated  to  its  authority. 

The  general  relation  between  the  finance  committee  and  the 
treasurer  should  be  that  of  harmonious  and  effective  co-operation. 
Both  are  working  to  the  same  end,  i.e.,  the  best  possible  admin- 
istration of  the  financial  affairs  of  the  corporation,  and  there 
should  be  no  conflict  or  friction  between  them. 

§  451.    To  the  Auditor 

In  the  smaller  corporations  the  auditor  is  merely  an  occasional 
officer  called  in  for  the  purpose  of  investigating  and  passing  upon 
the  treasurer's  accounts.  In  such  case  his  relation  to  the 
treasurer  is  temporary  and  needs  no  special  discussion.  The 
treasurer's  books  are  opened  to  the  auditor,  who  examines  them, 
checks  up  their  statements,  and  reports  his  finding  to  the  board. 


390  CORPORATE  LAW  [Bk.  I- 

The  treasurer  will,  naturally,  furnish  any  proper  information 
and  assistance  required  by  the  auditor  in  the  course  of  this  exam- 
ination and  will  facilitate  his  work  in  every  way. 

In  the  larger  corporations,  however,  the  conditions  are  ma- 
terially different.  Here  the  auditor,  or  comptroller  as  he  is 
sometimes  designated,  is  one  of  the  regular  officials  of  the  cor- 
poration, and  his  duties  and  the  relations  existing  between  him 
and  the  treasurer  depend  entirely  upon  the  respective  duties  of 
the  two  officials.  These  are  usually  set  forth  in  the  by-laws 
and  vary  in  different  corporations. < 

In  the  larger  corporations  the  auditor  is  the  accounting 
officer,  taking  entire  charge  of  the  general  bookkeeping.  The 
actual  receipt,  custody,  and  disbursement  of  the  funds  and  their 
general  management  remain  with  the  treasurer.  Detailed 
records  of  these  receipts  and  disbursements  as  well  as  the  general 
accounts  of  the  corporation  are  kept  in  the  auditor's  department, 
the  treasurer's  records  also  covering  these  items  but  in  a  less 
detailed  way. 

In  some  corporations,  accounts  to  be  paid  are  authorized 
by  the  auditor,  are  approved  perhaps  by  some  other  officer,  and 
the  actual  payment  is  made  by  the  treasurer.  In  other  cases  the 
payments  are  for  all  practical  purposes  made  by  the  auditor; 
vouchers,  duly  signed  and  countersigned,  being  sent  out  to  the 
parties  to  whom  payments  are  due,  and  these  vouchers  being 
payable  on  presentation  to  some  designated  bank  which  acts  for 
the  treasurer.  Or  again,  the  voucher  will  be  prepared  or  passed 
upon  by  the  auditor  and  perhaps  by  the  official  in  whose  depart- 
ment the  obligation  arises,  and  this  voucher  when  signed  by  the 
treasurer  becomes  a  check,  honored  upon  presentation  at  a 
designated  bank. 

The  whole  matter  is  one  of  adjustment,  varying,  as  stated, 
in  different  corporations.  In  any  case  the  auditor  and  the 
treasurer  usually  have  distinct  departments,  and  while  their 
accounts  overlap  in  some  measure  as  to  cash  received  and  dis- 

•  See  {  308. 


Ch.  47]  TREASURER'S  RELATION  TO  OTHERS  391 

bursed,  there  is  but  little  room  for  conflict  between  them.  Each 
is  independent  of  the  other  and  exercises  functions  that  should 
be  distinct  and  so  clearly  defined  that  clashing  is  impossible,    -."t 

§  452.    To  the  Other  Officials 

The  three  essential  executive  officers  of  the  corporation  are 
the  president,  the  secretary,  and  the  treasurer.  In  the  usual 
corporate  organization  the  president  is  the  superior  officer  of  the 
three,  and  is  usually  given  certain  powers  of  supervision  over  the 
other  two. 

The  secretary  and  treasurer  are  entirely  independent  of  each 
other.  Also  their  respective  functions  are  so  distinct  that 
friction  between  them  is  unusual  and  absolutely  unnecessary. 
In  the  smaller  corporations  the  two  offices  are  frequently  and 
advantageously  united  in  the  same  person. 

Between  the  president  and  the  treasurer  the  probability  of 
friction  is  much  greater.  The  president,  as  already  stated,  is 
usually  given  certain  general  powers  of  supervision  over  the 
other  corporate  officers,  and,  as  these  powers  are  rarely  defined 
with  clearness,  there  is  at  times  room  for  real  difference  of  opinion 
as  to  their  limits. 

Under  the  usual  by-law  provisions  the  president  has  the  right 
to  inspect  and  examine  the  books,  accounts,  and  records  of  the 
treasurer  at  any  reasonable  time.s  He  has,  however,  no  right 
to  interfere  directly  with  the  treasurer's  actions  unless  he  sees 
some  actual  neglect  or  improper  performance  of  duty.  In  any 
such  case  it  is  his  duty  to  call  the  matter  to  the  treasurer's 
attention.  If  the  latter  is  obviously  at  fault,  it  is  his  duty  to 
heed  the  president's  instructions.  If,  however,  there  is  a  differ- 
ence of  opinion  between  the  two  officials  as  to  whether  or  not  the 
treasurer  is  at  fault,  the  president,  unless  specially  empowered, 
cannot  enforce  his  views  directly.  All  he  can  do  is  to  report  the 
matter  to  the  directors,  and  both  officers  will  then  be  governed  by 
the  directors'  decision. 


•People,  etc.  v.  GoWstein,  37  App.  Div.  (N.  Y.)  sso  (i8go). 


392  CORPORATE  LAW  [Bk.  I- 

As  the  president  is  the  chief  executive  officer  of  the  corpora- 
tion, the  treasurer  is  naturally  expected  to  confer  with  him  on 
matters  of  unusual  importance  or  difficulty  and  to  be  guided  to 
a  greater  or  less  extent  by  his  opinions  and  suggestions.  The 
president,  however,  as  stated,  cannot  himself  force  the  treasurer 
to  heed  his  instructions  unless  he  has  been  given  some  special 
power  in  the  matter  by  charter  or  by-law  provisions,  or  by  action 
of  the  board  of  directors. 

The  offices  of  president  and  treasurer  are  occasionally  united 
in  one  person  but  not  commonly,  as  the  respective  duties  of  the 
two  positions  are  apt  to  conffict.  Thus  in  some  states  the 
statutes  require  the  signature  of  both  the  president  and  treasurer 
to  certificates  of  stock,  and  the  by-laws  commonly  prescribe  a 
similar  signature  for  the  corporate  checks  and  other  instruments. 
It  is  obvious  that  the  whole  purpose  of  these  precautionary 
measures  would  be  defeated  if  the  two  offices  were  combined. 


CHAPTER  XL VIII 
THE  TREASURER'S  LIABILITIES 

§  453.    The  Treasurer  as  Agent 

The  treasurer's  duty  in  regard  to  the  moneys  and  the  prop- 
erty of  the  corporation  entrusted  to  his  care  is  that  of  an  agent, 
and  he  is  held  to  the  same  measure  of  accountability.  In  an 
early  New  York  case  it  was  expressed  as  follows:  "The  duty 
of  a  treasurer  is  to  keep  the  moneys  of  his  principal  distinct 
from  his  own,  and  to  be  ready  at  all  times  to  pay  over  what 
balance  he  owes  to  his  principal."  With  sage  recognition  of 
the  fact  that  readiness  to  perform  is  not  performance,  the 
learned  judge  continues,  "and  to  pay  the  balance  on  demand.  "1 

In  his  duties  outside  the  e  relating  directly  to  the  custody 
of  the  corporate  funds  and  property,  the  treasurer  is  likewise 
acting  as  an  agent  and  employee  of  the  corporation,  and  is 
liable  to  it  if  he  fails  in  the  proper  performance  of  these  duties, 
as  is  any  other  agent  or  employee. 

§  454.    To  Whom  Liable 

When  liability  is  incurred  by  the  treasurer  in  connection 
with  the  duties  of  his  office,  it  is  usually  to  the  corporation 
though  it  may  be  to  the  individual  stockholders  of  the  corpora- 
tion, or  even  to  individuals  outside  the  corporation.  Beyond 
this  there  is  in  some  states  a  civil  liability  for  the  non-perform- 
ance of  certain  duties  prescribed  by  statute,  and  in  all  states 
there  is  a  criminal  liability  for  acts  in  violation  of  the  penal 
statutes. 

Thus,  if  the  treasurer  loses  a  portion  of  the  company  funds 


i  Second  Ave.  R.  R.  Co.  v.  Coleman,  34  Barb.  (N.  Y.)  300  (1857);  Hunter  v.  Robbins,  117 
Fed.  Rep.  920  (1902). 

393 


394  CORPORATE  LAW  [Bk.  I- 

through  careless  handling,  he  is  responsible  to  the  corporation. 
If  he  makes  an  official  report  to  the  stockholders  which  is  false 
in  some  material  respect  and  the  stockholders  act  upon  this 
false  information  and  lose  money  thereby,  the  treasurer  is  per- 
sonally liable  to  the  individual  stockholders  by  whom  these 
losses  are  incurred.  Or  if  he  misrepresents  the  financial  status 
and  ability  of  the  corporation  to  an  outsider  in  order  to  induce 
him  to  give  credit  to  the  company,  he  is  liable  to  such  outsider 
for  any  losses  incurred  as  a  result  of  his  false  representations. 
In  many  states  if  he  fails  to  make  certain  specified  reports,  he 
is  liable  to  fine.  In  all  states,  if  he  embezzles  the  corporate 
funds  or  uses  his  official  position  to  defraud,  he  is  subject  to 
a  criminal  prosecution. 

§  455.    Sources  of  Liability 

Speaking  generally,  the  treasurer  may  be  liable  for  failure 
to  perform,  or  for  the  improper  performance  of  the  duties  of 
his  office,  as  follows: 

1.  Neglect  of  or  non-performance  of  duties. 

2.  Faulty  performance  of  duties. 

3.  Unauthorized  acts.  t  ^IdBti 

4.  Illegal  acts.  .. , 

§  456.     (i)  Neglect  or  Non-Performance  of  Duties  ^^^  a 

As  a  rule  the  treasurer  is  liable  for  any  loss  or  damage  in- 
curred through  his  neglect  of  or  failure  to  perform  his  duties. 
Thus,  if  he  fails  to  deposit  the  corporate  funds  in  due  time,  or 
in  accordance  with  the  requirements  of  the  by-laws  or  the 
directors,  and  because  of  this  neglect  they  are  burned,  stolen, 
or  otherwise  lost,  the  treasurer  is  responsible  to  the  corporation. 
Or  if  money  is  due  and  the  treasurer  does  not  take  the  necessary 
steps  for  its  collection,  and  as  a  result  it  is  lost  to  the  corporation, 
he  is  again  responsible.  Or  if  he  refuses  to  perform  his  proper 
duties  and  the  corporation  is  involved  in  losses  thereby,  he  is 
responsible  to  the  corporation  for  the  amount  so  lost. 


Ch.  48]  TREASURER'S  LIABILITIES  395 

In  any  case  of  loss  to  the  corporation  because  of  neglect  of 
duty  on  the  part  of  the  treasurer,  the  measure  of  his  liability  is 
usually  the  amount  actually  lost,  or  the  damage  actually  sus- 
tained in  consequence  of  such  failure  or  non-performance.  He 
cannot  ordinarily  be  held  liable  for  losses  indirectly  due  to  his 
failure.  :»t)irj     . 

It  is  to  be  noted  that  the  liability  of  the  treasurer  for  neglect 
or  non-performance  of  his  duty  is  to  the  corporation,  and  not 
to  the  individual  stockholders.  Any  action,  therefore,  against 
the  treasurer  for  losses  incurred  by  reason  of  his  neglect  or 
failure  must  be  instituted  by  the  board  of  directors,  and  not 
by  the  stockholders,  either  as  a  body  or  individually. 
^'  In  the  larger  corporations  and  wherever  the  value  of  the 
Corporate  funds  and  property  in  the  treasurer's  hands  is  mate- 
rial, it  is  usual  to  require  him  to  give  bond  for  the  faithful  per- 
formance of  his  duties.  This  bond,  if  good  and  of  sufficient 
amount,  will  usually  cover  any  losses  occasioned  by  the  failure 
or  the  misdeeds  of  the  treasurer  and  be  an  efficient  protection 
to  the  corporation. 2 

§  457.     (2)  Faulty  Performance  of  Duties 

The  treasurer  may  render  himself  liable  for  faulty  perform- 
ance of  his  duties  as  well  as  by  neglect  of  these  duties,  and  in 
such  case  his  liability  may  be  to  outside  parties  or  to  the  cor- 
poration. For  instance,  if  the  treasurer  signs  a  note  of  the 
corporation,  and,  instead  of  using  the  proper  corporate  signa- 
ture, signs  his  own  name  followed  by  the  term  "Treasurer,"  he 
will  in  some  states  and  under  some  circumstances  make  himself 
liable  as  a  principal,  although  he  had  no  intention  of  so  doing  and 
was  not  expected  to  be  personally  involved.' 

So  also,  if  the  treasurer  in  paying  some  corporate  indebted- 
ness, carelessly  draws  a  check  for  a  larger  amount  than  is  re- 


»  See  Ch.  XLIX,  "The  Treasurer's  Bond." 
;       «  Merchants  Nat.  Bank  v.  Clark  et  al.,  139  N.  Y.  314  (1803);  First  Nat.  Bk.  v.  Wallis, 
ISO  N.  Y.  455  (1896). 


396  CORPORATE  LAW  [Bk.  I- 

quired,  and  the  excess  cannot  be  recovered  from  the  payee,  the 
treasurer  is  liable  to  the  corporation  for  its  amount. 

The  liability  of  the  treasurer  from  faulty  performance  of 
duty  seldom  arises.  His  position  is  one  of  trust  and  responsi- 
bility, and  the  incumbent  is  usually  experienced  in  business 
matters  and  accustomed  to  the  handling  of  funds.  Under  these 
circumstances  it  is  hardly  to  be  expected  that  he  will  err  so 
grossly  in  any  of  his  oflEicial  acts  as  to  subject  himself  to  liability. 

§  458.     (3)  Unauthorized  Acts 

The  treasurer  is  the  agent  of  the  corporation,  and  within  the 
scope  of  his  authority  can  act  for  and  bind  it.  If,  however,  he 
acts  beyond  the  scope  of  his  usual  duties,  not  being  authorized 
thereto,  his  act  is  without  validity  and  the  corporation  is  not 
necessarily  bound.-*  Also,  in  any  case  of  loss  resulting  from  his 
unauthorized  acts  he  is  liable  in  damages  to  the  party  suffering 
such  loss,  whether  it  be  the  corporation  or  an  individual.  This 
is  the  usual  liability  of  an  agent  exceeding  his  authority. s 

For  instance,  if  the  treasurer  of  a  corporation,  not  being 
authorized  thereto,  orders  a  costly  piece  of  machinery  for  the 
use  of  his  company,  the  corporation  may  lawfully  refuse  to 
receive  it  even  though  the  order  was  accepted  by  the  manu- 
facturer on  the  supposition  that  the  treasurer  had  been  duly 
empowered  to  make  the  purchase.  In  such  case  the  maker  of 
the  machinery  is  the  injured  party  and  may  hold  the  treasurer 
personally  responsible  for  any  real  loss  involved  in  the  trans- 
action. 

Or  should  the  treasurer,  not  being  authorized  thereto,  enter 
into  a  contract  on  behalf  of  the  corporation  to  supply  certain 
goods  at  a  low  price,  the  corporation  is  not  bound  by  his  agree- 
ment unless  it  ratifies  his  act,  and,  if  it  does  not,  the  treasurer  i;> 
liable  to  the  other  party  for  any  direct  loss. 


*  Daniele  v.  Burlington,  etc.,  Co.,  84  N.  J.  Eq.  53  (1Q14);  Jacobus  v.  Jamestown  Mantel 
Co.,  211  N.  Y.  IS4  (1914)- 

'  Kroeger  v.  Pitcairn,  loi  Pa.  St.  311  (1882);  Baltzen  et  al.  v.  Nicholay,  53  N.  Y.  407 
(1873);  Taylor  v.  Nostrand,  134  N.  Y.  108  (1892). 


Ch.  48]  TREASURER'S  LIABILITIES  397 

If,  however,  the  treasurer,  though  really  unauthorized  there- 
to, performs  some  act  within  the  apparent  scope  of  his  powers — 
that  is,  an  act  within  the  powers  usually  incident  to  his  office^ — 
or  powers  which  he  has  been  represented  to  the  public  as  pos- 
sessing,'' and  the  party  with  whom  he  deals  is  unaware  of  the 
treasurer's  lack  of  authority,  the  corporation  is  bound  by  the 
act.  If  any  loss  results,  the  treasurer  is  liable  to  the  corporation. 
For  instance,  if  the  treasurer,  having  neither  express  nor  implied 
authority  therefor,  or  perhaps  acting  contrary  to  the  instruc- 
tions of  the  board,  enters  into  a  contract  with  a  banking  house' 
to  discount  a  large  amount  of  the  corporation  paper  at  such  an 
unfavorable  time  or  under  such  conditions  as  to  involve  a  loss, 
and  the  banking  house  supposed  the  treasurer  to  have  authority 
to  make  such  contract,  the  corporation  cannot  repudiate  the 
treasurer's  action  as  unauthorized.^  On  the  contrary,  it  must 
abide  by  the  terms  of  the  agreement  and  its  only  recourse  is 
against  the  treasurer  and  the  measure  of  its  damages  is  the  loss 
actually  involved. 

The   treasurer's  general   liability  for  unauthorized  actions 
is  well  expressed  in  the  following  quotations: 

It  is  the  first  duty  of  an  agent,  whose  authority  is  limited,  to 
adhere  faithfully  to  his  instructions,  in  all  cases  to  which  they  can 
be  properly  applied.  If  he  exceeds  or  violates  or  neglects  them,  he 
is  responsible  for  all  losses  which  are  the  natural  consequences  of  his 
act.9 

The  cases  in  which  agents  have  been  adjudged  liable  personally 
have  sometimes  been  classified  as  follows,  viz.:  first,  where  the 
agent  makes  a  false  representation  of  his  authority  with  intent  to 
deceive;  second,  where  with  knowledge  of  his  want  of  authority 
but  without  intending  any  fraud,  he  assumes  to  act  as  though  he 
were  fully  authorized;  and  third,  where  he  undertakes  to  act,  bona 
fide  believing  he  has  authority,  but  in  fact  has  none,  as  in  the  case 
of  an  agent  acting  under  a  forged  power  of  attorney.    As  to  cases 


•  Traitel  Marble  Co.  v.  Brown  Bros.,  IS9  App.  Div.  (N.  Y.)  485,  487  (1913). 
'  Culver  V.  Pocono,  etc.,  Ice  Co.,  206  Pa.  St.  481  (1903). 

'Austrian  &  Co.  v.  Springer,  94  Mich.  343  (1892);  Brown  v.  Franklin  Mut.  Fire  Ins.  Co., 
164  Mass.  565  (1896). 

•  Whitney  v.  Merchants'  Express  Co.,  104  Mass.  152,  154  (1870);  also  Wilts  v.  Morrell,  66 
Barb.  (N.  Y.)  511  (1873);  Taylor  v.  Nostrand,  134  N.  Y.  108  (1892). 


398  CORPORATE  LAW  [Bk.  I- 

fairly  brought  within  either  of  the  first  two  classes  there  cannot  be 
any  doubt  as  to  the  personal  liability  of  the  self-constituted  agent, 
and  his  liability  may  be  enforced  either  by  an  action  on  the  case  for 
deceit,  or  by  electing  to  treat  him  as  principal.  While  the  liability 
of  agents  in  cases  belonging  to  the  third  class,  has  sometimes  been 
doubted,  the  weight  of  authority  appears  to  be  that  they  are  also 
liable." 

The  treasurer  may  be  liable  for  wrongfully  paid  dividends." 

§459.     (4)  Illegal  Acts 

The  illegal  acts  of  which  the  treasurer  is  most  commonly 
guilty  may  be  divided  into  two  classes:  (i)  fraudulent  acts, 
such  as  false  or  misleading  statements  or  reports  as  to  the 
property  or  financial  condition  of  the  corporation  made  or  cer- 
tified to  by  him;  (2)  criminal  acts,  such  as  embezzlement  of  the 
funds  entrusted  to  his  charge. 

Offenses  of  the  first  class  are  not  infrequent  and  may  be 
offenses  against  individuals,  or  against  the  state.  In  case  of 
misrepresentation  to  individuals,  the  treasurer  is  liable  to  the 
parties  misled  as  is  any  agent,i2  and  may  subject  himself  to  a 
criminal  Hability  as  well.  In  case  of  false  representations  to 
the  state,  he  is  subject  to  special  penaltiea  provided  by  the 
statutes. 

False  or  fraudulent  reports  are  prohibited  by  the  laws  of 
almost  every  state.  Varying  punishments  are  imposed.  Usually 
the  statutes  provide  that  a  treasurer  making  or  concurring  in 
any  representation  materially  false  in  any  of  its  details,  shall 
be  liable  to  any  individual  damaged  thereby,  to  the  amount  of 
his  loss.  Frequently  a  further  and  more  serious  penalty  is 
imposed,  consisting  of  both  fine  and  imprisonment. 

The  criminal  acts  of  the  treasurer  may  be  of  two  classes:  (i) 
those  inuring  to  his  direct  personal  benefit,  such  as  embezzle- 


>o  Kroeger  v.  Pitcaim,  loi  Pa.  St.  311.  3i7  (1882). 
'1  See  }  499. 

"  Morgan  v.  Skiddy.  62  N.  Y.  319,  326  (187s);  Kroeger  v.  Pitcairn,  loi  Pa.  St.  311.  3i7 
(1883). 


Ch.  48]  TREASURER'S  LIABILITIES  399 

ment  of  the  corporate  funds  or  obtaining  money  under  false 
pretenses  from  the  corporation,  or  from  those  with  whom  the 
corporation  is  transacting  business;  (2)  participation  in  acts  of 
the  corporation  that  would  in  an  individual  be  criminal. 

The  liability  of  the  treasurer  for  criminal  acts  inuring  to 
his  personal  benefit  is  the  same  as  for  any  other  individual. 
Such  offenses  are  neither  better  nor  worse,  nor  does  their  pun- 
ishment differ  when  committed  by  a  corporation  official. 

If  criminal  acts  are  committed  by  the  corporation,  the  treas- 
urer or  any  other  officer  responsible  therefor,  or  knowingly 
assisting  or  concurring  therein,  is  liable  to  prosecution  and 
punishment.13  In  such  case  it  must  be  shown,  however,  that 
"the  corporation  did  them  by  his  hand,  act,  direction  or  per- 
mission, which  of  course  is  direct  proof  of  his  own  acts,  or  such 
circumstances  must  be  shown  as  to  justify  the  conclusion,  as  a 
fact,  that  what  the  corporation  did,  he  did."'*  In  other  words, 
he  is  an  agent  with  an  agent's  usual  liability,  but  no  more. 

Thus,  if  the  corporation  obtains  credit  or  moneys  by  means 
of  false  representations,  i.e.,  under  false  pretenses,  in  order  to 
hold  the  treasurer  responsible,  either  civilly  or  criminally,  it 
must  be  shown  that  he  participated  in  such  act  or  knowingly 
allowed  it  to  be  done.is  As  a  corporation  cannot  be  held  crimi- 
nally liable,  and  as  it  is  far  more  difficult  to  secure  the  criminal 
conviction  of  its  officials  than  to  enforce  a  civil  liability,  criminal 
prosecutions  against  the  treasurer  in  cases  of  the  kind  are 
exceedingly  rare.  Civil  prosecutions  are  not  so  uncommon  and 
if  his  participation  and  responsibility  can  be  proved,  he  is  held. 

Outside  of  false  representations,  acts  involving  criminal  lia- 
bility are  not  often  committed  under  corporate  direction.  Some- 
times, however,  they  do  occur,  as  where  the  agents  of  a  cor- 
poration resort  to  violence  or  the  destruction  of  property  of  a 
rival  concern  in  order  to  hinder  or  prevent  its  success.    In  any 

*•  Weber  v.  Weber,  47  Mich.  569  (1882);  Hubbard  v.  Weare,  79  Iowa  678  (1890);  Vreeland 
V.  N.  J.  Stone  Co.,  29  N.  J.  Eg.  188  (1878). 

"People  V.  England,  27  Hun  (N.  Y.)  139  (1882). 

"Wakeman  v.  Dalley,  51  N.  Y.  27  (1872);  Arthur  v.  Griswold,  55  N.  Y.  400  (1874); 
Morgan  v.  Skiady,  62  N.  Y.  319  (187s). 


400  CORPORATE  LAW  [Bk.  I- 

such  case  the  corporation  itself  can  naturally  be  held  only  in 
damages,  but  the  agents,  by  whom  the  criminal  act  is  performed, 
are  liable  to  punishment  as  if  the  act  were  their  own  deed,  insti- 
gated and  committed  by  them  alone. 

§  460.    Statutory  Liabilities 

In  many  of  the  states  the  liabilities  discussed  in  the  present 
chapter,  which  in  the  main  are  common  law  liabilities,  have 
been  further  enacted  into  statutory  Habilities.  Also  in  some 
cases  specific  additional  penalties  have  been  added.  An  instance 
of  this  has  already  been  given  in  the  case  of  false  reports,  where 
the  treasurer  is  not  only  liable  to  the  individuals  injured  by 
such  false  reports,  but  is  subject  to  a  prescribed  statutory  penalty 
as  well,  this  penalty  usually  including  both  fine  and  imprison- 
ment. 

In  addition  to  the  common  law  liabilities,  there  are  in  some 
states  penalties  for  refusal  to  allow  the  proper  inspection  of 
books;  for  failure  to  make  certain  reports;  for  permitting 
stockholders  to  withdraw  any  part  of  their  investment  in  the 
corporation  and  for  allowing  other  impairments  of  the  capital 
stock.  Most  of  the  things  thus  penalized  are  in  themselves 
morally  indefensible. 

It  will  be  found,  however,  that  occasionally  acts  or  omissions 
entirely  innocent  in  themselves  have,  by  direct  statutory  pro- 
vision, been  made  punishable  offenses.  Thus  in  some  states  the 
omission  to  file  certain  prescribed  reports  at  a  particular  time  is 
punished  by  fine.  Statutory  provisions  of  this  kind  are,  how- 
ever, not  numerous  and,  so  far  as  applicable  to  the  treasurer  of 
the  corporation,  are  restricted  almost  entirely  to  the  corporate 
reports. 


CHAPTER  XLIX 
THE  TREASURER'S    BOND 

§  461.    General 

The  corporate  funds  are  usually  placed  in  the  treasurer's 
care  with  but  little  reservation,  and,  in  the  absence  of  special 
protective  provisions,  the  measure  of  their  safety  is  the  integrity 
and  efficiency  of  the  treasurer.  If  he  is  dishonest,  they  may  be 
stolen;  if  he  is  careless,  they  may  be  lost. 

The  safeguards  that  can  be  thrown  round  the  corporate  funds 
while  in  the  treasurer's  custody  are  but  few.  Usually  he  is 
required  to  deposit  them  as  soon  as  they  come  into  his  hands,  and 
their  withdrawal  may  be  effected  only  by  check  signed  and 
countersigned  as  required  by  charter,  by-laws,  or  directors' 
resolution.  Notes  and  drafts  likewise  usually  require  signature 
and  countersignature.  Regulations  as  to  corporate  loans,  dis- 
counts, and  other  financial  transactions  restrict  his  power. 
Audits  of  the  treasurer's  books  are  held  from  time  to  time.  His 
character,  standing,  and  financial  responsibility  always  have 
much  weight. 

It  is  obvious,  however,  that  all  this  affords  but  very  partial 
protection  to  the  corporate  funds,  and  still  less  to  the  other 
property  entrusted  to  the  treasurer's  care.  One  further  pro- 
tective measure  of  importance  exists,  and  this  is  the  treasurer's 
bond,  the  most  effective  and  most  relied  upon  of  all  the  material 
safeguards  possible.  1 

The  treasurer's  bond  is  an  instrument  whereby  the  parties 
signing  it  bind  themselves  within  the  limits  of  the  bond  to  make 
good  any  losses  the  corporation  may  suffer  from  the  negligence, 
dishonest  acts,  or  wilful  omissions  of  the  treasurer.     The  obliga- 

>  See  Book  IV,  Form  248. 

401 


402  CORPORATE  LAW  [Bk.  I- 

tions  of  the  bond  are  governed  strictly  by  its  terms,  but  the 
usual  personal  bond  requires: 

1.  The  faithful  performance  of  the   treasurer's  duties. 

2.  The  safety  of  the  corporate  funds  and  other  property 

entrusted  to  his  care. 

3.  Their  due  return  on  the  expiration  of  his  term  of  office, 

or  at  any  prior  time  upon  legal  demand. 

§  462.    Statutory  Requirements 

In  many  states  the  statutes  are  silent  on  the  subject  of  the 
treasurer's  bond.  In  a  few  states,  notably  New  Jersey  and 
Pennsylvania,  the  statutes  require  that  the  treasurer  be  bonded 
in  such  sum  and  with  such  sureties  as  the  by-laws  provide.  In 
other  states,  as  in  New  York,  Colorado,  Delaware,  Massachu- 
setts, and  Illinois,  the  statutes  are  merely  permissive  and  provide 
that  security  may  be  demanded  of  the  treasurer.  As  to  the 
stockholders,  this  is  merely  a  restatement  of  a  power  already 
existing.  TJiey  may,  if  they  wish,  provide  in  the  by-laws  that  a 
bond  shall  be  required  of  the  treasurer,  but  they  might  do  this 
with  equal  force  if  the  statutes  were  silent.  As  to  the  directors, 
however,  such  statutes  are  of  greater  weight,  giving  them,  in 
the  silence  of  the  by-laws,  the  unquestioned  right  to  require  a 
bond  from  the  treasurer — a  power  which  otherwise  is  doubtful. 
The  statutes  of  the  states  mentioned  are  not,  however,  manda- 
tory, and  if  the  directors  see  fit,  they  may  omit  the  require- 
ment and  cannot  be  held  liable  in  case  of  resulting  loss  to  the 
corporation. 

§  463.     Corporate  Requirements 

Irrespective  of  any  statutory  provision,  the  stockholders 
have  full  power  at  common  law  to  require  the  treasurer  to  give  a 
bond.  Such  a  requirement  might  be,  and  sometimes  is,  incor- 
porated in  the  charter,  but  is  usually  found  in  the  by-laws. 

When  the  by-laws  require  a  bond,  they  will  sometimes  specify 
its  amount  and  the  number  of  sureties,  or  perhaps  provide  in- 


Ch.  49]  TREASURER'S  BOND  403 

stead  that  the  bond  of  a  reputable  surety  company  shall  be 
given.  Usually,  however,  they  merely  direct  that  a  bond  shall 
be  required  of  such  amount  and  with  such  sureties  as  the  board 
of  directors  may  prescribe.  Frequently  they  are  merely  per- 
missive, stating  that  the  board  may  require  the  treasurer  to  give 
a  bond,  all  details  being  left  to  the  board. 

In  all  cases  where  the  by-laws  require  a  bond  of  the  treasurer, 
the  directors  have  full  power  to  prescribe  any  details  not  covered 
by  the  by-law  provision.  Should  neither  the  statutes  nor  the 
chg,rter  or  by-laws  of  the  corporation  require  such  bond,  it  is 
doubtful  whether  the  board  would  of  its  own  authority  have 
power  to  compel  it. 

§  464.    Nature  of  the  Bond 

The  treasurer's  bond  is  a  formal  undertaking  of  certain 
parties  who  are  specified  therein  and  by  whom  the  bond  is 
signed,  that  in  the  event  of  loss  arising  from  the  defalcation  or 
other  dishonesty  of  the  treasurer,  they  will  make  good  such  loss 
up  to  the  amount  of  their  bond.  When  such  a  bond  is  given 
it  is  usually  signed  by  the  treasurer  and  by  his  bondsmen  as  well, 
and  in  all  cases  the  details  of  the  liability  involved  are  set  forth 
in  full  in  the  instrument. 

Formerly  personal  bonds  were  the  rule  and  the  bondsmen 
were  usually  friends  of  the  bonded  official.  Of  recent  years, 
however,  responsible  surety  companies  supply  bonds  of  the 
kind,  and  the  personal  or  individual  bond  has  been  largely 
superseded.  The  bond  of  a  good  surety  company  is  always  to 
be  preferred. 

The  personal  bond  is  generally  sweeping  in  its  nature,  cover- 
ing any  loss  occasioned  by  defalcation  or  dishonesty  on  the  part 
of  the  treasurer  and  also  providing  for  the  proper  restoration 
to  the  company,  when  legally  demanded  or  at  the  expiration 
of  the  treasurer's  term  of  office,  of  all  moneys,  papers,  vouchers, 
documents,  books  of  account,  and  other  property  belonging  to 
the  company  then  in  his  hands. 


404  CORPORATE  LAW  [Bk.  I- 

The  wording  of  the  bond  will,  however,  affect  and  directly 
limit  the  extent  of  the  sureties'  liability.  Usually  bondsmen  are 
not  held  liable  for  accidents  or  mistakes  of  the  principal,  or  for 
his  inability  to  perform  all  the  duties  of  his  official  position. 2 
But  where  the  condition  of  the  bond  provides  that  the  principal 
shall  perform  all  the  duties  of  his  office  and  that  the  sureties 
shall  pay  all  damages  or  losses  arising  from  any  failure  to  per- 
form such  duties,  the  bondsmen  may  be  held.s 

§  465.    Amount  of  Bond 

There  is  no  rule  as  to  the  amount  of  the  treasurer's  bond. 
Manifestly  the  matter  is  one  that  must  be  governed  by  the 
conditions  of  each  special  case.  Its  amount  is  supposed  to  be 
proportionate  to  the  risk  involved,  but  frequently  it  will  be  fixed 
haphazardly,  or  at  some  arbitrary  amount  deemed  sufficient, 
or  perhaps  the  cost  of  the  bond  will  determine  its  amount.  In 
all  cases  the  bond  should  be  adequate  to  cover  any  loss  reason- 
ably possible. 

The  treasurer  of  a  corporation  is  usually  a  man  of  standing 
and  character,  and  this  will  in  itself  have  a  direct  bearing  in 
fixing  the  amount  of  his  bond.  Also  he  is  frequently  of  some 
financial  responsibility  and  this  will  have  weight,  as  the  extent 
of  the  treasurer's  liability  is  not  limited  by  the  amount  of  his 
bond.  The  bond  is  merely  a  crystallization  of  a  portion  of  his 
liability  in  convenient  shape  for  ready  realization  in  case  of  loss 
for  which  he  is  responsible,  and  any  property  he  may  own  is 
available  beyond  this  in  case  the  bond  is  insufficient.  Also 
some  measure  of  safety  is  insured  by  the  usual  checks  existing 
or  placed  upon  the  treasurer's  official  actions,  i.e.,  the  general 
knowledge  of  the  business  and  of  the  treasurer's  accounts  and 
affairs  possessed  by  the  directors  and  other  corporation  officials, 
the  accounts  required  to  be  kept,  the  periodical  audits,  the 


»  Moms,  etc.,  Co.  v.  Administratrix,  21  N.  J.  L.  100  (1847);  Union  Bank  v.  Clossey. 
ID  Johns  (N.  Y.)  271  (1813);  contra.  Am.  Bank  v.  Adams,  12  Pick.  (Mass.)  303  fl83H. 
'  Union  Bank  v.  Thompson,  8  Rob.  (La  )  227  (1844).  , 


Ch.  49]  TREASURER'S  BOND  405 

prompt  deposit  of  funds,  the  countersignatures  to  checks,  notes, 
drafts,  etc. 

All  this  must  be  taken  into  consideration,  as  must  also  the 
general  improbability  that  in  event  of  the  treasurer's  neglect  or 
dishonesty  all  the  corporate  funds  and  property  in  his  possession 
will  be  lost.  The  bond  is  usually  but  a  small  proportion  of  the 
amount  entrusted  to  the  treasurer's  care  when  this  is  at  all 
considerable,  and  the  ratio  diminishes  rapidly  as  the  amount 
involved  increases.  For  instance,  the  treasurer  of  some  small 
corporation  with  a  cash  balance  never  exceeding  a  few  thousand 
dollars,  will  frequently  be  required  to  give  a  bond  for  a  thousand 
dollars  or  more.  In  this  case  the  bond  ranges  from  25  to  even 
100%  of  the  total  risk.  In  a  large  corporation  the  percentage 
would  be  relatively  much  smaller. 

Frequently,  as  stated,  the  cost  of  bonding  has  some  weight 
in  determining  its  amount.  Under  the  personal  bond  this  ele- 
ment does  not  enter  in,  but  with  the  suret)'  "ompany  bond  the 
cost  increases  with  the  size  of  the  bond  and  its  amount  will 
naturally  be  kept  as  low  as  prudence  will  permit.  Some- 
times, with  penny-wise  economy,  its  amount  is  fixed  still  lower. 

§  466.    Personal  Bonds 

As  already  stated,  the  bond  formerly  given  by  the  treasurer 
was  almost  invariably  signed  by  individuals.  These  individuals 
wete  usually  friends  of  the  treasurer  who  went  on  the  bond 
merely  as  an  accommodation  to  him  and  without  expectation  of 
compensation  and  equally  without  expectation  of  ever  being 
called  upon  to  meet  its  obligations.  If,  then,  through  the 
treasurer's  fault  or  misfortune,  losses  occurred  and  these  friends 
were  called  upon  to  make  good  the  undertakings  of  the  bond, 
they  naturally  felt  the  demand  to  be  a  hardship.  They  were 
legally  liable,  but  they  did  not  feel  the  moral  obligation  of  a  just 
debt,  and  would  delay  payment  as  long  as  possible  and  frequently 
evade  it  altogether,  or  perhaps  be  found  unable  to  pay.  The 
whole  system  was,  and  is,  unsatisfactory  and  ineffective. 


4^6  CORPORATE  LAW  [Bk.  I- 

The  personal  bond  is  still  used  to  a  considerable  extent,  and 
when  it  is  employed  the  standing  of  the  treasurer's  sureties  or 
bondsmen  becomes  a  matter  of  the  first  importance.  It  is 
obvious  that  the  value  of  the  bond  rests  not  alone  in  the  financial 
ability  of  the  bondsmen  but  to  a  considerable  extent  upon  their 
moral  responsibility  as  well,  and  both  their  financial  standing  and 
general  character  should  therefore,  when  the  bond  is  large,  be 
subjected  to  a  searching  scrutiny.  This  is  a  matter  entirely 
within  the  province  of  the  directors.  Usually  the  bondsmen 
of  a  corporation  treasurer  are  personally  known  to  the  directors, 
and  the  desirability  of  these  bondsmen  may  then  be  decided 
from  knowledge  so  gained  without  the  necessity  of  special 
investigation. 

It  need  hardly  be  said  that  the  actual  drafting  of  the  mstru- 
ment  by  which  the  treasurer's  bondsmen  are  held  should  be 
careful  and  competent.  A  defective  instrument  might  easily 
result  in  a  total  loss  of  the  protection  the  bond  was  expressly 
intended  to  afford. 

§  467.    Surety  Company  Bonds 

The  surety  company  bond  is  similar  in  its  general  nature  to  a 
personal  bond ;  its  carefully  restricted  liability  and  the  fact  that 
it  is  signed  by  a  surety  company  instead  of  by  individuals  con- 
stituting the  only  material  difference.  The  surety  companies 
supplying  these  bonds  are  usually  well-known  and  substantial, 
and  the  conditions  surrounding  the  issue  of  their  bonds  are  such 
as  to  make  the  security  afforded  far  superior  within  its  limits  to 
that  of  the  ordinary  personal  bond. 

When  a  surety  company  bond  is  desired,  the  treasurer  makes 
his  application  in  prescribed  form,  specifying  the  amount 
required.  The  company  then  investigates  the  character  and 
standing  of  the  treasurer  to  decide  whether  he  is  a  suitable 
person  for  the  position  and  one  who  may  be  safely  bonded.  If 
he  is  accepted,  a  fee  is  paid  the  company  according  to  the  amount 
of  the  bond  and  the  nature  of  the  risk,  and  the  bond  is  issued. 


Ch.  49]  TREASURER'S  BOND  407 

The  treasurer's  application  to  a  surety  company  is  formal. 
It  usually  involves  a  very  complete  statement  of  his  past  history 
and  present  condition,  covering  his  social  and  business  habits, 
standing,  and  connections,  and  giving  all  such  details  of  his 
earlier  and  present  life  as  will  enable  the  surety  company  to  judge 
of  his  fitness  as  a  custodian  of  money  and  property.  The  appli- 
cant is  also  required  to  give  a  number  of  suitable  references,  i.e., 
people  who,  while  not  relatives,  have  been  in  a  position  to  judge 
of  the  character  and  responsibility  of  the  applicant.  These 
references  are  communicated  with  and  a  written  statement  as 
to  the  important  features  of  the  treasurer's  character,  reputation, 
and  past  history  are,  if  possible,  obtained  from  each.  The 
investigation  is  usually  thorough  and  searching.  If  the  applicant 
passes  the  ordeal  successfully,  the  company  issues  its  bond  in 
accordance  with  his  application. 

In  the  case  of  a  corporation  treasurer,  the  surety  company's 
fee  for  a  bond  of  moderate  amount — say  a  few  thousand  dollars — 
is  from  $4  to  $7  per  annum  for  each  thousand  dollars  of  bonded 
obligation  assumed  by  the  company.  These  fees  are  sometimes 
paid  by  the  treasurer  himself  and  sometimes  by  the  corporation. 
It  would  seem  proper  that  the  corporation  should  assume  this 
expense,  though  no  established  rule  prevails. 

Bonding  by  a  surety  company  is,  as  has  been  said,  a  strictly 
business  transaction.  Before  taking  the  risk  the  company 
makes  a  careful  investigation  and  takes  every  proper  precaution. 
Its  fees  are  based  on  careful  calculation  and  long  experience  and 
are  an  adequate  payment  for  the  risk  assumed.  A  certain  per- 
centage of  loss  is  anticipated.  Then,  when  loss  does  occur  for 
which  the  company  is  liable  under  its  bond,  there  is  seldom,  if 
ever,  any  attempt  on  the  part  of  a  reputable  and  responsible 
surety  company  either  to  evade  or  delay  payment  of  its  obli- 
gation. 1  )^*j-x. 

Further,  it  may  be  said  that  the  reputation  and  financial 
standing  of  the  surety  companies  engaged  in  the  business  of 
bonding  may  be  easily  and  satisfactorily  ascertained ;  that  there 


4b8  CORPORATE  LAW  [Bk.  I- 

is  usually  neither  trouble  nor  delay  in  payment  when  unques- 
tioned obligations  arise;  that  in  case  of  doubt,  necessitating 
legal  proceedings  in  order  to  determine  whether  or  not  the 
bondsmen  are  liable,  the  courts  construe  the  bonds  given  by 
surety  companies  much  more  strictly  than  in  the  case  of  bonds 
given  by  individuals,  and,  finally,  that  in  spite  of  its  limited 
protection  and  many  conditions,  the  surety  company  bond  has 
almost  superseded  the  personal  bond. 

§  468.    Liability  of  Bondsmen 

The  contract  of  the  bondsmen  or  surety  company  is  an  agree- 
ment to  indemnify  the  corporation  against  loss  occurring  through 
the  defaults  of  the  treasurer.  The  treasurer  joins  with  his 
bondsmen  or  with  the  surety  company  in  signing  the  bond. 
This  is  not  for  the  purpose  of  binding  himself  to  the  corporation, 
to  which  he  already  owes  a  duty,  but  for  the  purpose  of  obligating 
himself  to  save  his  sureties  harmless.  In  bonds  prepared  by  the 
surety  companies  the  obligation  of  the  surety  company  is  usually 
made  conditional  upon  the  signing  of  the  bond  by  the  treasurer. 

If  the  bond  is  phrased  "jointly  and  severally,"  the  bondsmen 
signing  the  instrument  are  each  individually  liable  to  the  full 
amount  of  the  bond,  and  action  in  case  of  loss  may,  if  desired, 
be  commenced  against  the  treasurer  alone  or  against  any  one  of 
his  bondsmen,  or  against  any  or  all  of  the  parties  at  the  same 
time. 4  In  Massachusetts  suit  in  such  case  must  be  brought 
either  against  one  or  against  all  the  obligors,  s  As  among  them- 
selves, however,  each  one  of  the  bondsmen  is  responsible  for  his 
individual  proportion  of  any  loss  incurred  and  if  payment  is 
enforced  from  one  bondsman,  he  is  legally  entitled  to  collect 
the  pro  rata  amount  due  from  each  of  his  fellow  bondsmen. 

Usually  liability  of  a  personal  bond  is  Kmited  to  the  amount 
actually  and  directly  lost  by  the  neglect  or  dishonesty  of  the 


*  PouUain  v.  Brown,  80  Ga.  27  (1887);  McKee  v.  Grifiin,  60  Ala.  427  (1877);  Trustees  v. 
McBride.  81  Misc.  (N.  Y.)  618  (1913). 

'  Leonard  v.  Speidel,  104  Mass.  356  (1870). 


Ch.  49I  TREASURER'S  BOND  409 

treasurer.  In  case  the  amount  of  such  loss  Is  less  than  the 
amount  of  the  bond,  the  bondsmen  are  liable  only  for  the  loss 
actually  incurred  but  are  still  held  on  the  bond  for  any  future 
losses  and  this  liability  continues  until  the  bond  expires  or  until 
they  have  paid  out  the  full  amount  of  their  obligation  there- 
under. If  the  loss  is  greater  than  the  amount  of  the  bond,  the 
bondsmen  are  liable  up  to  its  full  amount  but  not  beyond,  and 
upon  payment  of  its  amount  the  bond  is  extinguished  and  of  no 
further  effect.  In  other  words,  the  amount  specified  in  the 
bond  marks  the  limit  of  the  bondsmen's  liability. 

When  a  bond  is  once  executed  the  bondsmen  cannot  with- 
draw or  escape  from  its  liability  until  the  legal  termination  or 
prior  cancellation  of  the  bond.  They  may  have  reason  to  sus- 
pect the  treasurer  of  dishonesty  or  carelessness,  or  for  other 
reasons  may  greatly  desire  to  end  their  liability,  but  this  they 
cannot  do  unless  with  the  consent  of  the  corporation.  They 
may  neither  cancel  their  obligation  nor  escape  it.^  They  can 
only  wait  until  time  works  their  relief  or  perhaps  their  ruin.  A 
cancellation  clause  is  sometimes  inserted  in  personal  bonds, 
and  always  in  surety  company  bonds,  for  the  express  purpose  of 
its  termination,  if  desired,  before  the  end  of  the  bonded  period. 

The  undertaking  of  a  bond  is  an  onerous  one  that  should  not 
be  entered  upon  by  individuals  as  lightly  as  is  usually  done.  The 
expectation  is,  of  course,  that  no  loss  will  occur  and  no  active 
obligation  fall  upon  the  bondsmen.  Instances  showing  the 
fallacy  of  this  expectation  are,  however,  numerous,  and  when 
liability  does  arise,  the  results  are  apt  to  be  serious — too  serious 
to  justify  the  signing  of  a  bond  as  a  mere  matter  of  friendship, 
when  a  few  dollars  will,  as  a  matter  of  ordinary  business,  obtain 
perhaps  a  better  bond  from  a  responsible  surety  company.  A 
personal  bond  is  an  imposition  on  the  individuals,  and  does  not 
safeguard  the  corporation. 

_  In  case  of  doubt,  or  when  legal  proceedings  are  necessary  to 
enforce  the  liability  of  bondsmen,  the  courts,  as  already  stated, 

•    Stearns  on  Suretyship,  |  1 19. 


416  CORPORATE  LAW  [Bk.  I- 

construe  the  bonds  given  by  surety  companies  much  more  strictly 
than  the  bonds  of  individuals.  The  leniency  shown  the  indi- 
vidual in  this  case  arises  from  the  fact  that  he  generally  takes 
no  part  in  the  writing  of  the  instrument  and  does  not  profit  from 
the  transaction.  He  is  in  fact  merely  an  accommodation  party 
and  is  therefore  entitled,  in  case  of  doubt,  to  the  strictest  con- 
struction in  his  favor.  7 

In  the  case  of  a  surety  company,  the  reverse  of  all  this  is 
true.  The  company  itself  prepares  the  form  of  bond,  carefully 
investigates  and  limits  the  risk  it  assumes,  protects  itself  in  every 
particular,  and  is  paid  adequately  for  its  undertaking.  Hence, 
when  the  courts  pass  upon  such  a  contract,  their  construction 
in  case  of  doubt  is  against  the  surety  and  in  favor  of  the  party 
seeking  indemnity. « 

§  469.    Termination  of  Bond 

Unless  the  treasurer's  bond  contains  some  clause  providing 
that  its  liability  shall  continue,  or  sooner  terminate,  it  is  limited 
to  the  term  of  office  foriwhich  the  treasurer  was  elected.  If  the 
treasurer  is  re-elected,  his  bond,  unless  specifically  so  provided 
in  the  instrument,  does  not  pass  over  to  the  new  term  but  must 
be  renewed. 9  Also,  if  the  election  of  officers  fails  and  the 
treasurer  holds  over  beyond  the  elected  term,-  his  bondsmen  are 
not  responsible  for  this  hold-over  term  unless  this  continuing 
responsibility  is  clearly  expressed  in  the  bond.i" 

The  death  of  the  treasurer  terminates  his  bond,  as  does  like- 
wise his  peremptory  or  accepted  resignation,  provided  in  either 
case  that  all  the  corporate  funds  and  other  corporate  property 
entrusted  to  him  are  returned.  Also,  if  there  is  any  material 
change  in  the  duties  and  responsibilities  of  the  treasurer,  the  old 


'  Steams  on  Suretyship,  {  255;  Ulster  Co.  Sav.  Inst.  v.  Ostrander,  15  App.  Div.  (N.  Y.) 
137  (1897);  Ward  V.  Stahl,  81  N.  Y.  406  (1880). 

•Am.  Surety  Co.  v.  Pauly,  170  U.  S.  133  (1897);  Tarboro  v.  Fidelity  Co.,  128  N.  C.  366 
(1901). 

>  Citizens'  Loan  Assn.  v.  Nugent,  40  N.  J.  L.  215  (1878);  Savings  Bank  v.  Hunt,  72  Mo. 
597  (1880);  Ulster  Co.  Sav.  Inst.  v.  Ostrander,  163  N.  Y.  430  (1900). 

1"  Brandt  on  Suretyship,  §  191;  Ulster  Co.  Inst.  v.  Young,  161  N.  Y.  23  (1899). 


Ch.  49]  TREASURER'S  BOND  41 1 

bond  may  be  terminated  or  vitiated  by  the  changed  conditions 
and  a  new  bond  should  then  be  required." 

It  is  to  be  noted  that  while  the  liabilities  of  a  bondsman  are 
Umited  to  losses  occurring  during  the  term  for  which  the  bond 
is  given,  the  bondsmen  are  not  released  entirely  at  the  end  of  this 
period,  but  may  still  be  held  for  any  defalcation  or  loss  which 
occurred  during  the  bonded  term,  even  though  such  loss  were  not 
discovered  until  long  after  this  term  expired.  In  other  words, 
the  bondsmen  undertook  to  make  good  certain  possible  specified 
losses  if  they  occurred  during  a  certain  specified  time,  i.e.,-  during 
the  treasurer's  term  of  office.  If  such  losses  do  occur,  the  mere 
fact  that  they  are  not  discovered  till  later  does  not  affect  the 
liability  of  the  bondsmen  one  way  or  the  other,  unless  perhaps 
the  bondsmen's  liability  is  then  barred  by  the  statutes  of  limita- 
•tion,  or  some  limitation  has  been  imposed  by  the  terms  of  the 
bond.  It  has  been  held  that  defalcations  in  three  successive 
years  under  an  original  bond  and  two  renewals  were  recoverable, 
although  the  total  amount  was  greater  than  the  liability  of  the 
bond  for  any  one  year.12 

This  continuing  liability  is  a  disturbing  feature  of  the  personal 
bond  and  is  a  strong  reason  for  its  avoidance.  In  a  surety  com- 
pany bond,  on  the  contrary,  this  feature  is  taken  into  considera- 
tion and  provided  against  by  careful  limitations. 


'I  National,  etc.  Assn.  v.  Conkling,  90  N.  Y.  116  (iijS2);  Smith  v.  MoUeson,  148  N.  Y.  241 
(1896). 

u  Campbell  Milk  Co.  v.  U.  S.  Fidelity  &  G.  Co.,  161  App.  Div.  (N.  Y.)  738  (19x4). 


CHAPTER  I. 

THE  TREASURER'S  REPORTS  i 

§  470.    The  Report  to  Directors 

In  the  smaller  corporations  the  directors  usually  keep  in 
dose  touch  with  both  the  corporate  business  and  its  records, 
and  a  formal  report  from  the  treasurer  will  hardly  be  required 
more  than  once  a  year. 

In  the  larger  corporations  monthly  reports  showing  the  con- 
dition of  the  corporate  affairs  are  usually  required,  the  details 
and  scope  of  these  reports  depending  somewhat  on  the  nature 
of  the  corporate  business.  An  annual  report  is  also  made  at  the 
end  of  the  corporate  year,  usually  similar  in  form  to  the  monthly 
reports  but  covering  the  operations  of  the  entire  year. 

There  should  be  no  reservations  in  the  treasurer's  report  to 
the  directors.  The  directors  are  responsible  for  the  management 
of  the  business  and  should  be  fully  informed  on  every  detail  of 
the  corporate  operations  that  will  assist  them  in  the  intelligent 
and  capable  discharge  of  this  responsibility.  Occasionally  it 
will  happen  that  special  transactions  are  not  divulged  to  the 
entire  board  of  directors,  but  this  is  exceptional  and  is  proper 
only  when  the  directors  themselves  concur. 

The  treasurer's  report,  whether  monthly,  quarterly,  or  an- 
nual, should,  for  the  period  covered,  give  the  source  and  amount 
of  moneys  received,  the  amount  and  nature  of  disbursements, 
the  earnings  and  expenses,  and  the  assets  and  liabilities  as  of 
the  close  of  the  reported  period.  Any  special  data  peculiar  to 
the  particular  time  or  period,  or  of  importance  to  the  financial 
operations  of  the  corporation,  should  also  be  embodied  in  the 
treasurer's  report. 

'  See  generally,  Book  III,  Part  VII,  "Corporation  Reports  and  Statements  " 

412 


Ch.  50]  TREASURER'S  REPORTS  413 

The  form  and  the  details  of  the  report  submitted  depend  on 
the  requirements  of  the  board  and  also  on  the  possibilities  of  the 
accounting  system.  If  profits  can  only  be  ascertained  annually 
or  semiannually  after  taking  an  inventory,  then  the  monthly 
report  cannot  embody  an  accurate  balance  sheet  or  a  profit  and 
loss  statement.  A  summarized  statement  of  cash  receipts  and 
disbursements  can  always  be  made  and  such  statistical  data  as 
gross  sales,  returns,  purchases,  etc.,  can  be  presented  if  desired. 
If  made  in  a  comparative  form,  i.e.,  if  the  data  of  the  corre- 
sponding year  are  also  inserted,  the  directors  will  be  able  to  draw 
some  valuable  conclusions.  Frequently,  when  possible,  a  com- 
parative balance  sheet  is  also  submitted  showing  the  assets  and 
liabilities  as  at  the  close  of  the  month  of  the  report. 

"Usually  a  comparative  profit  and  loss  statement  is  made  up, 
showing  the  earnings  and  expenses  for  the  corresponding  month 
of  the  previous  year.  The  expenses  are  not  detailed  in  this 
statement,  reference  being  made  to  the  analysis  book  which 
shows  in  comparative  form  the  detailed  expenses  of  each  month. 
This  book  should  accompany  the  report  when  it  is  submitted  to 
the  directors.  This  obviates  the  necessity  for  detailing  all  ex- 
penses in  the  report,  which  should  be  done  if  an  analysis  book 
is  not  kept  or  is  not  presented  to  the  board. 

The  treasurer's  annual  report  to  the  directors  should  follow 
the  general  form  of  the  monthly  report. 

§  471.    Report  to  Stockholders 

The  stockholders  compose  the  corporation  and  are  entitled 
to  information  as  to  its  condition  and  progress.  Frequently, 
however,  there  are  trade  reasons  for  withholding  the  more  con- 
fidential details  from  them.  It  is  obvious  that  if  a  full  showing 
of  the  corporate  business  and  the  results  of  its  operations  were 
made  annually  to  the  stockholders  of  a  corporation,  it  would 
become  public  property  and  serious  results  might  follow.  Pri- 
marily for  this  reason,  but  also  because  the  stockholders  do 
not  need  nor  usually  desire  fully  detailed  statements  of  the 


414  CORPORATE  LAW  [Bk  I- 

corporate  business,  the  reports  made  to  the  stockholders  are 
ahnost  always  general  in  their  character. 

The  report  to  the  stockholders  generally  takes  the  form  of  a 
statement  of  earnings  designed  to  give  a  view  of  the  company's 
operations.  Sometimes  a  condensed  balance  sheet  will  make 
an  excellent  stockholder's  report.  This  may  be  accompanied 
by  an  income  tax  statement  showing  the  earnings  for  the  year, 
and  also  by  a  condensed  general  profit  and  loss  account.  In 
many  of  the  larger  corporations,  more  or  less  directly  comiected 
matter  accompanies  the  balance  sheet.2 

In  many  corporations  the  treasurer  makes  no  independent 
report,  the  president's  report  covering  the  general  affairs  and 
conditions  of  the  corporation  together  with  its  finances  and 
plans  for  the  future.  This  is  true,  for  instance,  of  the  United 
States  Steel  Corporation,  where  but  one  formal  report — that  of 
the  chairman  of  the  board — is  made  to  the  stockholders.  In 
perhaps  the  majority  of  cases,  however,  the  treasurer  makes 
his  own  report  to  the  stockholders,  covering  in  it  such  details  of 
the  financial  affairs  of  the  corporation  as  the  directors  deem  it 
expedient  for  the  stockholders  to  know;  or,  to  express  it  other- 
wise, all  such  financial  details  as  will  be  of  interest  to  the  stock- 
holders, the  publication  of  which  will  not  result  in  injury  to  the 
company's  business. 

Where  but  one  formal  report  is  made  to  the  stockholders 
and  this  report  is  made  by  the  president,  the  treasurer  or  the 
treasurer's  department  will,  of  course,  supply  the  president  with 
material  for  the  financial  portion  of  the  statement.  In  any  case, 
the  two  officials  should  work  in  sufficiently  close  touch  to  pre- 
vent any  serious  overlapping  of  their  reports.s 


'See  Book  IV,  Forms  264,  265. 
'  See  Book  IV,  Form  262. 


Part  XI — The  Corporate  Finances 


CHAPTER  LI 
THE  CORPORATE  FUNDS 

§  472.    General 

"Corporate  funds"  is  a  general  term  applied  to  the  moneys 
belonging  to  the  corporation.  Technically,  the  term  "funds" 
includes  securities  as  well  as  moneys,  but  used  in  connection 
with  the  treasurer's  work  it  is  customary  to  restrict  its  applica- 
tion to  cash,  sight  drafts,  checks,  and  similar  readily  convertible 
paper.  The  general  corporate  securities,  such  as  notes,  time 
drafts,  treasury  stock,  bonds,  securities  of  other  corporations, 
etc.,  are  also  usually  committed  to  the  treasurer's  care  but  not 
under  the  designation  "funds,"  the  provisions  regulating  the 
matter  usually  employing  the  phrase  "money  and  securities," 
in  order  to  avoid  any  uncertainty  as  to  their  scope. 

§  473.    Collections 

Whether  the  treasurer  is  responsible  for  the  collection  of 
moneys  due  the  corporation  or  not,  is  a  matter  determined 
entirely  by  the  requirements  or  practice  of  the  particular  cor- 
poration. 

In  the  smaller  corporations  collections  falling  due  in  the 
ordinary  course  of  business  are  within  the  usual  province  of  the 
treasurer;  in  the  larger  corporations  they  are  not.  In  these  all 
moneys  as  received  are  turned  over  to  the  treasurer,  but  his 
responsibility  as  to  collections  is  limited  to  such  special  collections 
as  may  be  specifically  assigned  to  him. 

41S 


4l6  CORPORATE  LAW  (Bk.  I- 

§  474.    Status  of  Treasurer  as  to  Corporate  Funds 

In  receiving  and  holding  the  corporate  moneys  the  treasurer 
acts  as  the  agent  of  the  corporation.  He  must  therefore  safe- 
guard them  with  all  reasonable  care,  and  use  them  only  on 
account  of  and  for  the  benefit  of  the  corporation  and  in  accord- 
ance with  its  instructions.  So  long  as  he  acts  within  these  limits, 
he  is  not  responsible  for  any  losses  which  may  occur.i 

If,  however,  the  treasurer  fails  to  use  reasonable  care  in  his 
custody  of  the  corporate  funds,  i.e.,  the  care  that  a  prudent 
man  of  business  would  exercise  in  regard  to  his  own  funds,  he  will 
be  liable  for  any  resulting  losses.  Also,  if  he  disburses,  uses,  or 
invests  the  corporate  funds  without  authority,  he  is  again 
liable  if  losses  result,  but,  should  gains  be  made,  these  gains 
belong  to  the  corporation.  In  other  words,  any  profits  resulting 
from  the  use  of  the  corporate  funds  while  in  the  treasurer's  care, 
belong  to  the  corporation  regardless  of  whether  such  use  be 
proper  or  improper.  If  losses  result  from  proper  use  of  the 
funds  the  loss  is  the  corporation's;  but  if  the  use  be  improper, 
the  loss  is  the  treasurer's. 

This  same  rule  holds  good  where  the  treasurer  privately 
employs  corporate  funds  for  his  own  benefit  or  account.  If 
the  transaction  is  discovered,  the  corporation  can  reclaim  not 
only  its  funds  but  any  resulting  profits  as  well.  If  losses  occur, 
the  treasurer  can  be  required  to  make  these  good  and  in  addition, 
in  either  case,  is  liable  to  prosecution  for  embezzlement. 

Such  a  condition  occasionally  occurs  where  the  cashier  or 
treasurer  of  an  institution  uses  its  funds  for  speculative  purposes, 
expecting  to  replace  the  borrowed  funds  from  the  returns  of 
the  venture,  while  any  profits  are  to  be  retained  as  his  own 
private  gain.  Usually  no  profits  are  made  and  the  discovery  of 
the  transaction  involves  the  defaulting  treasurer  in  disgrace  and 
punishment.  If,  however,  profits  should  be  made,  these  profits 
are  the  property  of  the  corporation  and,  if  retained  by  the 
treasurer,  his  offense  is  twofold.     Not  only  has  he  used  and 


>  First  Nat.  Bank  v.  Bank,  77  N.  Y.  320  (1879). 


Ch.  51]  THE  CORPORATE  FUNDS  417 

risked  the  corporate  funds  improperly,  but  he  has  stolen  the 
resulting  profits. 

§  475.    Custody  of  Corporate  Funds 

The  treasurer's  responsibility  for  the  corporate  funds  begins 
as  soon  as  they  are  turned  over  to  him,  and  continues  until  they 
are  surrendered  to  his  successor  or  to  some  other  properly 
.authorized  party. 

Usually  the  corporate  authorities  designate  a  depositary  and 
require  the  treasurer  to  deposit  the  corporate  funds  'therein.  If 
not,  it  would  still,  as  a  rule,  be  the  duty  of  the  treasurer  to 
deposit  in  a  reputable  bank  the  moneys  coming  into  his  hands, 
as  an  incident  of  the  "reasonable  care"  properly  required  of  him. 

Just  how  soon  funds  should  be  deposited  after  their  receipt 
is  a  matter  to  be  decided  by  conditions.  Usually  a  routine  for 
handling  the  corporate  moneys  and  securities  is  established  and 
the  treasurer  is  governed  by  its  rules. 

In  the  absence  of  any  express  provision  or  custom  requiring 
daily  deposits,  small  amounts  of  money  might  properly  be  held 
until  a  convenient  time  for  depositing  them,  particularly  if  there 
were  a  suitable  safe  or  vault  at  the  treasurer's  disposal  in  which 
such  funds*  could  be  kept.  If,  however,  material  amounts  of 
money  were  received  by  the  treasurer  during  banking  hours,  he 
would  ordinarily  be  grossly  negligent  if  they  were  not  deposited 
the  same  day.  If  received  after  banking  hours,  they  should  be 
kept  in  the  safest  place  at  his  command  until  they  can  be  de- 
posited on  the  next  banking  day.  The  temporary  receptacle 
for  such  funds  would  naturally  be  the  safe  or  vault  used  by  the 
corporation  for  the  preservation  of  its  books,  papers,  and  other 
valuables.  Should  the  treasurer  place  his  funds  elsewhere,  a 
very  clear  and  satisfactory  explanation  of  his  reasons  for  so 
doing  would  be  necessary  to  save  him  from  liability  in  case  of 
any  resulting  loss. 

In  the  larger  or  more  active  corporations  considerable 
amounts  of  money  are  often  kept  over  from  day  to  day  in  the 


4l8  CORPORATE  LAW  [Bk.  I- 

various  funds  or  for  special  purposes,  but  they  are  kept  under 
such  conditions  of  safety  as  to  render  the  risk  neghgible.  Also, 
as  this  is  done  with  intent,  and  with  the  knowledge  and  consent 
of  all  parties  concerned,  the  treasurer  is  not  liable  even  though 
losses  occur. 

The  general  rule  that  the  corporate  funds  should  be  deposited 
promptly  applies  particularly  in  the  case  of  checks.  The  check 
is  merely  an  order  for  money,  and  if  the  treasurer  accepts  this 
order  and  does  not  present  it  promptly  for  payment,  he  is  himself 
liable  for  any  loss  occasioned  by  the  delay.2 

§  476.    Disbursement  of  Corporate  Funds 

The  disbursement  of  the  corporate  funds  is  usually  made 
under  carefully  prescribed  conditions,  and  the  treasurer  can 
hardly  incur  liability  in  the  exercise  of  this  duty  save  as  a  result 
of  gross  negligence  or  downright  fraud. 

Usually  the  by-laws  provide  that  the  corporate  funds  shall 
be  paid  out  by  the  treasurer  in  accordance  with  the  instructions 
of  the  directors,  and  also  prescribe  the  exact  signature  to  the 
checks  by  means  of  which  payments  are  made,  and  require  that 
the  treasurer  shall  take  all  proper  receipts  and  vouchers.  If 
the  by-laws  are  silent,  the  directors  have  full  power  to  make  such 
rules  as  to  disbursements  as  they  deem  proper. 

If  neither  by-laws  nor  directors'  resolutions  make  any  pro- 
vision as  to  the  details  of  disbursements,  the  treasurer  may  then 
use  his  discretion  and  need  only  observe  the  rules  of  ordinary 
business.  These  would  undoubtedly  require  that  payments  of 
importance  be  made  by  check  whenever  reasonably  possible,  and 
that  receipts  or  vouchers  be  taken  for  all  moneys  paid  out. 

In  no  event  has  the  treasurer  authority  to  make  payments 
on  his  own  initiative.  The  matter  is  one  that  belongs  to  the 
directors  alone  and  the  treasurer  has  no  right  either  to  make  a 
payment  without  their  authorization  or  to  refuse  a  payment 
when  it  has  been  directed  by  them. 


•Smith  V.  Miller,  43  N.  Y.  176  (1870);  First  Natl.  Bank  v.  Bank,  77  N.  Y.  320  (1879) 


Ch.  si]  the  corporate  FUNDS  419 

The  payments  of  corporate  funds  customarily  made  by  the 
treasurer  in  practice  without  specific  authorization  are  not  in 
violation  of  this  rule.  Occasionally  he  will  in  an  emergency  or 
for  special  reason  pay  accounts  without  authorization  of  any 
kind,  but  he  then  relies  upon  the  acquiescence  or  express  ratifica- 
tion of  the  directors.  Usually,  however,  his  payments,  when 
not  specifically  authorized,  are  made  under  blanket  instructions 
empowering  the  payment  of  large  amounts  made  up  of  numerous 
small  items.  Or  perhaps  certain  routine  obligations,  as  the 
pay-roll  at  the  end  of  each  week,  will  be  paid  as  a  matter  of 
course,  the  treasurer  relying  entirely  upon  the  implied  authority 
of  custom. 

The  treasurer's  responsibility  for  the  correctness  and  validity 
of  accounts  paid  depends  upon  the  conditions.  If  bills  are 
ordered  paid  by  the  directors,  the  treasurer  ordinarily  has  no 
responsibility  in  the  matter  save  for  their  proper  payment,  unless 
he  is  aware  of  doubtful  or  fraudulent  circumstances  connected 
with  these  accounts  not  known  to  the  directors.  If,  however, 
under  a  general  authorization  he  pays  accounts  which  later 
prove  to  be  false  or  fraudulent,  he  might  be  held  for  any  resulting 
loss.  To  escape  it  he  must  show  that  he  was  unaware  of,  and 
could  not  have  been  reasonably  expected  to  discover,  the  fraudu- 
lent nature  of  the  accounts.^ 

§  477.    Return  of  Corporate  Funds 

At  the  conclusion  of  the  treasurer's  tenure  of  office,  it  is  his 
duty  to  turn  over  the  corporate  funds  to  his  successor  or  to  such 
other  party  as  may  be  designated  by  the  board  of  directors.  If 
he  does  not  do  this  voluntarily,  their  return  may  be  enforced  by 
legal  action.4  If  any  deficiencies  are  discovered  in  the  funds,  the 
treasurer  or  his  bondsmen  must  make  them  good,  and  if  such 
deficiencies  occurred  through  the  treasurer's  wrongdoings,  he  is 
liable  to  a  criminal  action. 


» See  Ch.  XLVIII,  "The  Treasurer's  Liabilities." 

'Hunter  v.  Robbins,  117  Fed.  Rep.  920  (1902);  Consolidated,  etc.,  Works  v.  Brew.,  113 
V/is.  610  (1902). 


CHAPTER  LII 

DIVIDENDS  1 

§  478.    Declaration  of  Dividends 

The  right  of  the  directors  to  declare  dividends  is  an  incident 
of  their  general  power  to  manage  the  affairs  of  the  corporation, 
and  is  recognized  either  directly  or  by  implication  by  the  stat- 
utes of  every  state.  The  right  is  subject  to  pro^dsions  of  the 
charter  or  by-laws  regulating  the  declaration  of  dividends,  and 
to  any  provisions  of  the  statutes  applicable  thereto.  The  by- 
laws almost  invariably  specifically  authorize  the  declaration  of 
dividends  by  the  board  of  directors.  An  example  of  compre- 
hensive by-law  provision  follows: 

The  Board  of  Directors  may  declare  dividends  from  the  surplus 
or  from  the  net  profits  of  the  Company. 

The  dates  for  the  declaration  of  dividends  upon  the  preferred 
stock  and  upon  the  common  stock  of  the  Company  shall  be  the 
days  by  these  By-laws  fixed  for  the  regular  monthly  meetings  of 
the  Board  of  Directors  in  the  months  of  April,  July,  October,  and 
January  in  each  year,  on  which  days  the  Board  of  Directors  in  its 
discretion  shall  declare  what,  if  any,  dividends  shall  be  declared 
upon  the  preferred  stock  and  the  common  stock,  or  either  of  such 
stocks. 

The  dividends  upon  the  preferred  stock,  if  declared,  severally 
and  respectively,  shall  be  payable  quarterly  upon  the  thirtieth  day 
of  May,  of  August,  of  November,  and  the  last  day  of  February  in 
each  year. 

The  dividends  upon  the  common  stock,  if  declared,  severally 
and  respectively,  shall  be  payable  quarterly  on  the  thirtieth  day  of 
June,  of  September,  of  December,  and  of  March  in  each  year.^ 


'See  also  Book  II,  Chs.  XXXI,  XXXII.  "Dividends";  also  Book  III,  Ch.  XIV,  "Divi- 
dends." 

J  By-Laws  of  the  U.  S.  Steel  Corporation,  Art.  VI,  {  5,  "Dividends." 

420 


Ch.  52]  DIVIDENDS  421 

In  the  smaller  corporations  the  by-laws  regulating  dividends 
are  much  more  general  in  their  provisions,  usually  merely  re- 
stating the  common  or  statutory  law  on  the  subject,  as  in  the 
following  extract: 

Dividends  shall  be  declared  only  from  the  surplus  profits  at  such 
times  as  the  Board  shall  direct,  and  no  dividend  shall  be  declared 
that  will  impair  the  capital  of  the  Company. 

Under  this  by-law  the  directors  have  wide  discretion  and, 
provided  no  statutory  provisions  conflict,  may  reserve  any 
profits  they  please  for  surplus  or  working  capital,  or  may  declare 
any  legally  available  profits  as  dividends,  and,  so  long  as  the 
exercise  of  their  discretion  is  honest,  can  be  neither  restrained 
nor  compelled. 

Statutory  provisions  prohibiting  dividends  that  will  impair 
the  capital  stock  or  that  will  render  the  corporation  insolvent 
are  found  in  practically  every  state.  It  is  but  seldom  that  the 
statutes  go  further  in  respect  to  dividends.  In  New  Jersey, 
however,  there  is  a  certain  unique  statute  that  compels  directors 
to  pay  dividends  if  there  are  any  corporate  profits,  unless  the 
charter  or  by-laws  provide  otherwise.  Hence  it  is  necessary 
for  New  Jersey  corporations,  either  in  charter  or  by-laws,  to 
prescribe  that  directors  may  make  reserves  and  accumulate 
working  capital. 

The  by-laws  frequently  regulate  the  declaration  of  dividends. 
In  some  cases  they  provide  that  a  specified  surplus  fund  shall 
be  reserved  before  any  dividends  may  be  declared.  In  other 
cases  they  specify  that,  after  the  reservation  of  a  designated 
surplus,  any  remaining  profits  shall  be  declared  as  dividends. 
Occasionally  the  matter  is  reversed,  the  by-laws  requiring  that 
dividends  to  a  specified  amount  shall  be  declared  before  any 
profits  may  be  reserved  as  surplus.  Such  a  by-law  provision 
is,  as  a  rule,  obviously  undesirable,  since  it  compels  the  declara- 
tion of  dividends  regardless  of  the  business  conditions  which 
should  control. 


428  CORPORATE  LAW  [Bk.  I- 

Usually,  before  the  date  fixed  for  declaration  of  dividends  or, 
if  no  such  date  is  fixed,  at  the  time  a  dividend  is  contemplated, 
the  treasurer  is  called  upon  for  a  statement  showing  the  cor- 
porate profits  available  for  the  purpose.  If,  however,  the  cor- 
poration has  ample  surplus  profits,  or  if  the  business  is  so 
prosperous  as  obviously  to  justify  the  proposed  dividend,  no 
statement  is  necessarily  required,  the  directors  merely  declaring 
the  dividend  as  a  matter  of  course. 

§  479.    Resolution  Declaring  a  Dividend 

When  the  fact  and  the  amount  of  the  dividend  have  been 
decided  upon,  a  formal  resolution  declaring  it  is  adopted  by 
the  directors.  This  resolution  usually  fixes  specifically  the 
amount  of  the  dividend  and  states  to  whom  and  when  it  shall 
be  paid.s  The  amount  is  ordinarily  expressed  as  a  percentage 
upon  the  par  value  of  the  stock,  though  sometimes  as  a  fixed 
amount  per  share.  The  recipients  must  necessarily  be  stock- 
holders of  the  company,  but  are  usually  stockholders  of  a 
specified  future  date,  and  the  time  of  payment  is  usually  fixed 
at  a  still  later  future  date. 

Thus,  a  semiannual  dividend  declared  by  the  Pennsylvania 
Railroad  Company  November  i,  provided  for  a  payment  of 
3^%  upon  the  capital  stock  of  the  company,  payable 
on  and  after  November  30  to  stockholders  as  registered  upon 
the  books  of  the  company  at  the  close  of  business  November  4. 
In  the  notice  of  this  dividend  the  statement  of  the  amount  on 
each  $50  share,  i.e.,  $1.75  per  share,  is  also  included. 

The  directors  have  fuU  power  to  declare  a  dividend  aeffective 
at  any  future  date  they  please.  They  cannot,  however,  antedate 
it.  Thus,  the  directors  could  not  on  January  2,  191 7,  legally 
declare  a  dividend  payable  to  stockholders  of  record  on  the 
15th  of  the  preceding  October.*  The  power  to  do  so  would,  it 
is  obvious,  open  a  wide  door  for  injustice  and  fraud. 


'See  Book  IV,  Forms  149-151. 

« Jones  V.  Terre  Haute,  etc.,  R.  R.,  57  N.  Y.  196  (1874). 


Ch.  52]  DIVIDENDS  423 

If  the  treasurer  is  a  member  of  the  board  or  is  present  at 
the  board  meeting,  the  passage  of  the  resolution  declaring  the 
dividend  is  undoubtedly  sufficient  notice  to  him  of  the  fact 
and  he  is  then  authorized  to  carry  the  resolution  into  effect. 

If  the  treasurer  is  not  present  at  the  board  meeting,  a  verbal 
statement  made  to  him  by  a  member  of  the  board  or  by  the 
secretary  of  the  company  is  a  common,  but  in  itself  hardly 
sufficient,  notice  of  the  board's  action.  A  personal  inspection 
of  the  resolution  entered  in  the  secretary's  minutes  is  better, 
and  though  informal  is  sufficient.  Written  notice  from  the  sec- 
retary of  the  passage  of  the  resolution,  with  a  copy  of  the 
resolution  itself  incorporated,  is  more  formal  and  may,  if  he 
chooses,  be  demanded  by  the  treasurer.  As  soon  as  the  treas- 
urer has  authoritative  notice  of  the  resolution,  no  matter  how 
his  knowledge  is  derived,  he  may  proceed  at  once  to  the  pay- 
ment of  the  dividend  in  accordance  with  its  terms. 

The  resolution  declaring  a  dividend  usually  provides  for 
the  closing  of  the  stock  books  to  transfers  of  stock  for  a  certain 
period  before  the  dividend  day,  i.e.,  the  day  when  the  dividend 
is  to  be  paid.  This  provision  for  closing  the  transfer  books  is 
usually  and  properly  part  of  the  charter  or  by-law  requirements 
of  the  corporation.  It  is  questionable  whether  the  directors 
would  have  power  to  close  the  transfer  books  unless  so  authorized. 

§  480.    Prbfits  and  Dividends 

Profits  are  the  only  proper  source  of  dividends.  The  dec- 
laration of  dividends  when  there  are  no  profits  is  contrary  to 
law,  usually  involves  a  personal  liability  by  the  parties  respon- 
sible, and  in  many  states  involves  a  criminal  Uability  as  well. 
If  an  illegal  dividend  is  contemplated,  any  stockholder  may 
enjoin  its  declaration  or  payment,  and,  should  the  company 
become  insolvent,  the  stockholders  who  receive  such  dividends 
may  be  compelled  to  make  restitution." 


'2  Cook  on  Corp.,  {{  S47.  548;  Stevens  v.  U.  S.  Steel  Corp.,  68  N.  J.  Eq.  373  (190s); 
Fricke  V.  Angemeier,  loi  N.  E.  (Ind.)  329  (loia). 


424  CORPORATE  LAW  [Bk.  I- 

The  general  rule  in  this  country  is  that  before  dividends 
can  be  properly  declared,  any  impairment  of  capital  through 
business  losses  in  previous  years  or  through  depreciation,  must 
first  be  made  good.  In  other  words,  dividends  must  be  declared 
out  of  "surplus.''^  As  it  is  stated  in  a  Missouri  case,  "dividends 
can  properly  be  declared  only  from  the  profits  over  and  above 
the  capital  stock  and  the  debts  of  the  company.''  Before  de- 
claring a  dividend  the  directors  should  examine  carefully  the 
financial  condition  of  the  company  and  the  statutory  provisions 
regulating  the  declaration  of  dividends  in  the  state  of  incor- 
poration. 

An  exception  to  the  general  rule  that  dividends  impairing 
the  capital  stock  may  not  be  paid,  is  found  in  the  case  of  com- 
panies working  mines  or  operating  under  leases,  patent  rights, 
etc.  Here  the  corporation  is  organized  for  the  express  purpose 
of  working  out  the  property  which  is  represented  by  its  capital 
stock  and  the  impairment  and  final  exhaustion  of  this  property 
is  the  object  of  the  corporate  operations. 

In  any  such  case  if  a  company  is  formed 

...  to  acquire  and  work  a  property  of  a  wasting  nature,  for 
example,  a  mine,  a  quarry  or  a  patent,  the  capital  expended  in 
acquiring  the  property  may  be  regarded  as  sunk  and  gone,  and  if 
the  company  retains  assets  sufficient  to  pay  its  debts,  it  appears  to 
me  that  there  is  nothing  whatever  in  the  Act  to  prevent  any  excess 
of  money  obtained  by  working  the  property  over  the  cost  of  work- 
ing it  from  being  divided  amongst  the  shareholders,  and  this,  in 
my  opinion,  is  true  although  some  portion  of  the  property  itself  is 
sold  and  in  some  sense  the  capital  is  thereby  diminished.  ^ 

The  decision  in  the  English  case  from  which  the  foregoing 
quotation  is  taken,  has  been  generally  followed  in  this  country 
and  is  regarded  as  establishing  the  rule.  It  must,  however,  be 
noted  that  in  this  case  the  assets  of  the  company  were  ample 


•  Williams  v.  Western  Union  Telegraph  Co.,  93  N.  Y.  162  (1883);  Roberts  v.  Roberts- 
Wicks  Co.,  184  N.  Y.  257  (1906);  Thompson  on  Corp.,  {  5312. 
'  Shields  V.  Hobart,  172  Mo.  491,  S17  (1902). 
«  Lee  V.  Neuchatel  Asphalte  Co..  L.  R.  41  Ch.  D.  i  (1889). 


Ch.  52]  DIVIDENDS  425 

and  there  was  no  question  of  insolvency  or  charge  of  indis- 
cretion in  the  declaration  of  dividends  which  formed  the  basis 
of  litigation. 

A  difficulty  sometimes  arises  when  determining  the  cor- 
porate profits  for  dividend  purposes,  as  to  what  expenditures 
may  properly  be  charged  to  capital  stock  account  and  what 
should  be  charged  to  current  expenses.  Thus,  if  a  manufac- 
turing concern  purchases  machinery  and  this  is  charged  to 
capital  stock  account,  the  books  will  show  a  larger  net  profit 
for  the  year  than  if  the  item  is  charged  to  expense  account. 
The  matter  is  one  of  bookkeeping  and  the  actual  assets  of  the 
company  are  not  affected  in  either  case,  but  its  profits  legally 
available  for  dividends  are  directly  increased  or  diminished 
according  to  the  account  to  which  the  item  is  debited- 

This  question  usually  arises  when  the  directors  are  anxious 
to  divert  every  possible  penny  into  dividends.  The  problem  is 
a  difficult  one  and  its  solution  will  vary  with  the  conditions. 
"It  may  be  safely  said  that  what  losses  can  be  properly  charged 
to  capital  and  what  to  income  is  a  matter  for  business  men  to 
determine  and  it  is  often  a  matter  on  which  the  opinions  o\ 
honest  and  competent  men  will  differ.*' 9  Speaking  generally, 
only  those  expenditures  for  which  stock  or  bonds  might  be 
issued  with  propriety  can  be  properly  charged  to  capital  account. 

§  481.    Equality  of  Dividends 

Dividends,  as  stated,  are  usually  declared  as  a  percentage 
upon  the  outstanding  capital  stock,  or  as  a  certain  amount  on 
each  class  of  stock,  and  each  stockholder  in  any  class  of  stock 
participates  according  to  the  stock  he  holds.  This  rule  is 
absolute. 

When  they  (the  directors)  undertake  to  declare  a  dividend,  they 
are  bound  to  make  it  equal  and  just  among  all  who  are  interested. 
They  would  have  no  right  to  divide  their  profits  among  a  few  par- 
ticular friends,  neither  would  they  have  authority  to  say  that  one 


•Gregory  v.  Patchett,  33  Beav.  (N.  Y.)  595  (1864). 


426  CORPORATE  LAW  [Bk.  I- 

class  of  stockholders  should  receive  a  larger  amount  of  the  profits 
or  a  greater  dividend  than  others.  They  are  but  the  agents  of  the 
Stockholders.  The  profits  belong  to  the  stockholders  and  they 
must  apportion  them  fairly  and  justly  with  due  regard  to  the 
interests  of  each  and  all  of  them.  They  cannot  make  an  unjust 
discrimination,  giving  one  an  advantage  over  another.  If  they  do 
this,  they  exceed  their  powers  and  the  courts  have  a  right  to 
interpose  their  authority  to  prevent  it.^" 

The  general  rule  of  equality  applies,  however,  only  to  stock- 
holders of  the  same  class.  In  the  organization  of  a  corporation, 
or  later  if  the  proper  formalities  are  observed,  different  classes 
of  stock  may  be  created  and  these  may  be  given  different  divi- 
dend rights. 11  Thus,  preferred  stocks  are  frequently  created 
with  preferential  dividends  which  they  receive  before  other 
classes  of  stock  receive  anything  at  all.  The  difference  is,  how- 
ever, one  that  was  intended  and  one  that  is  clearly  set  out  in 
the  provisions  by  which-  the  preferred  stock  is  created;  and  as 
it  is  understood  and  by  implication  agreed  to  by  every  stock- 
holder of  the  corporation,  no  injustice  results. 

As  between  the  members  of  any  one  class,  however,  divi- 
dends must  be  paid  with  absolute  impartiality.  The  number 
of  shares  of  stock  each  holds  must  determine  the  amount  re- 
ceived by  him  when  dividends  are  paid.  The  time  of  payment 
and  the  method  of  payment  must  be  the  same  for  all.  Some, 
unless  by  consent  or  agreement,  cannot  be  paid  in  cash  while 
others  are  paid  in  stock  or  scrip.    All  must  fare  alike. 12 

§  482.     Compelling  the  Declaration  of  Dividends 

The  declaration  of  dividends  rests  entirely  in  the  discretion 
of  the  board  unless  otherwise  provided  by  statutes,  charter,  or 
by-laws.i3    It  is  but  seldom  that  the  stockholders  can  compel 


lOLuling  V.  Atl.  Mut.  Ins.  Co.,  45  Barb.  (N.  Y.)  510  (1865);  Miller,  J. 

"  See  Ch.  XI,  "Preferred  Stock";  also  Book  II,  Ch.  VI,  "Preferred  Stock." 

"Jones  V.  Terre  Haute,  etc.,  R.  R.,  57  N.  Y.  196  (1874);  State  v.  Bait.,  etc.,  R.  R.,  6 
Gill  (Md.)  272  (1848);  Godley  v.  Crandall  &  Godley  Co.,  153  App.  Div.  (N.  Y.)  697  (1912). 

"  Hunter  v.  Roberts,  Throp  &  Co.,  83  Mich.  63  (1890);  Burden  v.  Burden,  IS9  N.  Y.  287 
(1899);  New  York,  etc.,  R.  R.  v.  Nickals,  119  U.  S.  296  (1886). 


Ch.  52]  DIVIDENDS  427 

the  directors  against  their  judgment  to  declare  a  dividend,  even 
though  Hberal  reservations  of  profits  are  being  made  for  working 
capital  or  as  a  surplus  fund  for  future  contingencies. 

The  courts  have,  no  doubt,  in  many  cases  overruled  the  di- 
rectors who  proposed  to  pay  dividends,  but  I  am  not  aware  of  any 
case  in  which  the  court  has  compelled  them  to  pay  when  they  have 
expressed  their  opinion  that  the  state  of  the  accounts  did  not  admit 
of  any  such  payment." 

There  is,  however,  a  point  at  which  the  courts  will  intervene 
to  prevent  undue  or  improper  retention  of  profits. 

The  directors  must  act  in  good  faith.  If  they  fail  to  do  so  and 
it  clearly  appears  that  they  have  accumulated  earnings  not  required 
in  the  prosecution  of  the  business  which  they  withhold  from  the 
stockholders  for  illegitimate  purposes,  a  court  of  equity  may 
interfere  and  compel  a  distribution  of  such  earnings.*' 

Courts  of  equity  wiU  not  interfere  in  the  management  of  the 
directors  unless  it  is  clearly  made  to  appear  that  they  are  guilty  of 
fraud  or  misappropriation  of  the  corporate  funds  or  refuse  to 
declare  a  dividend  when  the  corporation  has  a  surplus  of  net  profits 
which  it  can,  without  detriment  to  its  business,  divide  among  its 
stockholders,  and  when  a  refusal  to  do  so  would  amount  to  such 
an  abuse  of  discretion  as  would  constitute  a  fraud  or  breach  of  that 
good  faith  which  they  are  bound  to  exercise  towards  the  stock- 
holders, i^ 

§  483.    The  Case  of  the  Ford  Mot&r  Company 

An  interesting  and  unique  case  was  the  suit  of  certain  stock- 
holders against  the  Ford  Motor  Company,  to  force  the  directors 
to  pay  out  part  of  its  large  surplus  in  dividends  instead  of 
carrying  out  the  more  altruistic  ideas  of  the  founder  of  the 
business. 

"My  ambition,"  said  Mr.  Ford,  "is  to  employ  still  more 


"Bond  V.  Barrow,  etc.,  Co.,  86  L.  T.  Rep.  10  (1902). 

"  Matter  of  Rogers,  161  N.  Y.  108  (1899);  Wilson  v.  Am.  Ice  Co.,  206  Fed.  736  {1913); 
Gehrt  v.  Collins  Plow  Co.,  156  III.  App.  98  (1910);  Spear  v.  R.  R.  Lime  Co.,  93  Atl.  (Me.) 
754  (1915). 

"  Hunter  v.  Roberts,  Throp  &  Co.,  83  Mich.  63  (1890). 


428  CORPORATE  LAW  (Bk.  I- 

men,  to  spread  the  benefits  of  this  industrial  system  to  the 
greatest  possible  number,  to  help  them  build  up  their  lives 
and  their  homes.  To  do  this  we  are  putting  the  greatest  share 
of  our  profits  back  in  the  business."     The  court  said: 

It  is  not  within  the  lawful  powers  of  a  board  of  directors  to 
shape  and  conduct  the  affairs  of  a  corporation  for  the  mere  in- 
cidental benefit  of  shareholders,  and  for  the  primary  purpose  of 
benefiting  others,  and  no  one  wiU  contend  that,  if  the  avowed 
purpose  of  the  directors  was  to  sacrifice  the  interests  of  share- 
holders, it  would  not  be  the  duty  of  the  courts  to  interfere. 

It  appeared  that  the  company  paid  60%,  or  $1,200,000 
on  its  capitalization  of  $2,000,000,  leaving  some  $58,000,000  to 
be  reinvested.  The  decree  of  the  court  required  the  directors 
to  declare  an  additional  dividend  of  over  $19,000,000,  which 
decree  the  highest  court  of  Michigan  unanimously  affirmed." 

§  484.    Dividend  Rights  of  Preferred  Stockholders 

Cases  sometimes  arise,  however,  where  a  refusal  to  declare 
dividends,  even  where  apparently  reasonable  on  its  face,  is 
inequitable  because  of  the  conditions.  For  instance,  preferred 
stock  not  infrequently  carries  non-cumulative  dividends,  and 
if  these  dividends  are  not  declared  in  any  year,  they  are  lost 
to  the  preferred  stock  entirely.  It  is  obvious,  then,  that  if 
profits  exist  from  which  the  dividends  might  be  paid  but  the 
directors,  instead  of  declaring  these  dividends,  carry  them  over 
in  surplus  until  the  following  year,  the  preferred  stock  has 
been  juggled  out  of  a  dividend  that  properly  belongs  to  it  and 
there  is  a  distinct  advantage  to  the  holders  of  the  common  stock. 

Thus,  if  a  company  has  a  capitalization  of  $200,000,  of 
which  $50,000  is  preferred,  non-participating  stock  carrying  a 
7%  non-cumulative  dividend,  and  the  remainder  is  common 
stock,  and  the  directors  pay  no  dividends  for  five  years  although 
profits  sufficient  to  pay  the  preferred  dividends  were  made,  these 


"  Dodge  V.  Ford  Motor  Co.,  204  Mich.  4sg  (igig). 


Ch.  52]  DIVIDENDS  429 

dividends,  amounting  to  $17,500,  are  lost  absolutely  to  the 
preferred  stock.  Then  in  the  sixth  year  the  directors,  should 
they  so  desire,  might  declare  a  7%  dividend  on  the  preferred 
stock  amounting  to  $3,500,  which  is  all  the  preferred  stock  is 
entitled  to  for  that  year,  and  thereafter  declare  the  entire  re- 
maining profits  as  a  dividend  on  common  stock.  This  latter  then 
receives  $14,000  that  really  belongs  to  the  preferred  stock. 

In  cases  of  this  kind  the  courts  are  much  less  reluctant  to 
intervene  and  will  usually  compel  payment  of  the  dividends  on 
the  preferred  stock  for  any  year  if  satisfactory  proof  is  adduced 
that  profits  exist  sufficient  for  the  purpose  which  can  be  used 
without  injury  to  the  corporation.  Even  here,  however,  the 
court  scrutinizes  the  condition  of  the  corporation  closely  and 
refuses  the  dividend  unless  it  is  clearly  and  unmistakably  with- 
held wrongfully  and  to  the  injury  of  the  preferred  stock.is 

§  485.    Status  of  Declared  Dividends 

When  a  dividend  is  once  declared  it  becomes  a  debt  of  the 
corporation  and  stands  on  a  parity  with  its  other  debts.  Should 
the  corporation  become  insolvent  before  such  dividend  is  paid, 
the  stockholders  take  their  place  among  the  other  creditors  of 
the  corporation  and  may  enforce  their  claims  as  would  any 
other  corporate  creditor.is 

Further  than  this,  if  the  money  to  pay  a  declared  dividend 
is  set  aside  in  a  separate  fund -for  the  purpose,  even  though 
merely  placed  on  deposit,  it  has  been  held  that  this  particular 
fund  becomes  the  absolute  property  of  the  stockholders — a  trust 
fund  held  by  the  corporation  for  their  benefit — and,  provided 
only  that  the  dividend  is  legal  and  the  fund  is  set  aside  in  good 
faith,  such  fund  cannot  be  reclaimed  by  the  corporation  nor  is 
it  liable  to  taxation  or  for  the  corporate  debts.20     However, 


"  Belfast,  etc.  R.  R.  v.  Belfast,  77  Me.  44s  (1885);  Wilson  v.  Amer.  Ice  Co.,  206  Fed.  Rep. 
736  (1913). 

"Hunt  V.  O'Shea,  69  N.  H.  600  (1899). 

»»  Pollard  V.  First  Nat.  Bk.,  47  Kans.  406  (1891);  Searles  v.  Gebbid,  115  App.  Div.  (N.  Y.) 
778  (1906). 


43©  CORPORATE  LAW  [Bk.  I- 

"simply  declaring  a  dividend  does  not  create  a  trust  fund.  To 
create  such  a  fund  some  specific  sum  of  money  must  be  set 
apart  for  paying  the  dividend.  Until  this  is  done,  the  relation 
of  the  corporation  to  its  stocldiolders  in  respect  to  dividends  is 
that  of  debtor  and  creditor. "21 

A  dividend  does  not,  however,  become  an  irrevocable  fact 
until  notice  of  the  resolution  declaring  it  has  been  given  or  the 
fact  that  it  has  been  adopted  has  become  known.  If  the  direc- 
tors have  voted  the  dividend  but  the  fact  has  not  been  made 
public  in  any  way,  the  action  may  be  rescinded. 22 

Also,  under  some  circumstances  a  formally  declared  divi- 
dend may  be  revoked.  Thus,  should  the  board  declare  a  divi- 
dend in  defiance  of  or  in  ignorance  of  facts  which  make  it  illegal, 
the  action  of  the  board  may  be  rescinded  at  any  time  before 
payment  of  the  dividend  has  actually  been  made.2» 

As  a  declared  dividend  is  a  debt  due  from  the  corporation  to 
the  stockholder,  any  real  existing  indebtedness  of  the  stock- 
holder to  the  corporation  may  be  set  off  against  the  dividend 
and  be  deducted  from  it,  provided  the  debt  is  actually  due  at 
the  time  the  dividend  is  payable.  Accordingly  the  corporation 
has  fuU  power  to  apply  dividends  in  payment  of  subscriptions 
due  on  its  stock  from  the  stockholders.24 

It  may  be  noted  that  a  contract  between  the  corporation 
and  a  subscriber  to  its  stock  that  his  subscription  shall  be  paid 
for  in  dividends,  is  absolutely  invalid  both  as  against  the  cor- 
poration and  against  corporate  creditors.  Under  such  an  agree- 
ment any  credits  of  declared  dividends  actually  made  would  be 
held  a  valid  payment,  but  in  case  of  the  insolvency  of  the 
corporation  before  the  stock  was  full-paid,  the  stockholder  could 
be  called  upon  to  pay  in  cash  all  amounts  still  due  on  his  sub- 
scription, regardless  of  the  agreement.^s 


21  Hunt  V.  O'Shea,  69  N.  H.  600  (1899). 

22  Ford  V.  Easthampton  Rubber  Thread  Co.,  158  Mass.  84  (1893). 
»  Marquard  v.  Federal,  etc.,  Co.,  95  Fed.  Rep.  725  (1899). 
"Kenton,  etc.,  Co.  v.  McAlpin,  s  Fed.  Rep.  737  (1880). 
"Hawkins  v.  Citizens',  etc.,  Co.,  38  Ore.  544  (1901). 


CHAPTER  LIII 

DIVIDENDS   (Continued) 

§  486.    Form  of  Dividends 

Dividends  are  usually  paid  in  cash  and,  unless  otherwise 
stated,  cash  payment  is  always  understood.  Dividends  may, 
however,  be  declared  from  existing  profits  regardless  of  the  form 
of  these  profits.  "The  surplus  may  be  in  cash  and  then  it  may 
be  divided  in  cash;  it  may  be  in  property,  and  if  the  property 
is  so  situated  that  a  division  thereof  among  the  stockholders  is 
practicable,  a  dividend  in  property  may  be  declared,  and  that 
may  be  distributed  among  stockholders."  Also,  if  the  profits 
are  not  in  the  form  of  cash  and  not  in  a  form  to  be  distributed 
directly  as  property  among  the  stockholders,  the  property  might 
be  sold  or  be  used  as  a  basis  for  a  loan  of  cash  to  be  used 
in  payment  of  dividends;  or  scrip,  bonds,  or  stock  might  be 
issued  against  it  as  dividends.  1 

§  487.    Distribution  of  Profits  as  Salaries 

Another  method  of  disbursing  profits  occasionally  practiced, 
is  that  of  paying  these  profits  to  the  officers  of  the  corporation 
under  the  guise  of  salaries.  The  excess  amount  of  these  salaries 
represents  the  dividends  that  would  otherwise  be  declared.  It 
is  obvious  that  this  practice  is  proper  only  when  all  the  stock- 
holders are  also  officers  of  the  corporation  or  consent  to  the  other- 
wise excessive  salaries.  "So  long  as  all  the  parties  in  interest, 
incorporators,  stockholders,  directors  and  officers,  assented  to 
the  scheme  for  the  distribution  of  assets  by  the  payment  of 
salaries,  the  plan  was  not  objectionable. "2    But  if  any  interested 

'  Williams  V.  W.  U.  Tel.  Co.,  93  N.  Y.  162  (1883).  See  also  Book  II.  Ch.  XXXII, 
"Payment  of  Dividends." 

'  Fitchett  V.  Murphy,  46  App.  Div.  (N.  Y.)  181  (1899). 


432  CORPORATE  LAW  [Bk.  I- 

parties  do  not  consent,  the  plan  becomes  not  only  objectionable, 
but  illegal. 

What  has  been  said  on  this  subject  might  be  considered  as 
modified  by  the  federal  income  tax  law  of  1918,  which  provides: 

That  in  computing  net  income  there  shall  be  allowed  as  deduc- 
tions: 

(i)  All  the  ordinary  and  necessary  expenses  paid  or  incurred 
during  the  taxable  year  in  carrying  on  any  trade  or  business,  in- 
cltiding  a  reasonable  allowance  for  salaries  or  other  compensation  for 
personal  services  actually  rendered. 

This  would  seem  to  prevent,  and  was  intended  to  prevent, 
the  distribution  of  profits  as  salaries.  Salaries  are  limited  to  "a 
reasonable  allowance"  and  to  "personal  services  actually 
rendered"  and  they  must  be  reasonable  under  all  the  circurii- 
stances. 

Under  former  conditions,  in  many  cases  officers  in  close 
corporations  were  content  to  work  for  nominal  salaries.  Now, 
as  corporate  incomes  are  taxed  at  a  much  higher  rate  than  or- 
dinary personal  incomes,  such  officers  naturally  desire  to  make 
their  salaries  as  high  as  they  can  legally.  The  situation  is  a  diffi- 
cult one  and  it  is  not  easy  to  give  any  rule  that  is  really  helpful 
in  actual  practice. 

The  problem  of  determining  reasonable  compensation  for  per- 
sonal services  is  one  of  difficulty,  in  that  there  are  few  general  rules 
which  can  be  laid  down  as  guides  to  a  decision.  Many  factors  are 
involved,  among  them  being  the  character  and  amount  of  respon- 
sibility, ease  or  difficulty  of  the  work  itself,  time  required,  working 
conditions,  future  prospects,  living  conditions  of  the  locality,  in- 
dividual abUity,  technical  training,  profitableness  to  the  employer 
of  the  services  rendered,  and  the  number  of  available  persons 
capable  of  performing  the  duties  of  the  position.  These  and  other 
factors  have  a  bearing,  and  the  amount  of  weight  to  be  attached  to 
each  one  can  be  determined  only  in  the  light  of  the  circumstances 
in  each  particular  case.' 


•Bulletin  lo,  1919,  Income  Tax  Ruling  No.  362;  Advisory  Tax  Board  Memorandum  No. 


Ch.S3l  DIVIDENDS  433 

In  but  few  cases  have  the  courts  been  called  upon  to  pass  on 
these  matters.     An  authority  on  income  tax  matters  writes: 

In  the  opinion  of  the  author  the  courts  will  not  disallow  any 
compensation,  no  matter  how  unreasonable  it  appears  to  be  on  the 
surface,  and  no  matter  how  large  it  seems  to  be  compared  with  the 
amounts  paid  by  other  concerns,  unless  the  payment  is  proved  to 
be  merely  a  division  of  profits  distributed  proportionately  to  stock- 
holders.^ 

§  488.    Cash  Dividends 

The  simplest  form  of  dividends  are  those  paid  in  cash.  Such 
dividends  are  usually  declared  and  paid  from  cash  profits  on 
hand.  If,  however,  the  profits  of  the  company  exist  in  some 
other  form  of  property,  the  directors  may,  as  already  stated,  sell 
such  property  and  use  the  proceeds  for  the  cash  payment  of 
dividends,  or  may  borrow  the  cash  on  the  security  of  this 
property  or  on  the  general  credit  of  the  corporation  and  pay  the 
dividends  from  the  money  thus  obtained;  or  they  may,  under 
proper  conditions,  issue  stocks,  bonds,  or  scrip  against  the 
property  and  secure  cash  for  the  payment  of  dividends  from  the 
sale  of  these  securities. 

§  489.    Dividends  Not  in  Cash 

If  corporate  profits  available  for  dividends  are  in  the  form  of 
property  and  the  directors  do  not  care  to  sell  or  encumber  this 
property,  or  if  they  wish  to  reserve  the  cash  profits  for  the  use 
of  the  corporation,  dividends  may  be  declared  in  several  different 
forms : 

1.  The  capital  stock  may  be  increased  and  this  increase  be 

distributed  as  a  stock  dividend,  or  any  unissued  or 
treasury  stock  on  hand  may  be  used  for  the  purpose. 

2.  Bonds  may  be  issued  to  the  amount  of  the  dividend  and 

these  bonds  be  distributed. 


*  Montgomery  on  Inc.  Tax  Proc.  (1921),  p.  688. 


434  CORPORATE  LAW  [Bk.  I- 

3.  Scrip  may  be  issued  against  the  profits  and  the  scrip  be 

distributed  as  dividends. 

4.  If  the  property  is  in  such  shape  as  to  permit,  it  may  i|;self 

be  distributed  as  a  property  dividend. 

Dividends  in  all  these  different  forms,  if  issued  under  proper 
conditions,  are  held  to  be  legal  and  are  sustained  by  the  courts. s 

In  the  case  of  dividends  paid  in  other  forms  than  cash,  the 
same  general  rules  apply  as  to  cash  dividends.  There  must  be 
an  equality  among  the  stockholders,  and  the  proportionate 
amount,  the  time  of  payment,  and  the  form  in  which  the  dividend 
is  paid  must  be  the  same  for  all. 

It  may  be  noted  that  preferred  stockholders  share,  in  relation 
to  holders  of  common  stock,  in  dividends  paid  in  other  forms 
than  cash  exactly  as  they  would  if  the  dividends  were  paid  in 
cash.  6 

§  490.     (i)  Stock  Dividends 

In  some  few  states  stock  dividends  are  prohibited  by  law. 
In  Massachusetts  telegraph,  telephone,  railroad,  and  some  other 
classes  of  public  service  corporations  are  forbidden  to  issue  stock 
or  scrip  dividends.  Even  there,  however,  the  end  is  practically 
accomplished  by  the  declaration  of  a  dividend  to  the  stockholders. 
These  dividends  are  then  a  debt  due  from  the  corporation  to  its 
stockholders.  A  simultaneous  offering  of  stock  to  an  equal 
amount  is  made  and  this  stock  is  purchased  by  the  stockholders, 
their  indebtedness  therefor  being  offset  by  the  dividends  due 
them.  7 

In  most  of  the  states,  however,  no  such  restriction  exists  and 
stock  dividends  are  not  uncommon,  and  under  proper  conditions 
are  not  legally  objectionable.  If  the  directors  wish  to  retain 
the  corporate  profits  to  increase  the  capital  of  the  corporation, 
"it  becomes  inmiaterial  whether  such  increase  is  made  by  award- 


'  Williams  v.  W.  U.  Tel.  Co.,  93  N.  Y.  162  (1883);  Soehnlein  v.  Soehnlein,  146  Wis.  330 
(1911). 

«  Howell  V.  Chicago,  etc.,  Ry.  Co.,  51  Barb.  (N.  Y.)  368  (1868);  Gordon  v.  Richmond,  etc., 
R.  R..  78  Va.  501  (1884). 

»  Jones  V.  Brown,  171  Mass.  318  (1898) ;  Hyde  v.  Holmes,  198  Mass.  287  (1908). 


Ch.  53]  DIVIDENDS  435 

ing  the  stock  to  stockholders  as  dividends  in  lieu  of  money, 
retaining  the  money  for  the  purposes  of  the  company,  or  by 
paying  the  stockholders  the  dividends  in  cash  from  the  earnings 
of  the  company  and  seUing  the  stock  in  the  market  to  raise 
money  for  the  use  of  the  corporation. "«  Or  as  stated  in  a  later 
case: 

So  long  as  every  dollar  of  stock  issued  by  a  corporation  is  reF>- 
resented  by  a  dollar  of  property,  no  harm  can  result  to  individuals 
or  the  public  from  distributing  stock  to  stockholders.  .  .  .  All 
that  can  be  required  in  any  case  is  that  there  shall  be  an  actual 
capital  in  property  representing  the  amount  of  share  capital  issued.^ 

A  stock  dividend  issued  against  actual  corporate  property  of 
at  least  equal  value  is  held  to  be  full-paid  10  but,  if  not  so  issued 
in  good  faith,  is  not.n 

Where  a  corporation  purchases  the  stock  of  another  corpora- 
tion out  of  its  surplus  earnings  and  later  distributes  such  shares 
of  stock  among  its  stockholders  as  a  dividend,  such  a  dividend  is 
not  a  "stock  dividend.  "12 

It  will  be  observed  that  a  stock  dividend  of  the  kind  here 
considered  is  entirely  different  from  that  derived  from  "stock 
watering,"  in  which  the  new  stock  does  not  represent  profits  at 
all  but  is  merely  a  dilution  of  the  existing  'capital  and  is  illegal 
and  objectionable. 

§  491.     (2)  Bond  Dividends 

The  corporate  bonds  may  take  the  place  of  cash  in  payment 
of  dividends  at  the  discretion  of  the  directors,  provided  that  they 
are  issued  only  against  actual  profits.  The  argiunent  for  their 
issue  is  the  same  as  for  the  issue  of  stock  as  dividends.  If  the 
company  has  profits  available  for  dividends,  it  may  take  these 


'Howell  V.  Chicago,  etc.,  Ry.  Co.,  51  Barb.  (N.  Y.)  378  (1868). 

»  Williams  v.  W.  U.  Tel.  Co.,  93  N.  Y.  162  (1883);  Earl  J.;  Rose  v.  Barclay,  191  Pa.  St.  S94 
(1899). 

"Kenton,  etc.,  Co.  v.  McAlpin,  s  Fed.  Rep.  737  (1880);  Berwind-White  Coal  Co.  v. 
Ewart,  II  Misc.  (N.  Y.)  490  (1895). 

"  Shaw  V.  Gilbert,  iii  Wis.  i6s  (1901). 

«  Gray  v.  Hemenway,  3i3  Masa.  339  (1912);  Union,  etc..  Trust  Co.  v.  Taintor,  85  Conn. 
4S2  (1912). 


436  CORPORATE  LAW  [Bk.  I- 

profits  for  the  corporate  purposes  and  replace  them  with  the 
bonds  and  distribute  these  bonds  as  dividends.  The  bond 
dividend  is  held  legal  when  issued  against  actually  existing 
corporate  profits." 

From  the  practical  standpoint  it  must,  however,  be  observed 
that  bonds  carry  interest  which  becomes  a  fixed  charge  against 
the  company  and  must  be  paid  thereafter  whether  profits  are 
made  or  not.  Also  the  bond  itself  is  an  absolute  obligation  of 
the  company  which  must  be  paid  at  maturity.  Both  these 
features  may  be  objectionable,  and  do  not  exist  in  the  case  of 
stock. 

§  492.     (3)  Scrip  Dividends 

The  favorite  method  of  paying  dividends  when  neither  stock 
nor  bonds  are  available  or  expedient,  is  by  means  of  scrip. 
This  is  practically  a  deferred  dividend,  scrip  being  a  certificate 
stating  that  the  owner  or  holder  is  entitled  to  certain  rights  or 
privileges  specified  in  the  certificate — usually  a  certain  amount 
of  cash  payable  at  some  fixed  future  date.  In  the  issue  of  scrip 
dividends  the  same  rule  obtains  as  in  the  case  of  any  other 
dividends.     Profits  must  exist  as  a  basis  for  their  issue. 

Usually  scrip  represents  existing  profits  which  are  not  in  the 
form  of  money  but  which  may  be  realized  upon  at  some  future 
date  and  the  money  then  be  used  to  pay  off  this  scrip.  Or  there 
may  be  no  intention  that  the  corporate  property  shall  be  realized 
upon,  the  expectation  being  that  at  the  time  the  scrip  becomes 
due,  cash  will  be  on  hand  for  its  payment  without  regard  to 
whether  the  property  in  question  is  sold  or  not. 

Sometimes,  however,  scrip  represents  an  absolute  reservation 
of  cash  profits,  as  in  a  case  where  the  cash  is  available  for  divi- 
dends, but  the  directors  determine  that  it  can  be  used  advan- 
tageously to  improve  the  corporation/s  plant  or  equipment.  It 
is  generally  within  the  discretion  of  the  directors  whether  a  scrip 


"Wood  V.  Lary.  124  N.  Y  83  (1891);  s.  c,  47  Hun  sso;  N.  Y..  etc.,  R.  R.  v.  Nickals,  119 
U.  S.  296  (1886). 


Ch.  53]  DIVIDENDS  437 

dividend  be  declared,  or  whether  the  earnings  be  held  merely  as 
surplus  profits.  The  effect  of  the  issuance  of  a  scrip  dividend  is 
to  increase  the  indebtedness  of  the  corporation  by  the  amount  of 
the  dividend.  1* 

The  payment  date  on  scrip  may  be  made  absolute,  or  it  may 
be  made  contingent,  as  where  it  is  provided  that  scrip  be  payable 
as  soon  as  the  company  accumulates  sufficient  surplus  funds 
for  the  purpose  or  when  specific  property  upon  which  the  scrip 
is  based  shall  be  sold,  or  it  may  be  made  "at  the  pleasure  of  the 
Company."  In  the  latter  case  it  has  been  held  that  the  dividend 
must  be  paid  within  a  reasonable  time. is 

Scrip  is  issued  in  many  different  forms.  Sometimes  the 
certificates  are  convertible,  being  exchangeable  at  a  certain  time 
for  stock  or  bonds  of  the  company  on  demand  of  the  holder.  At 
times  scrip  certificates  entitle  the  holders  to  dividends  as  would 
stock  to  the  same  value.  The  scrip  then  partakes  much  of  the 
nature  of  stock  save  that  it  has  no  voting  power. 

Scrip  certificates,  though  issued  as  a  dividend  and  in  lieu  of 
certain  property  in  the  possession  of  the  corporation,  do  not  fix 
the  ownership  of  that  property  in  the  holders  of  the  certificates. 
They  do  give  the  holder  a  claim  against  the  corporation — not 
the  absolute  claim  which  the  ordinary  declared  dividend  gives, 
but  a  conditional  claim  dependent  upon  the  terms  of  the  scrip 
certificate. 

Provided  only  that  the  principal  and  any  interest  to  be  paid 
on  corporate  scrip  are  'either  represented  by  corporate  profits 
actually  on  hand  or  are  payable  only  from  future  profits,  or 
profits  for  such  payments  actually  exist  at  the  time  or  will  exist 
when  the  demands  fall  due,  the  scrip  dividend  is  not  illegal. 

§  493.     (4)  Property  Dividends 

Dividends  may  consist  of  actual  property,  though,  except  in 
the  case  of  corporate  securities,  there  are  obvious  difficulties 


"BilHngham  v,  Gleason  Mfg.  Co.,  loi  App.  Div.  476  (1905);  affd.,  185  N.  Y.  S7i  (1006). 
"  Billingham  v.  Gleaaon  Mfg.  Co.,  loi  App.  Div.  (N.  Y.)  476  (1905). 


438  CORPORATE  LAW  [Bk.  I- 

in  the  way  of  distribution  which  make  such  dividends  rare. 
Thus  a  company  whose  profits  were  in  land,  might  divide  this 
land  among  its  stockholders  as  a  dividend,  if  it  could  do  so 
equitably,  and  no  objection  could  be  raised.  The  more  usual 
form  of  property  dividends  is,  however,  that  of  securities  of 
other  corporations  received,  when  the  corporation  sells  property 
or  rights  of  some  kind  to  another  corporation,  taking  the  stocks 
and  bonds  of  that  other  corporation  in  payment.  Or  securities 
may  have  been  bought  outright  at  some  previous  time  from 
profits.  The  stock  and  bonds  so  received  are  then  divided 
among  the  stockholders  of  the  receiving  company  as  dividends. 
There  are  no  objections  to  such  dividends  provided  they  repre- 
sent actual  profits. 

Usually,  however,  dividends  of  this  kind  are  declared  only 
when  a  corporation  is  liquidated,  all  its  property  perhaps  having 
been  exchanged  for  stock  or  bonds,  or  both,  of  the  purchasing 
corporation.  In  this  case  the  distribution  is  not,  strictly  speak- 
ing, a  payment  of  dividends  but  is  a  distribution  of  assets,  and 
the  ordinary  rule  that  dividends  may  be  delared  only  from 
profits  does  not  apply. 

§  494.    Notice  of  Dividends 

The  directors  of  a  corporation  have  full  power  to  fix  the  time 
and  place  of  payment  of  dividends,  if  reasonable  and  in  good 
faith,  but  they  must  give  stockholders  due  notice. i^ 

When  dividend  checks  are  not  mailed,  notice  must  be  given 
the  stockholders  of  the  time  and  place  at  which  dividends  will 
be  paid.  These  notices  are  sent  out  by  the  treasurer  or  the 
secretary,  according  to  the  regulations  of  the  particular  corpora- 
tion. The  officer  sending  the  notices  must  be  governed  abso- 
lutely by  the  stock  book,  unless  he  has  personal  knowledge 
or  has  received  formal  notice  of  the  fact  that  some  particular 
stockholder  of  record  is  not  the  stockholder  in  fact.    The  party 


"  See  Book  IV,  Forms  178-183;  also  King  v.  Paterson,  etc.,  R.  R.  Co.,  29  N.  J.  L.  82  (i860). 


Ch.  S3]  DIVIDENDS  439 

to  whom  the  dividend  is  to  be  paid  is  always  the  proper  party 
to  notify.  If  there  is  doubt  in  any  particular  case  as  to  whom 
a  dividend  is  to  be  paid,  responsibility  may  be  avoided  by 
sending  notices  to  all  the  parties  interested,  leaving  the  owner- 
ship of  the  dividend  to  be  settled  later. 

In  some  of  the  larger  corporations,  notice  of  a  dividend 
giving  its  amount,  time  and  place  of  payment,  and  the  period  for 
which  the  stock  books  are  closed,  is  usually  mailed  to  every  stock- 
holder and  is  published  in  the  newspapers  as  well — this  latter 
not  entirely  as  a  legal  requirement  but  as  a  general  notification 
to  the  stockholders  and  to  the  general  public  as  well  that  the  cor- 
poration is  paying  dividends.  The  publication  of  the  dividend 
notice  is  presumptive  proof  of  notice  to  the  stockholders  but  is 
not  alone  conclusive.  If  the  stockholders  see  the  notice,  it  is 
sufficient,  but  if  any  particular  stockholder  does  not  happen  to 
see  the  newspaper  announcement,  he  cannot  be  held  to  have  re- 
ceived notice  and  the  corporation  is  liable  for  any  resulting  loss.i' 

At  the  present  time  corporations,  when  paying  dividends, 
usually  mail  checks  to  the  stockholders,  and  this  if  properly 
done  avoids  any  possibility  of  failure  of  notice.  The  dividend 
checks  are  nothing  more  than  orders  upon  the  bank  for  payment 
of  the  amount  due  the  stockholder,  but  the  recipient  of  such  a 
check  has  in  the  check  itself  sufficient  notice  of  the  time  and  place 
for  the  payment  of  his  dividend.  Where  checks  are  mailed,  a 
newspaper  notice  of  dividends  is  usually  deemed  entirely  suffi- 
cient. 

Dividend  notices  are  frequently  signed  and  issued  by  the 
secretary  but  more  commonly  are  issued  over  the  signature  of 
the  treasurer.    The  legal  effect  is  the  same  in  either  case. 

§  495.    To  Whom  Paid 

A  stockholder  of  record  is  one  whose  name  appears  upon  the 
stock  books  of  the  corporation  as  an  owner  of  its  stock.     Divi- 


"  King  V.  Paterson,  etc.,  R.  R.  Co.,  29  N.  J.  L.  83  (i860). 


440  CORPORATE  LAW  [Bk.  I- 

dends  are  ordinarily  payable  to  those  who  at  the  time  the  divi- 
dend becomes  effective  are  stockholders  of  record.  The  stock 
book,  therefore,  at  this  time  shows  to  whom  the  dividend  must 
be  paid. 

The  rule  is  not,  however,  invariable.  It  may  be  that  stock 
is  pledged  and  the  pledgee  has  not  had  the  stock  transferred  to  his 
own  name,  though  dividends  are  payable  to  him.  Or  occasion- 
ally it  happens  that  stock  has  been  sold  before  the  declaration  of 
the  dividend  but  the  transfer,  through  neglect  or  other  cause, 
has  not  been  recorded  on  the  books.  The  equitable  ownership 
of  the  stock  and  the  right  to  the  dividend  then  vests  in  the  party 
to  whom  the  stock  has  been  assigned,  but  the  ownership  of  record 
still  remains  in  the  former  owner. 

The  treasurer,  in  the  absence  of  notice,  has  no  concern  as  to 
these  equitable  owners.  The  stock  books  of  the  corporation  are 
conclusive  for  his  purposes  until  their  evidence  is  impeached  by 
the  presentation  of  duly  assigned  certificates,  or  other  satisfac- 
tory evidence  of  a  different  ownership  or  by  information  that 
would  put  the  corporation  "on  notice."  Therefore,  even  though 
it  proves  later  that  the  holder  of  record  is  not  the  rightful  owner 
of  the  dividend,  the  treasurer  and  the  corporation  are  protected 
in  payments  made  according  to  the  unimpeached  record  of  the 
stock  books.  They  have  used  all  reasonable  care  and  cannot 
be  held  for  the  results  of  negligence  on  the  part  of  others.is 

If,  however,  the  treasurer  or  the  corporation  receives  notice 
of  some  unrecorded  transfer  involving  the  ownership  of  the 
dividend,  i.e.,  a  transfer  made  before  the  dividend  became  effec- 
tive or  perhaps  thereafter  with  an  assignment  of  the  dividend, 
the  treasurer  is  bound  to  take  notice  of  the  facts  and  pay  the 
dividend  to  the  rightful  owner. 1 9 

As  the  stock  books,  if  unimpeached,  control  absolutely,  the 
production  of  a  stockholder's  certificate  of  stock  is  not  necessary, 
nor  can  it  be  required  to  prove  his  ownership  either  of  stock  or 

i»  Cleveland,  etc.,  R.  R.  v.  Robbins,  35  O.  St.  483  (1880). 
"  Rose  V.  Barclay,  191  Pa.  St.  S94  (1899)- 


Ch.  S3]  DIVIDENDS  441 

of  dividends  if  this  ownership  is  shown  by  the  stock  books.  If 
the  true  ownership  is  not  so  shown,  the  duly  assigned  certificate 
is  good  evidence  thereof  and  sufficient  to  justify  the  treasurer  in 
paying  the  dividend  to  the  owner  of  the  certificate,  provided 
only  that  the  assignment  was  made  before  the  effective  date  of 
the  dividend. 

If  there  is  any  real  doubt  as  to  whom  a  dividend  is  properly 
payable,  the  treasurer's  only  safe  course  is  to  withhold  payment 
until  the  matter  is  satisfactorily  settled  by  the  parties  them- 
selves, or  until  the  ownership  of  the  dividend  is  determined  by 
proper  legal  procedure.  This  litigation  may  involve  only  the 
disputants  but  may  be  directed  also  against  the  corporation. 
If  in  any  case  the  corporation  is  likely  to  suffer,  it  may  interplead 
and  ask  the  court  to  decide  to  whom  the  dividend  belongs. 

In  case  stock  stands  in  the  name  of  a  married  woman,  the 
treasurer  must  pay  the  dividends  declared  thereon  to  the  wife, 
unless  the  husband  is  empowered  as  her  agent  to  receive  it. 

If  stock  is  pledged,  the  pledgee  is  entitled  to  any  dividends 
declared  meanwhile  even  though  he  is  not  a  stockholder  of  record, 
provided  the  corporation  has  had  due  notice  of  the  pledge.  But 
the  pledgee  must  account  for  these  dividends  to  the  pledger 
when  the  pledge  is  redeemed.20 

If  a  corporation  holds  stock  of  other  corporations,  it  is 
entitled  to  receive  dividends  on  this  stock  as  is  any  other  stock- 
holder. It  cannot,  however,  pay  dividends  on  its  own  stock 
held  in  the  treasury  of  the  corporation.  When  dividends  are 
payable  to  a  corporation  the  dividend  check  may  be  made 
either  in  the  name  of  the  corporation,  or  to  the  treasurer  as 
treasurer  of  the  corporation.  If  stock  belongs  to  an  estate, 
payment  of  dividends  should  be  made  to  the  administrator.  If, 
however,  the  stock  passes  to  a  legatee,  all  dividends  declared 
after  the  date  of  the  testator's  death  belong  to  the  legatee,  but  if 
any  dividends  have  been  declared  before  that  date  but  are  not 
yet  paid,  they  will  belong  to  the  general  estate. 

'"  ".  Cook  on  Corps.,  {  468. 


442  CORPORATE  LAW  [Bk.  I- 

§  496.    Payment  of  Dividends 

It  is  customary  to  close  the  stock  books  a  certain  number  of 
days  before  a  dividend  is  to  be  paid,  in  order  to  give  the  treasurer 
an  undisturbed  opportunity  to  make  up  his  dividend  statement 
from  the  books.  The  "closed"  period  usually  continues  until 
the  date  of  its  payment,  or,  if  this  period  is  lengthy,  for  such 
reasonable  time  as  will  enable  the  treasurer  to  secure  from  the 
books  the  data  he  requires  for  his  dividend  statement.  During 
this  period  no  transfers  of  stock  will  be  made. 

As  a  rule  the  closing  of  the  transfer  books  works  no  hardship. 
They  are  not  usually  closed  until  the  day  on  which  the  dividend 
is  effective.  Transfers  of  stock  made  after  that  -date  do  not, 
therefore,  carry  the  dividend,  unless  by  special  agreement 
between  the  parties,  and  the  fact  that  the  transfer  cannot  be 
immediately  recorded  is  in  most  cases  immaterial.  If  transfers 
prior  to  the  declaration  of  the  dividend  have  not  been  recorded, 
they  are  of  course  shut  out,  and,  to  secure  the  dividend  which 
rightfully  belongs  to  such  unrecorded  stockholders,  they  must 
take  up  the  matter  with  the  transferrer  and  secure  from  him  an 
order  on  the  treasurer. 

§  497.    Dividend  Checks 

As  soon  as  the  stock  books  are  closed,  the  treasurer  is  fur- 
nished by  the  secretary  with  a  list  of  the  stockholders  of  record 
as  they  appear  on  the  date  of  closing,  or  otherwise  the  stock 
books  are  turned  over  to  him  and  he  secures  the  names  and  the 
addresses  of  the  stockholders  himself.  The  treasurer  then  makes 
up  his  dividend  statement,  showing  the  amount  of  stock  held 
by  each  stockholder  and  the  amount  of  dividends  due  him.  The 
checks  for  dividends  are  made  out  and  on  the  appointed  date 
are  mailed  to  the  parties  to  whom  they  are  due,  or  if  dividend 
checks  are  not  mailed,  the  stockholders  are  notified  to  call  and 
receive  their  dividends  in  person. 

In  the  smaller  corporations  the  dividend  check  is  usually 
nothing  more  than  the  ordinary  check  of  the  corporation,  either 


Ch.  S3]  DIVIDENDS  443 

marked  or  stamped  ''Dividend  Check,"  or  accompanied  by  a 
brief  notice  stating  that  the  check  is  in  payment  of  the  specified 
dividend.  In  the  larger  corporations  special  checks  are  usually 
printed,    with    the    words    "Dividend    Check"    or    "Dividend 

No "or  some  other  identifying  phrase  appearing  on  the 

face  of  the  check. 

Where  the  stockholders  call  in  person  for  dividends,  they 
are  usually  required  to  sign  the  regular  receipt  form  upon  the 
dividend  book.  If  the  checks  are  mailed,  receipt  forms  are 
sometimes  sent  with  them,  to  be  signed  and  returned  by  the 
stockholders.  Usually  and  preferably,  however,  the  check 
itself  is  deemed  an  all-sufficient  receipt.  When  stamped  "Divi- 
dend No "  or  with  some  equivalent  identifying  phrase, 

as  is  usually  the  case,  and  indorsed  by  the  recipient,  as  must 
be  done  before  the  check  can  be  collected,  and  stamped  or  can- 
celed by  the  drawee  bank  when  paid,  the  check  itself  undoubtedly 
does  afford  the  best  possible  evidence  of  the  payment  of  the 
dividend.  The  check  is  usually  accompanied  by  a  notice  that  a 
receipt  either  is  or  is  not  required,  as  the  case  may  be. 

The  dividend  check  is  in  no  wise  different  in  its  nature  from 
any  other  corporate  check.  It  should  be  deposited  or  otherwise 
presented  for  payment  promptly,  and  if  this  is  not  done,  the 
recipient  must  bear  any  loss  due  to  such  delay  in  presentation. 
The  dividend  check  is  also  subject  to  all  the  usual  customs  and 
requirements  relating  to  checks. 

§  498.    Illegal  Dividends 

The  declaration  of  an  illegal  dividend  or  the  payment  of  an 
illegal  dividend  already  declared  may  be  enjoined  and  stopped 
by  proper  action  of  the  stockholders. 

Illegal  dividends  may  be  of  three  characters : 

1.  Those  declared  in  disregard  of  the  rights  of  some  of  the 

stockholders. 

2.  Those  declared  in  violation  of  charter  or  by-law  pro- 

visions of  the  particular  corporation. 


444  CORPORATE  LAW  [Bk.  1- 

3.  Those  which  either  impair  the  capital  stock  or  threaten 
the  solvency  of  the  corporation. 

1.  Dividends  which  are  unequal  among  stockholders  of  the 
same  class  are  absolutely  in  disregard  of  the  rights  of  the  stock- 
holders discriminated  against — so  much  so,  that  cases  directly 
involving  the  principle  but  seldom  arise.  When  inequalities  are 
attempted  it  is  usually  by  means  of  diversions  of  the  profits,  such 
as  payments  of  excessive  salaries  or  unnecessary  expenditures. 

Another  instance  of  dividends  in  disregard  of  the  rights  of 
stockholders  is  sometimes  found  when  the  directors  declare 
dividends  on  common  stock  while  cumulative  dividends  due  on 
preferred  stock  have  not  been  paid.  In  such  a  case  the  court  will 
compel  a  readjustment  of  the  dividends.21 

2.  Dividends  declared  in  violation  of  charter  or  by-law  pro- 
visions may  be  perfectly  proper  in  themselves  but  illegal  merely 
because  of  their  prohibition.  Thus,  the  charter  or  by-laws  may 
provide  that  no  dividend  shall  be  declared  until  after  surplus 
funds  have  been  accumulated  to  some  specified  amount.  Then 
if  dividends  are  declared  before  this  surplus  has  been  reserved, 
they  are  illegal  and  pa)niient  may  be  enjoined  by  proper  action 
of  the  stockholders. 

3.  The  most  common  form  of  illegal  dividends  is  that  which 
impairs  the  capital  stock  or  which  endangers  the  solvency  of  the 
corporation.  In  a  case  of  this  kind  it  is  to  some  extent  a  matter 
of  bookkeeping  and  judgment  as  to  whether  a  dividend  is  such 
as  to  impair  the  capital  stock  or  render  the  company  insolvent. 
If  the  directors  declare  a  dividend  in  good  faith,  after  a  proper 
investigation  of  the  financial  condition  of  the  company,  the  courts 
are  not  likely  to  interfere. 

A  case  of  illegal  dividends  comes  within  the  jurisdiction  of 
courts  of  equity,  and  any  stockholder  may  bring  suit  therein  to 
enjoin  the  declaration  of  a  dividend  believed  by  him  to  be  illegal. 
An  illegal  dividend  may  be  rescinded  by  the  directors  at  any  time 
before  its  payment. 

»  Luling  V.  Atl.  Mut.  Ins.  Co.,  45  Barb.  (N.  Y.)  510  (1865). 


Ch.  S3l  DIVIDENDS  445 

§  499.    Liability  for  Illegal  Dividends 

In  most  of  the  states  a  liability  is  imposed  upon  the  directors 
by  statute  for  any  violation  of  the  laws  regulating  dividends. 
In  some  cases  offending  directors  are  made  liable  for  any  and 
all  debts  of  the  corporation  incurred  during  their  term  of  office. 
In  other  cases  they  are  liable  only  for  the  amount  actually  paid 
out  in  these  illegal  dividends.  In  some  states  they  are  not  only 
held  liable  for  the  corporate  debts,  or  for  restitution  in  case  of 
dividends  illegally  declared,  but  are  also  guilty  of  a  misde- 
meanor punishable  by  fine  and  imprisonment. 
I  If  the  directors  of  a  corporation  declare  a  dividend  in  violation 
of  its  charter  or  by-law  provisions,  they  may  be  enjoined  from 
its  payment,  or  if  not,  would  undoubtedly  be  held  liable  for  any 
damage  to  the  corporation  which  may  result  from  the  illegal 
dividend. 

When  dividends  are  declared  which  impair  the  capital  stock 
or  render  the  corporation  insolvent,  they  not  only  subject  the 
directors  to  liabilities  and  in  some  cases  penalties,  but  such  illegal 
dividends  may  be  recovered  from  the  stockholders  to  whom  they 
were  paid. 

It  is  the  weU  determined  doctrine  of  the  courts  of  this  country 
that  the  capital  stock  is  a  fund  to  be  preserved  for  the  benefit  of 
corporate  creditors.  Hence  the  rule  has  been  firmly  established 
that  where  dividends  are  paid  in  whole  or  in  part  out  of  the  capital 
stock,  corporate  creditors  being  such  when  the  dividend  was 
declared  or  becoming  such  at  any  subsequent  time,  may  to  the 
extent  of  their  claims,  if  such  claims  are  not  otherwise  paid,  compel 
the  shareholders  to  whom  the  dividend  has  been  paid  to  refund 
whatever  portion  of  the  dividend  was  taken  out  of  the  capital 
stock.** 

If  a  dividend  has  been  paid  out  of  the  capital  stock,  the  stock- 
holders are  conclusively  presumed  to  have  known  it  and  are  liable 
to  an  action  for  repayment.  They  cannot  claim  to  hold  the 
position  of  innocent  or  bona  fide  holders. 


°  2  Cook  on  Corps.,  {  548. 


446  CORPORATE  LAW  [Bk.  I- 

As  already  said,  in  some  few  states  the  officers  are,  together 
with  the  directors,  liable  for  dividends  paid  in  violation  of 
statutory  provisions.  As  a  rule,  however,  the  treasurer  is  not 
personally  liable  in  any  way  for  the  payment  of  dividends 
ordered  by  the  directors  unless  he  knows  such  dividends  to 
be  absolutely  fraudulent.  In  a  few  states,  however,  liability 
for  dividends  prohibited  by  statute  has  been  extended  by  express 
enactment  to  the  executive  officers  of  the  corporation  if  they 
consent  or  concur  therein.  In  such  states,  if  the  treasurer, 
knowing  the  dividends  to  be  in  violation  of  the  statutory  pro- 
vision, nevertheless  obeys  the  instructions  of  the  directors  and 
either  pays  such  dividends  or  permits  them  to  be  paid,  he  is 
liable  with  the  directors.  There  are,  it  may  be  said,  but  few 
states  in  which  this  liability  exists. 

The  treasurer  usually  furnishes  to  the  directors  the  statement 
of  the  corporate  accounts  and  finances  which  determines  whether 
or  not  dividends  shall  be  declared.  It  is  his  duty  to  provide  an 
accurate  statement,  and  should  his  presentment  be  so  erroneous 
or  so  carelessly  compiled  as  to  mislead  the  directors  and  cause 
the  declaration  and  payment  of  improper  dividends,  he  would 
have  failed  in  the  "due  diligence"  and  reasonable  care  exacted 
of  the  treasurer  as  an  agent  of  the  corporation  and  would  be  liable 
for  any  resulting  loss. 

Beyond  this  the  treasurer  is  also  responsible  for  the  proper 
payment  of  dividends,  not  only  as  to  the  actual  computation  of 
amounts  due  and  the  proper  drawing  of  the  dividend  checks, 
but  for  their  delivery  to  the  proper  persons. 


CHAPTER  LIV 
BONDS  1 

§  500.    Nature  of  a  Bond 

When  a  corporation  borrows  money,  its  indebtedness  may 
be  evidenced  by  either  notes  or  bonds.  If  the  amount  bor- 
rowed is  small,  or  if  it  is  borrowed  in  a  single  sum,  or  from  but 
few  persons,  or  for  a  short  time,  notes  are  usually  given.  If, 
however,  the  amount  is  large  and  obtained  from  a  number  of 
people  and  extends  over  a  period  of  years,  the  corporate  obliga- 
tion is  preferably  and  usually  evidenced  by  bonds. 

The  difference  between  a  corporate  note  and  a  bond  is  not 
always  clearly  marked.  Both  are  promises  to  pay  money.  The 
phrasing  of  the  bond  is  usually  more  formal  than  that  of  the 
note.  Also  it  must  be  executed  under  seal,  while  the  corporate 
note  need  not.  Also  payment  of  bonds  is  usually,  though  not 
invariably,  secured  as  to  both  principal  and  interest  by  certain 
specified  property  held  for  the  purpose  under  a  formal  deed  of 
trust. 

A  bond  payable  to  order,  or  bearer,  or  holder  is  a  negotiable 
instrument,  and  this  in  spite  of  the  fact  that  it  is  executed  under 
seal.  Hence,  if  such  a  bond  is  in  due  form  and  is  purchased  for 
value  and  in  good  faith,  the  purchaser  is  protected  against  any 
defenses  set  up  by  the  corporation  and  against  any  claims  of 
previous  owners. 

A  bond  issue  consists  of  a  number  of  bonds  which,  while  they 
may  vary  as  to  denomination,  and  some  may  be  registered  and 
some  unregistered,  are  all  of  like  general  tenor,  and  if  secured 
are  all  secured,  and,  unless  otherwise  expressly  provided,  equally 
secured,  under  one  deed  of  trust. 


•  See  Book  II,  Part  II,  "Corporate  Securities";  also  Book  III,  Part  IV, "Bonds  and  Funds." 

447 


448  CORPORATE  LAW  [Bk.  I- 

Bonds  are  issued  in  varying  denominations  but  those  of  the 
larger  corporations  are  usually  of  $i,ooo  denomination  and 
issued  in  coupon  form.  Bonds  of  the  face  value  of  $500  are  not 
infrequently  issued  and  $100  bonds  are  seen  occasionally. 

Coupon  bonds  usually  have  a  space  for  the  recording  by  the 
company  of  the  name  of  the  bond  owner  when  the  latter  so 
desires,  the  company  or  its  fiscal  agents  keeping  a  record  of  all 
such  registrations.  Such  bonds  are  termed  "registered  as  to 
principal  only,"  and  until  registered  "to  bearer,"  negotiability 
by  delivery  ceases.  The  interest  instalments  on  such  bonds 
continue  to  be  represented  by  coupons  which  are  payable  to 
bearer. 

Coupon  bonds  can  usually  be  exchanged  for  "fully  regis- 
tered bonds"  without  coupons,  these  usually  being  issued  in 
denominations  of  $1,000,  $5,000,  $10,000,  and  even  larger.  The 
interest  on  fully  registered  bonds  is  paid  by  check,  as  in  the 
case  of  dividends  on  stocks,  to  the  holder  of  record. 

The  advantage  of  the  unregistered  coupon  bond  is  found  in 
the  readiness  with  which  it  may  be  transferred.  The  advantage 
of  a  registered  bond,  whether  coupon  or  otherwise,  lies  in  the 
difficulty  of  its  negotiation  in  case  the  bond  is  lost  or  stolen. 
If  a  bond  payable  to  bearer  is  either  lost  or  stolen,  its  sale  or 
disposal  is  comparatively  easy  and,  once  in  the  hands  of  an 
innocent  holder  for  value,  the  stolen  bond  is  valid.  A  registered 
bond,  on  the  contrary,  should  it  be  lost  or  stolen,  is  practically 
non-negotiable.  It  is  payable  only  to  the  party  named  in  the 
bond,  and  a  successful  negotiation  of  the  bond  involves  a  forgery 
of  his  signature  which  would  prevent  a  valid  transfer. 

When  registered  bonds  are  assigned,  the  assignee  usually 
surrenders  the  old  bond  and  receives  in  exchange  a  bond  issued 
in  his  own  name,  the  new  ownership  being  recorded  upon  the 
books  of  the  company  at  the  same  time. 

Bonds  are  a  direct  corporate  obligation  and  do  not  in  any 
way  partake  of  the  nature  of  stork.  They  may,  however,  be 
given  rights  of  participation  in  corporate    profits    if    desired, 


Ch.  S4]  BONDS  449 

and,  in  the  absence  of  statutory  prohibition,  may  be  given  vot- 
ing rights  as  well.  But  even  though  this  last  privilege  is  extended, 
it  is  rarely  exercised  if  the  bonds  are  in  coupon  form  and  widely 
scattered. 

§  501.    Authorization  of  Bond  Issues 

"The  power  of  a  corporation  to  borrow  money  is  implied 
and  exists  without  being  expressly  granted  by  charter  or  stat- 
utes. "2  In  the  absence  of  restraining  laws,  a  corporation  may 
therefore  issue  corporate  notes  and  bonds  to  any  desired  amount. 

In  most  states,  however,  constitutional  or  statutory  provi- 
sions are  found  directly  limiting  or  otherwise  affecting  the  com- 
mon law  right  of  corporations  to  borrow  money  or  incur  debt, 
particularly  by  the  issue  of  bonds,  and  in  many  states  statutes 
prohibit  the  directors  from  issuing  bonds  until  authorized  thereto 
by  the  stockholders. 

Constitutional  provisions  affecting  the  issue  of  bonds  are 
found  in  many  states  but  as  a  rule  confine  themselves  to  the 
requirement  that  bonds  shall  be  issued  for  value  only  and  that 
any  fictitious  increase  of  indebtedness  is  void. 

Statutory  provisions  Hmiting  the  amount  of  corporate  in- 
debtedness are  found  in  many  states.  Thus  in  Florida,  Ken- 
tucky, Minnesota,  and  some  other  states,  the  maxinjum  cor- 
porate indebtedness  that  may  be  incurred  must  be  stated  in  the 
charter.  In  Illinois  and  in  some  other  states,  the  total  aggre- 
gate of  the  corporate  indebtedness  must  not  exceed  the  total 
amount  of  the  capital  stock.  In  other  states,  as  Nebraska  and 
Vermont,  the  corporate  indebtedness  must  not  exceed  two-thirds 
of  the  capital  stock.  In  New  Hampshire  it  may  not  exceed  one- 
half  the  value  of  the  company  assets. 

Provisions  requiring  the  assent  of  a  specified  majority  of  the 
stockholders  before  bonds  may  be  issued  are  also  found  in 
many  states.    Thus  in  California,  Nevada,  New  York,  and  other 


'  3  Cook  on  Corps.,  i  760. 


45©  CORPORATE  LAW  [Bk.  I- 

states,  a  bond  issue  must  be  authorized  by  a  two-thirds  vote 
of  the  stockholders.  In  Alabama,  Missouri,  Pennsylvania,  and 
a  number  of  other  states,  it  may  be  authorized  by  a  mere  ma- 
jority of  the  voting  stock.  In  Ohio  a  three-fourths  vote  of  the 
stockholders  is  required  before  convertible  bonds  may  be  issued. 
The  statutory  provisions  also  frequently  specify  the  notice 
which  must  be  given  for  stockholders'  meetings  to  authorize 
bond  issues. 

In  some  states  specific  provisions  exist  as  to  the  selling  price 
of  bonds,  as  in  North  Carolina  where  the  statutes  provide  that 
bonds  may  be  sold  below  par  and  commissions  may  be  paid 
upon  the  sale,  or  in  Wisconsin  where  the  true  value  of  the 
money,  labor,  or  property  received  for  bonds  must  be  at  least 
75%  of  their  par  value.  The  Wisconsin  provision,  it  must  be 
added,  is  further  weakened  by  the  enactment  that,  notwith- 
standing its  terins,  bonds  may  be  sold  at  the  best  price  obtain- 
able on  the  stock  exchanges  of  Chicago,  New  York,  Boston,  or 
Philadelphia. 

Special  provisions  as  to  bond  issues  are  found  in  some  states, 
as  in  Louisiana,  New  Mexico,  Nevada,  Missouri,  New  Jersey, 
and  Ohio,  where  the  statutes  expressly  authorize  the  issue — 
under  proper  procedure — of  bonds  convertible  into  stock;  or 
in  Delaware,  where  bondholders  may  be  given  the  same  rights 
as  stockholders;  or  in  Nevada  and  Virginia,  where  by  proper 
procedure  bondholders  may  be  given  the  right  to  vote.  It  may 
be  noted  that  the  Illinois  courts  hold  that  bondholders  cannot 
be  given  the  right  to  vote  at  corporate  meetings. 

§  502.    Secured  and  Unsecured  Bonds  " 

The  payment  of  corporate  bonds  may  be  either  secured  or 
unsecured.  If  unsecured,  the  bonds  are  usually  termed  "de- 
bentures." 

The  usual  unsecured  debenture  bond  is  merely  the  formal 
corporate  promise  to  pay  money.     It  is  an  obligation  of  the 

'  See  Book  II,  Ch.  VIII,  "Secured  Bonds,"  and  Ch.  IX,  "Unsecured  Bonds." 


Ch.  54]  BONDS  451 

corporation,  but  as  it  is  unsecured  there  can  be  no  foreclosure 
in  case  of  default  on  either  interest  or  principal.  In  such  case 
the  holder  has  no  remedy  except  the  ordinary  suit  at  law  on  an 
unpaid  note.  It  is  merely  an  unsecured  debt  of  the  corporation 
and  has  no  precedence  over  any  other  unsecured  debt.  Its 
claim  is  superior  to  that  of  preferred  stock,  but  is  inferior  to 
that  of  any  secured  indebtedness  of  the  corporation.  Its  value 
depends  entirely  upon  the  solvency  of  the  issuing  corporation. 

A  mortgage  bond  is  one  the  payment  of  which  is  secured  by 
a  mortgage  or  deed  of  trust  on  part  or  all  of  the  property  of  the 
corporation.  This  deed  of  trust  usually  authorizes  the  trustees, 
in  case  of  default  on  interest  or  principal  of  the  secured  bonds, 
to  take  possession  of  the  property  and  either  operate  it  or  sell 
it,  as  may  be  provided,  for  the  benefit  of  the  bondholders. 

"Mortgage"  bonds  are  in  effect  first  mortgage,  second  mort- 
gage, etc.,  according  to  the  lien  of  the  deed  of  trust  by  which 
they  are  secured.  But  unfortunately  a  so-called  first  mortgage 
bond  is  not  always  what  its  name  implies,  as  it  may  be  preceded 
by  a  prior  lien  mortgage  securing  bonds  senior  in  lien  to  those 
issued  under  the  so-called  first  mortgage.  A  notable  instance 
of  this  is  the  Toledo,  St.  Louis  and  Western  $6,500,000  of  First 
Gold  4's,  which  are  actually  junior  in  lien  to  $9,575,000  Prior 
Lien  Gold  3>^'s;  in  other  words,  there  is  a  prior  lien  before  the 
first  mortgage. 

A  second  mortgage  bond  secured  on  the  same  property  as 
that  already  covered  by  one  mortgage  is  a  second  lien,  i.e.,  in 
case  of  foreclosure  the  first  mortgage  bonds  must  be  paid  in 
full,  both  principal  and  interest,  before  the  holders  of  the  second 
mortgage  bonds  receive  anything.  Hence,  real  first  mortgage 
bonds  are  more  desirable  than  those  of  a  junior  lien,  i.e.,  those  of 
an  inferior  or  later  lien,  unless  the  property  is  of  such  value  as 
to  be  an  absolute  and  unquestionable  security  for  the  entire 
amount  of  outstanding  bonds;  but  a  bondholder  must  ascertain 
that  the  so-called  first  mortgage  bond  is  actually  a  first  mortgage 
or  first  lien,  and  not  such  in  name  only. 


452  CORPORATE  LAW  [Bk.  I- 

§  503.    Coupon  Bonds 

A  coupon  bond  is  one  to  which  coupons  are  attached,  each 
coupon  requiring  payment  on  its  due  date  of  the  interest  instal- 
ment represented  by  that  particular  coupon.  Such  coupons  are 
in  effect  promissory  notes,  each  calling  for  the  pajmient  of  one 
instalment  of  interest  on  a  bond.  The  interest  on  coupon  bonds 
is  payable  to  the  holders  of  these  coupons  and  not  to  the  holder 
or  owner  of  the  bonds  unless  he  is  also  the  holder  of  the  coupon.* 

Interest  on  bonds  is  usually  payable  semiannually,  and  each 
of  the  coupons  attached  to  a  coupon  bond  calls  for  the  exact 
amount  of  one  of  the  semiannual  interest  payments  on  that 
bond.  Thus  a  bond  running  ten  years  with  interest  payable 
semiannually  would  have  attached  to  it  twenty  coupons.  Each 
coupon  is  numbered  to  correspond  with  its  bond  but  also  has 
a  serial  number — running  from  one  to  twenty  in  the  instance 
cited — indicating  the  order  in  which  the  coupons  come  due. 

A  coupon  is  in  form  a  promissory  note.  It  is  attached  to  the 
bond  as  a  convenient  method  of  indicating  the  amount  and  the 
due  date  of  interest  and  for  its  collection  when  due.  One  coupon 
is  attached  to  the  bond  for  each  interest  instalment.  Thus  a 
20-year  bond  with  semiannual  interest  payments  would  carry 
forty  coupons.  These  coupons  are  numbered  serially  and  also 
carry  the  number  of  the  bond  to  which  they  are  attached. 
Coupon  No.  I  represents  the  interest  that  will  be  due  at  the  first 
interest  period.  As  soon  as  that  period  arrives  the  coupon 
matures,  and  it  is  then  detached  from  the  bond  and  either  pre- 
sented for  payment  or  deposited  for  collection  as  would  be  done 
with  any  other  promissory  note. 

When  an  interest  payment  on  coupon  bonds  is  about  to  fall 
due,  the  amount  necessary  to  meet  the  maturing  coupons  is 
usually  deposited  in  some  designated  baiik  which  acts  for  the 
corporation  and  pays  the  coupons  as  they  are  presented.  The 
coupons  are  then  canceled  and  are  pasted  in  the  coupon  register. 


*  See  Book  IV.  Form  a.^o. 


Ch.  54]  BONDS  453 

§  504.    Deed  of  Trust 

Usually  a  statement  of  the  general  conditions  of  a  bond 
issue  appears  upon  the  face  of  each  bond  and  reference  is  made 
to  any  features  of  special  importance,  such  as  the  existence  of 
a  sinking  fund,  the  conditions  of  redemption,  the  method  of 
transfer  and  exchange  when  bonds  payable  to  bearer  and  regis- 
tered bonds  are  issued  under  the  same  deed  of  trust,  etc. 

The  language  of  a  bond  is  usually  more  formal  than  that 
of  a  note,  it  must  be  executed  under  seal,  and,  if  secured,  refer- 
ence is  made  in  the  bond  itself  to  the  deed  of  trust  under  which 
it  is  issued. 

Bonds  issued  under  a  deed  of  trust  must  usually  be  certified 
by  the  trustee  before  they  are  issued.  The  trustee's  certificate 
appears  on  the  back  of  each  bond,  and  evidences  the  fact  that 
the  bond  is  one  of  the  issue  mentioned  in  the  deed  of  trust.  ^ 
As  a  rule,  the  object  of  this  certificate  is  merely  to  identify  the 
bond  and  to  prevent  overissues.  If  the  trustee  certifies  more 
bonds  than  are  called  for  by  the  deed  of  trust,  he  may  make 
himself  personally  responsible  for  the  overissue,  but  otherwise 
he  incurs  no  liability  whatsoever  by  reason  of  his  certification. 

A  certification  is  not  part  of  the  bond,  though  it  may  be 
required  before  the  bond  itself  can  be  considered  as  issued,  nor 
is  it  in  any  sense  an  indorsement  of  the  bond  nor  a  certification 
of  its  correctness  as  to  form  or  subject  matter. 

A  deed  of  trust  is  a  mortgage  on  certain  specified  property 
given  to  a  trustee  who  acts  for  the  holders  of  the  bonds  secured 
thereby.  The  deed  of  trust  recites  at  length  the  terms  and  con- 
ditions under  which  the  bonds  are  issued  and  under  which  the 
property  for  their  security  is  held.* 

A  modern  deed  of  trust  is  usually  a  very  comprehensive  and 
formidable  instrument.  A  brief  form  may  occupy  perhaps  from 
10  to  20  pages  of  printed  matter.  More  extended  forms  fre- 
quently occupy  100  pages  or  more. 


»  See  Book  IV,  Form  251. 
•  See  Book  IV,  Form  253. 


454  CORPORATE  LAW  [Bk.  I- 

In  the  bond  itself  reference  is  always  made  to  the  deed  of 
trust  by  which  it  is  secured,  and  in  the  deed  of  trust  the  bond  is 
recited  in  full.  The  bond  by  express  terms  is  subjected  to  the 
conditions  of  the  deed  of  trust.  Accordingly  the  statements  of 
the  bond  are  controlled  by  the  explanations  and  any  non- 
conflicting  conditions  of  the  deed  of  trust.  If,  however,  the  terms 
of  the  bond  and  of  the  deed  of  trust  conflict,  the  bond  prevails.'' 

If  the  deed  of  trust  fails  for  any  reason,  the  bonds  then 
become  the  unsecured  obligation  of  the  corporation  and  take 
their  place  on  a  parity  with  the  other  unsecured  corporate  debts. 

§  505.    Recitals  of  Deed  of  Trust 

In  the  deed  of  trust  usually  employed  the  preamble  recites 
the  conditions  precedent  to  the  issue,  the  form  of  bond  in  full, 
and  the  form  of  coupon  and  trustee's  Certificate,  also  in  full; 
followed  by  the  granting  clauses,  including  description  of  prop- 
erty covered,  and  by  the  trust  reservation  with  stipulation  for 
equal  participation  of  all  the  bonds  of  that  issue  in  the  protection 
afiforded  by  the  mortgaged  property. 

Following  this  come  the  ''covenants,  conditions,  uses,  and 
trusts"  subject  to  which  the  bonds  are  issued  and  the  mortgaged 
property  is  held.  These  have  a  wide  range.  Some  of  the  more 
usual  are  as  follows: 

1.  Procedure  for  execution,  certification,  and  delivery  of 

bonds. 

2.  Enjoyment  of  property  by  mortgagor  until  default  in 

payment. 

3.  Payment  of  principal  and  interest  without  deduction  for 

taxes,  and  in  "gold  coin,"  "legal  tender,"  or  otherwise, 
as  the  case  may  be. 

4.  Payment  of  all  taxes  and  assessments  on  property  held 

under  the  deed  of  trust  and,  if  the  nature  of  the 
property  is  such  as  to  require  it,  maintenance  of  the 
same  in  repair,  under  due  insurance  and  free  from  hens. 

»  Railway  Co.  v.  Sprague,  103  U.  S.  756  (1880). 


Ch.  54]  BONDS  455 

5.  Provision  for  any  necessary  additional  assurances  for 

protection  of  bondholders. 

6.  Provision  for  trustee  to  enter  upon  property  and  conduct 

business  without  foreclosure  under  certain  conditions. 

7.  Sinking  fund  for  retirement  of  bonds. 

8.  Procedure  for  foreclosure  in  case  of  default. 

9.  Provision  that  bonds  shall  be  matured  by  failure  to  pay 

interest. 

10.  Stipulation  that  loans,  advances,  or  payments  made  on 

coupons  for  account  of  the  mortgagee  shall  not  keep 
such  coupons  alive. 

1 1 .  Provision  for  redemption  of  bonds. 

12.  Provision  for  discharge  of  deed  of  trust. 

13.  Provision  for  substitution  or  appointment  of  new  trustee. 

14.  Disclaimer  of  responsibility  on  part  of  trustee. 

15.  Interpretation  of  terms  used  in  deed  of  trust. 

16.  Provision  that  deed  of  trust  may  be  executed  in  duplicate 

parts. 

In  addition  to  these  common  provisions,  others  are  often 
dictated  by  particular  conditions.  Thus,  if  both  registered  and 
coupon  bonds  are  issued,  provision  must  be  made  for  registra- 
tion and  for  the  exchange  of  one  for  the  other  if  this  is  prescribed; 
also  provisions  may  be  inserted  for  the  issue  of  temporary  cer- 
tificates, or  for  replacement  of  destroyed  or  mutilated  bonds,  or 
for  discrimination  against  coupons  detached  or  assigned  before 
maturity,  or  for  exemption  of  the  stockholders  and  officers  of 
the  issuing  company  from  all  liability  under  the  deed  of  trust 
or  for  the  bonds  issued  thereunder;  or  in  a  mortgage  on  realty 
it  may  be  provided  that  upon  payment  to  the  trustee  of  a  certain 
specified  price,  parts  of  the  property  may  be  sold  free  from  the 
encumbrance  of  the  mortgage,  or  that  under  prescribed  condi- 
tions properties  may  be  withdrawn  from  the  mortgage  and 
new  properties  substituted  in  their  place. 

The  duties  of  the  trustee  under  a  deed  of  trust  are  usually 
few  but  may  be  onerous.    He  certifies  each  bond  issued.    At 


4S6  CORPORATE  LAW  [Bk.  I- 

times  the  recording  of  the  deed  of  trust  is  made  one  of  his  duties. 
In  case  of  default  he  is  usually  required  either  to  take  possession 
of  the  property  and  operate  it  or  sell  it,  ^.ccording  to  the  condi- 
tions of  the  deed  of  trust,  for  the  benefit  of  the  bondholders.  If 
called  upon  to  operate  the  property,  his  duties  and  liabilities 
may  be  heavy. 

§  506.    Execution  and  Filing  of  Deed  of  Trust 

The  deed  of  trust  is  executed  with  the  same  formality  as  a 
deed  of  land.  It  must  be  signed  and  sealed  both  by  the  cor- 
poration and  by  the  trustee,  and  be  duly  acknowledged  before 
a  notary  public  or  other  duly  authorized  officer.  The  corporate 
signature  is  usually  affixed  by  the  president,  and  the  corporate 
seal  is  affixed  and  attested  by  the  secretary.  The  acknowledg- 
ment is  also  usually  made  by  the  president  of  the  corporation, 
but  is  of  equal  force  if  made  by  the  secretary,  treasurer,  or  any 
other  duly  authorized  executive  officer.  It  is  immaterial  whether 
the  deed  of  trust  be  executed  within  the  state  in  which  the  cor- 
poration was  organized  or  elsewhere. 

If  realty  is  included,  the  deed  of  trust  must  be  filed  in  the 
office  of  the  county  clerk  in  every  county  in  which  the  real 
estate  is  situated. 


CHAPTER  LV 

BONDS  (Continued) 

§  507.     Sinking  Fund  ^ 

A  sinking  fund  as  applied  to  bond  issues  is  a  fund  created  for 
the  purpose  of  redeeming  the  bonds  when  due,  or  prior  thereto, 
as  may  be  provided  by  the  deed  of  trust.  Thus  bonds  may  be 
retired  from  time  to  time  as  the  sinking  fund  accumulates,  or 
the  fund  may  be  allowed  to  remain  intact  until  the  maturity 
of  the  bonds,  when,  if  properly  constituted  and  maintained,  it  is 
sufficient  for  the  retirement  of  the  issue. 

Sinking  fund  requirements  will  vary  with  the  conditions. 
Sometimes  a  stated  annual  amount  is  paid  into  the  fund.  At 
other  times  the  income  from  a  certain  source  will  be  devoted 
to  this  purpose.  Coal  mining  companies  frequently  reserve  a 
certain  amount  for  each  ton  of  coal  mined.  Lumber  companies 
sometimes  reserve  a  certain  amount  on  each  thousand  feet  of 
lumber  cut. 

In  the  smaller  corporations  the  sinking  fund  is  usually  infor- 
mal and  is  kept  in  the  custody  of  the  corporation.  For  the  larger 
bond  issues,  a  sinking  fund  is  usually  established  in  the  hands  of 
a  special  trustee,  subject  to  the  conditions  of  the  deed  of  trust. 

The  wisdom  of  a  sinking  fund  is,  in  the  case  of  most  bond 
issues,  apparent.  Reserving  as  it  does  a  moderate  amount  each 
year  for  the  payment  of  the  bonds,  their  final  redemption  is 
effected  with  comparative  ease.  Without  such  a  fund  another 
bond  issue  to  retire  the  maturing  bonds,  or  a  default,  would 
be  the  probable  result. 

In  the  case  of  .railroads  there  is  a  tendency  to  dispense  with 

■  See  also  Book  II,  Ch.  XI,  "Redemption  of  Bonds — Sinking  Funds";  also  Book  III. 
Ch.  XXII,  "Prind pies  of  Fund  Accounting."  ','iili    in 

457 


4S8  CORPORATE  LAW  [Bk.  I- 

sinking  funds  when  bonds  are  issued  for  permanent  additions  or 
improvements,  the  bonds  when  due  being  replaced  by  a  second 
issue.  This  is  based  upon  the  principle  that  the  additions  or 
improvements  being  permanent  and  being  maintained  out  of 
earnings,  are  as  much  for  the  benefit  of  subsequent  as  of  present 
stockholders  and  that  the  present  stockholders  should  not  be 
deprived  of  their  dividends  merely  to  provide  a  more  valuable 
property  and  larger  dividends  for  those  who  come  after.  Or  it 
may  be  considered  that  the  bonds  are  a  permanent  portion  of  the" 
capitalization  on  which  interest  is  paid  instead  of  dividends. 

§  508.     Sale  of  Bonds 

Unless  prevented  by  statutory  enactment,  bonds  may  be 
sold  at  any  price  that  can  be  obtained.  In  most  of  the  states 
there  are  provisions  that  bonds  may  be  issued  only  for  value 
actually  received,  but  in  the  absence  of  some  more  specific 
limitation,  bonds  may  still  be  issued  below  par  if  in  good  faith. 
In  some  few  states  more  specific  provisions  exist. 

The  sale  of  bonds  below  par  by  the  issuing  corporation  may, 
however,  constitute  an  infraction  of  the  laws  against  usury. 
Thus,  if  a  5%  bond  of  the  face  value  of  $1,000  be  sold  for  $500, 
the  rate  of  interest  paid  on  the  money  so  secured  is  10%.  If, 
then,  this  exceeds  the  legal  rate  of  interest  in  the  state  in  which 
the  sale  was  made,  the  transaction  is  usurious  and  illegal,  and 
for  this  reason  the  original  purchaser,  or  subsequent  purchaser 
knowing  the  conditions,  might  be  unable  to  enforce  the  payment 
of  his  bond.  This  could  not,  however,  be  the  case  if  the  bonds 
were  in  the  hands  of  an  innocent  holder  for  value,  nor  in  states 
in  which  the  statutes  are  silent  as  to  usury,  nor  in  states  where 
bonds  may  by  statute  proA^sion  be  sold  below  par,  nor  in  states 
where  corporations  are  not  allowed  the  defense  of  usury. 

§  509.     Vendors  and  Holders 

The  vendor  of  a  bond  does  not  warrant  the  legality  of  the 
issue  nor  in  any  way  guarantee  payment  of  the  bond.     All  he 


Ch.  ss]  BONDS  459 

undertakes  is  that  so  far  as  he  has  knowledge  the  bond  is  legally 
issued  and  is  what  it  purports  to  be,  that  it  has  come  into  his 
hands  in  due  course  and  for  valuable  consideration,  and  that  he  is 
legally  competent  to  transfer  it  to  the  purchaser.  In  this  the 
bond  differs  from  a  note,  draft,  or  check,  which  the  vendor  is 
held  to  guarantee  unless  assigned  "without  recourse." 

A  bond  as  a  negotiable  or  quasi-negotiable  instrument  is  not 
subject  to  the  defenses  that  might  exist  between  the  original 
parties.  In  practice,  "the  courts  go  very  far  in  protecting  bona 
fide  holders  of  corporation  bonds,  and  will  uphold  and  enforce 
such  bonds  under  nearly  all  circumstances.  The  defense  that 
the  bond  was  issued  below  par  does  not  avail  as  against  a  bona 
fide  holder.  "2 

A  first  mortgage  bond  does  not  lose  its  priority  though  issued 
after  a  second  mortgage  bond.  Nor  does  the  number  or  date  of 
issue  of  a  bond  in  any  way  affect  its  rights  of  payment  as  regards 
the  other  bonds  of  the  same  issue,  unless  expressly  so  provided 
by  the  bond  or  the  deed  of  trust.  Such  provisions  are  legal  but 
unusual,  and  as  a  rule  every  bond  of  an  issue  has  all  the  rights 
of  any  other  bond  of  that  issue. 

Bonds  cannot  be  paid  by  the  issuing  corporation  before  they 
are  due  save  by  consent  of  the  holders,  unless  there  is  express 
provision  in  the  deed  of  trust  for  such  prior  redemption,  but  this 
does  not  preclude  their  purchase  in  the  open  market  prior  to 
maturity  by  the  debtor  corporation.  If  at  the  maturity  of  the 
bonds  all  are  not  presented  for  payment,  the  trustee  may 
reserve  a  sufficient  amount  of  money  for  the  retirement  of  the 
missing  bonds  and  discharge  the  deed  of  trust. 

Suit  may  be  brought  on  a  bond  or  coupon  if  not  paid  at 
maturity,  just  as  suit  may  be  brought  on  a  promissory  note,  and 
this  even  though  the  mortgage  is  not  foreclosed.  In  case  of 
judgment,  however,  no  execution  may  be  had  against  the  mort- 
gaged property.     In  some  few  states,  as  in  New  Jersey,  such 


*  I  Cook  on  Corps.,  {  766;  also  Dickermann  v.  Northern  Trust  Co.,  176  U.  S.  188  (1900). 


460  CORPORATE  LAW  [Bk.  I- 

suit  by  the  individual  holders  before  foreclosure  is  forbidden  by 
statute. 

In  case  of  foreclosure,  if  the  property  held  under  the  deed 
of  trust  is  not  sufficient  to  pay  the  bonds  secured  thereby,  the 
bondholders  have  recourse  against  the  corporation  for  the 
balance  due. 

§  510.    Redemption  of  Bonds  ^ 

The  date  of  maturity  of  bonds  is  stated  in  the  deed  of  trust 
and  also  on  the  face  of  each  bond.  The  deed  of  trust  also  usually 
provides  that  if  any  instalment  of  interest  is  not  paid  when  due 
and  the  default  continues  for  some  specified  length  of  time,  the 
principal  of  the  bond  is  thereby  matured  and  must  be  paid. 

In  event  of  default  either  on  principal  or  interest,  it  is  usually 
provided  that  foreclosure  may  follow,  or  perhaps,  preliminary 
thereto  or  in  lieu  thereof,  the  trustee  is  authorized  to  take 
possession  of  the  mortgaged  property  and  operate  it  for  the 
benefit  of  the  bondholders. 

When  bonds  are  redeemed  in  accordance  with  the  terms  of 
the  deed  of  trust,  they  are  canceled  and  cannot  be  reissued  unless 
expressly  so  provided  in  the  deed  of  trust.  A  corporation  might, 
however,  purchase  its  bonds  in  the  open  market  and  sell  them 
again  later. 

In  some  cases  provision  is  made  in  the  deed  of  trust  for 
redemption  of  bonds  prior  to  the  maturing  date.  Also,  con- 
vertible bonds  are  at  times  issued  which,  if  the  holder  elects, 
may  be  redeemed  in  stock  of  the  corporation.  Also  at  times 
it  is  provided  that  as  the  sinking  fund  accumulates,  the  funds 
may  be  used  from  time  to  time  to  redeem  the  outstanding  bonds. 

§  511.    Investment  Value  of  Bonds 

"^    If  bonds  are  purchased  at  par,  the  return  on  the  investment 
is  the  exact  interest  paid  on  the  bond.    If,  however,  bonds  are 


»  See  also  Book  II,  Ch.  XI,  "Redemption  of  Bonds — Sinking  Funds";  also  Book  III, 
Ch.  XXIV.  "Redemption  of  Bonds." 


Ch.  5s]  BONDS  461 

purchased  either  above  or  below  par,  the  determination  of  the 
actual  return  on  the  money  invested  becomes  somewhat  difficult. 

Thus,  if  a  $1,000  bond  due  in  10  years  and  bearing  interest 
at  the  rate  of  5%,  is  purchased  at  $900,  it  is  obvious  that  the 
direct  interest  on  the  investment  is  considerably  in  excess  of 
5%,  amounting  to  5  5/9%.  In  addition  to  this,  when  the  bond 
is  paid  at  maturity,  its  full  face  value.of  $1,000  is  received,  giving 
a  further  return  or  profit  of  $100  on  the  original  investment. 

On  the  other  hand,  if  the  bond  is  purchased  at  a  premium, 
say  at  $1,100,  the  direct  interest  returns  are  but  4  6/11%,  and 
on  maturity  of  the  bond  the  purchaser  receives  but  $1,000, 
which  is  $100  less  than  the  price  he  paid  for  his  bond.  There  is 
therefore  a  double  loss — both  on  interest  and  principal. 

A  rough  approximation  of  the  returns  on  the  investment 
when  bonds  are  purchased  at  a  discount  or  at  a  premium,  may 
easily  be  made,  but  if  exact  results  are  to  be  reached — which  are 
required  when  large  investments  are  to  be  made — the  calcula- 
tions are  laborious.  For  use  in  such  cases  bond  tables  may  be 
purchased  from  which  the  actual  investment  value  of  any 
ordinary  bond,  whether  sold  at  a  discount  or  at  a  premium,  may 
be  found  at  any  period  of  its  life. 

§  512.    Kinds  of  Bonds 

Many  classes  of  bonds  are  issued  under  varying  designations, 
usually  derived  from  the  more  important  or  distinctive  features 
of  the  particular  issue.  The  bonds  most  frequently  issued  are 
briefly  discussed  in  the  present  section.* 

Bonds  frequently  possess  the  characteristics  of  several  dif- 
ferent classes.  Thus,  the  bonds  of  the  United  States  Steel 
Corporation,  known  as  "ten-sixty-year  five  per  cent  sinking 
fund  gold  bonds,"  are  redeemable  at  any  time  after  ten  years 
from  date  of  issue  at  110%  of  their  face  value.  Their  payment 
is  provided  for  by  a  sinking  fund,  and  they  are  payable  in  gold 
coin.     Also,  if  not  previously  redeemed,  they  must  be  paid  at 

«  See  also  Book  II.  Ch.  VII-X. 


462  CORPORATE  LAW  [Hk.  I- 

the  end  of  60  years  and  bear  5%  annual  interest.     All  this  is 
indicated  by  the  name. 

1.  First  Mortgage,  etc.,  Bonds. — A  real  first  mortgage  or 
prior  lien  bond  is  one  secured  on  property  upon  which  no  other 
bonds  or  similar  obHgations  are  secured.  Usually  a  first  mort- 
gage bond  is  a  first  lien  on  the  property  by  which  it  is  secured, 
though  this  is  not  invariably  the  case,  as  for  instance,  a  builder's 
lien  upon  property  covered  by  the  deed  of  trust  takes  precedence 
over  the  bonds. 

A  number  of  bonds  may  be  secured  by  the  same  property. 
In  such  case  the  first  issue  is,  as  stated,  a  first  mortgage  bond  or 
prior  lien;  the  next  a  second  mortgage  bond;  the  next  a  third 
mortgage  bond,  etc.;  the  lien  of  each  of  these  latter  being 
inferior  to  that  of  the  bond  or  bonds  which  precede  it,  but  su- 
perior to  that  of  the  bond  or  bonds  which  follow. 

As  a  matter  of  practice,  however,  bonds  are  rarely  issued 
under  the  term  of  second  mortgage,  third  mortgage,  etc.  A 
more  euphemistic  term  is  usually  chosen,  as  general  mortgage, 
refunding  mortgage,  consoUdated  mortgage,  etc.  The  par- 
ticular description  used  has  no  significance,  as  in  some  cases  a 
general  mortgage  precedes  a  refunding  mortgage  and  in  other 
cases  the  reverse  is  true. 

2.  Junior  Lien,  etc..  Bonds. — A  junior  lien  bond  is  one 
which  comes  after  or  is  inferior  to  some  other  bond  or  bonds  in 
its  lien  upon  the  property  by  which  it  is  secured.  Thus  the  lien 
of  a  second  mortgage  bond  is  a  junior  lien  to  that  of  the  first 
mortgage  bond. 

When  several  different  issues  of  bonds  are  secured  by  the 
same  property,  those  having  the  superior  lien  are  sometimes 
styled  underlying  bonds,  the  term  indicating  that  they  are 
closer  to  the  property  and  have  a  superior  claim.  Thus,  if 
first  and  second  mortgage  bonds  are  secured  oil  the  same  prop- 
erty, the  first  mortgage  bonds  are  underlying  bonds.  If  third 
mortgage  bonds  are  also  issued,  both  first  and  second  mortgage 
bonds  are  underlying  bonds. 


Ch.  55]  BONDS  463 

3.  Gold,  etc.,  Bonds. — A  bond  may  in  express  terms  provide 
for  payment  in  gold,  silver,  legal  tender  money,  etc.  Such 
provisions  are  legal  and  enforceable.  If  no  medium  is  specified 
in  which  payment  of  a  bond  must  be  made,  legal  tender  is  always 
understood. 

4.  Convertible  Bonds. — A  convertible  bond  is  one  which 
under  prescribed  conditions  carries  the  right  of  conversion  into 
other  securities  of  the  same  corporation.  The  usual  form  of 
convertible  bond  is  that  which  may  be  exchanged  for  common 
or  preferred  stock  of  the  issuing  corporation  at  a  fixed  rate  of 
exchange  and  within  a  certain  period. 

It  is  obvious  that  the  conversion  privilege  gives  a  bond  a 
speculative  character  which  adds  greatly  to  its  attractiveness 
as  an  investment.  If  the  stock  of  the  issuing  company  advances 
materially,  the  exchange  can  be  made  at  a  profit.  If  the  stock 
does  not  advance,  the  bonds  themselves  are  still  a  good  invest- 
ment. In  short,  the  plan  combines  the  safety  of  a  bond  invest- 
ment with  the  profit  possibilities  of  an  investment  in  stock;  but 
it  must  be  borne  in  mind  that  the  conversion  privilege  is  usually 
given  to  a  junior  lien  bond,  the  conversion  privilege  being  in- 
tended to  offset,  in  part  at  least,  the  bond's  inferior  lien. 

5.  Income  Bonds. — Income  bonds — to  which  some  prefix 
is  frequently  added — usually  come  into  existence  as  a  result  of 
a  reorganization  where  holders  of  bonds  bearing  a  fixed  rate  of 
interest  accept  in  exchange  a  bond  whose  interest  is  contingent 
on  earnings.  Income  bonds  vary  in  their  nature  materially. 
Usually  they  are  an  absolute  junior  mortgage  on  the  property, 
but  rarely  a  first  lien,  and  occasionally  they  are  mere  deben- 
tures. Some  carry  cumulative  interest,  others  do  not.  The 
security  of  the  latter  is  precarious  unless  secured  by  an  instru- 
ment that  clearly  defines  just  what  is  to  be  construed  as  net 
income  applicable  to  interest  payment.  In  general,  the  use  of 
such  bonds  is  unfortunate  and  the  credit  of  the  issuing  company 
lower  than  if  preferred  stock  were  used. 

v*  As  a  rule  income  bonds  carry  no  voting  power  and  the  bond- 


464  CORPORATE  LAW  [Bk.  I  ■ 

holders  having  acquired  their  security  in  exchange  for  an  interest- 
bearing  bond  feel  themselves  in  the  position  of  creditors  eager 
for  their  interest  regardless  of  the  advisability  of  payment  from 
the  company's  standpoint,  and  the  latter  is  equally  eager  to 
delay  payment  of  interest  until  the  general  finances  of  the  com- 
pany are  in  good  shape.  Not  infrequently  the  whole  matter 
ends  in  court  if  the  bondholders  can  find  legal  ground  upon  which 
to  bring  an  action.  The  use  of  preferred  stock  would  be  better 
for  all  concerned,  but  bondholders  will  accept  an  income  bond  in  a 
reorganization  where  they  refuse  preferred  stock,  hence  the  use 
of  the  bond.  ^ 

6.  Collateral  Trust  Bonds. — A  collateral  trust  bond  is 
one  which  is  secured  by  collateral — usually  stocks  and  bonds  of 
other  corporations  owned  by  the  issuing  corporation.  These 
are  deposited  with  a  trustee  under  an  agreement  setting  forth 
the  conditions  of  the  trust.  The  bond  is  then  in  effect  a  collat- 
eral note  and  is  frequently  termed  a  "collateral  trust  bond." 

7.  Guaranteed  Bonds. — A  guaranteed  bond  is  one  the 
payment  of  which,  either  as  to  interest  or  principal  or  both,  has 
been  guaranteed  by  some  other  corporation.  Such  a  guarantee 
must  be  in  writing  and  must  either  be  written  on  the  instrument 
itself  or  be  attached  to  it  to  be  effective. 

Under  proper  conditions  such  guaranteed  bonds  are  legal  and 
are  frequently  issued.  Thus  the  bonds  of  a  subsidiary  road 
may  be  guaranteed  by  the  parent  road,  or  a  bond  of  a  compo- 
nent corporation  may  be  guaranteed  by  the  holding  company  or 
trust  of  which  it  forms  a  part.  Guarantees  are  of  doubtful 
value  in  most  cases,  and  when  trouble  comes  upon  a  company, 
the  bondholders  usually  have  to  look  to  their  real  security  rather 
than  the  guarantor. 

8.  Terminal,  etc..  Bonds. — Terminal  bonds  are  those 
issued  by  and  secured  on  the  property  of  a  terminal  company 
which  is  usually  subsidiary  to  the  railroad  or  steamship  line  using 
the  terminal.  Such  bonds  are  usually  issued  for  terminal  pur- 
chases or  improvements.     Extension  bonds  are  those  issued  by 


Ch.  ss]  BONDS  465 

a  railroad  to  extend  its  lines.  Equipment  bonds  are  those  issued 
for  equipment,  usually  by  a  railroad  company,  though  they  might 
be  issued  in  connection  with  an  industrial  corporation.  Con- 
struction bonds,  as  their  name  indicates,  are  those  issued  to 
secure  money  for  the  purposes  of  construction. 

9.  Car  Trust  Bonds. — Car  trust  or  equipment  trust  bonds 
or  certificates  are  issued  by  a  trustee  who  holds  for  their  security 
equipment  purchased  or  leased  by  a  railroad  company.  The 
money  realized  from  the  sale  of  these  bonds  goes  to  the  manu- 
facturers or  vendors  of  the  equipment,  or  the  bonds  may  be 
turned  over  to  them  direct.  The  railroad  company  receives 
its  equipment,  subject  to  the  trust  agreement,  and  retires  the 
equipment  bonds  in  such  amounts  and  at  such  periods  as  are 
fixed  by  the  trust  agreement.  The  title  to  the  equipment  does 
not  usually  vest  in  the  railroad  company  until  all  the  bonds  are 
redeemed. 

Bonds  and  notes  of  this  character  are  usually  issued  in  series 
and  are  redeemable  in  their  serial  order  as  payments  are  made 
by  the  railroad  company.  When  the  final  payment  is  made  by 
the  railroad  company,  the  deed  of  trust  by  which  the  property 
is  held  is  released  and  the  equipment  becomes  the  property  of  the 
purchasing  company. 

10.  Purchase  Money  Bonds. — Purchase  money  bonds  are 
those  given  to  secure  money  for  the  purchase  of  the  property  by 
which  they  are  secured. 

§  513.    Short-Term  Notes 

A  short-term  note  is  merely  a  corporation's  promissory  note. 
It  may  be  secured  or  unsecured.  If  secured,  it  is  usually  by  the 
deposit  of  collateral  with  a  trustee  under  a  trust  agreement. 
The  larger  issues  are  generally  in  coupon  form  and  differ  but 
little  from  the  usual  bond,  except  in  their  early  maturity. 

Short-term  notes  are  issued  when  the  existing  conditions 
are  unfavorable  for  a  long-time  loan,  and  usually  carry  either 
a  larger  rate  of  interest  than  a  bond  issue  or  arc  sold  at  a  discount 


466  CORPORATE  LAW  [Bk.  I- 

that  produces  the  same  practical  result.  Short-term  notes  are 
usually  floated  with  the  expectation  that  they  will  either  be 
retired  at  maturity  or  will  be  taken  up  by  a  bond  issue  on  more 
favorable  terms  than  would  have  been  possible  at  the  time  the 
notes  were  issued. 


Part  XII — Corporate  Arrangements 


CHAPTER  LVI 

VOTING  TRUSTS 

§  514.    General 

It  is  frequently  necessary  or  important  that  the  agreed 
management  of  a  corporation  be  preserved  consecutively  for  a 
term  of  years.  This  may  be  for  the  protection  of  minority  or 
special  interests,  or  to  maintain  a  control  satisfactory  to  the 
majority  as  then  existing,  or  in  pursuance  of  organization  agree- 
ments, or  in  accordance  with  the  terms  of  a  reorganization  or 
consolidation.  In  any  such  case  the  voting  trust — sometimes 
called  a  "stock  pool" — is  the  usual  means  by  which  this  is 
secured.  1 , 

Shareholders  have  the  right  to  combine  their  interests  and 
voting  powers  to  secure  such  control  of  the  corporation  and  the 
adoption  of  and  adhesion  by  it  to  a  specific  policy  and  course  of 
business.  Agreements  upon  a  sufficient  consideration  between 
them,  of  such  intendment  and  effect,  are  valid  and  binding,  if  they 
do  not  contravene  any  express  charter  or  statutory  provision,  or 
contemplate  any  fraud,  oppression  or  wrong  against  the  other 
stockholders  or  other  illegal  object.^ 

The  voting  trust  is  an  arrangement  under  which  sufficient 
stock  to  insure  the  desired  ends  is  placed  in  the  hands  of  trustees 
for  some  certain  period  of  time,  with  definite  instructions  as  to 
the  way  in  which  this  stock  shall  be  voted.  Other  features  may 
enter  in,  as  provisions  to  prevent  the  alienation  of  the  stock  held 


'  Mason  v.  Curtis,  223  N.  Y.  320  (1918);  Palmboume  v.  Magulsky,  217  Mass. 300  (1914). 

467 


468  CORPORATE  LAW  [Bk.  I- 

by  these  trustees,  and  for  special  dispositions  of  the  dividends 
thereon,  etc.,  but  these  are  inconsiderable  and  the  designated 
exercise  of  the  voting  power  of  the  trusteed  stock  for  the  given 
period  is  the  main  end  sought.^ 

It  is  to  be  noted  that  the  objects  attained  by  the  voting  trust 
can  be  secured  more  permanently  by  the  formation  of  a  "holding 
corporation,"  where  this  is  permissible.^ 

§  515.    Distinctions 

The  voting  trust  as  here  considered  must  be  distinguished 
from  the  trust  under  which  it  was  formerly  attempted  to  mon- 
opolize certain  industries.  Under  that  plan  the  stock  of  a  num- 
ber of  otherwise  competing  corporations  was  placed  in  the  hands 
of  trustees,  who  were  to  manage  them  so  that  they  did  not  cut 
prices  or  otherwise  conflict  with  each  other — an  arrangement 
that  was  held  illegal  and  has  been  abandoned.  The  voting  trust 
here  considered  affects  only  the  stock  of  one  corporation  and 
that  usually  as  to  its  voting  rights,  and  has  nothing  to  do  with 
competition  or  prices. 

Neither  has  it  any  connection  with  the  associations  under 
deeds  of  trust,  treated  in  later  chapters,^  which  is  an  arrange- 
ment designed  to  effect  an  organization  somewhat  similar  to 
the  corporation,  but  free  from  the  formaUties  and  restrictions 
that  hedge  about  the  corporation. 

Nor  has  the  arrangement  here  discussed  any  connection  with 
restrictions  on  the  sale  of  stock.  Provisions  restricting  the  sale 
of  stock  f6r  a  specified  period  or  to  anyone  not  embraced  in  the 
agreement  may  be  included,  but  the  voting  restrictions  are  the 
main  end  of  the  trust  and  these  others  are  merely  incidental. 

The  primary  object  of  the  voting  trust  here  outlined,  as  inti- 
mated, is  the  continuance  and  perpetuation  of  a  certain  agreed 
management  of  one  corporation.    It  concerns  the  stockholders 


2  See  Knickerbocker  Inv.  Co.  v.  Voorhees,  100  App.  Div.  (N.  Y.)  414  (1905);  see  also 
Book  IV.  Form  104. 

'  See  Ch.  LVII,  "Holding  Companies." 

*  Ch.  LXIII,  "Express  Trusts  as  a  Form  of  Business  Organization,"  and  Ch.  LXIV 
"How  an  Express  Trust  Is  Organized." 


Ch.  56]  VOTING  TRUSTS  469 

of  the  particular  corporation,  and  does  not  concern  or  affect  in 
any  way  other  corporations  or  persons  deaUng  with  the  corpora- 
tion controlled  by  the  voting  trust. 

§  516.    How  Formed 

A  voting  trust  is  formed  by  placing  in  the  hands  of  trustees 
such  proportion  of  the  stock  of  the  particular  corporation  as 
may  be  necessary  to  secure  the  desired  control.  These  trustees 
act  under,  and  their  powers  are  defined  by,  an  agreement  styled 
the  "voting  trust  agreement,"  subscribed  to  by  all  the  parties 
entering  the  trust,  s  This  agreement  specifies  the  length  of  time 
for  which  the  stock  is  to  be  held  and  the  manner  in  which  it  is 
to  be  voted  at  the  annual  election  of  directors.  If  the  manage- 
ment then  in  power  is  to  be  retained,  the  trustees  would  be 
instructed  to  cast  the  vote  of  the  trusteed  stock  in  all  elections 
of  directors  for  the  parties  then  constituting  the  board,  suitable 
provision  being  made  in  case  of  the  possible  death  of  any  of  the 
directors  named.  If  the  object  of  the  trust  were  to  insure 
minority  representation  on  the  board,  the  trustees  would  be  in- 
structed to  cast  the  trustee  vote  for  directors  in  favor  of  parties 
named  by  the  designated  minority  interests  up  to  a  specified 
number,  the  other  members  of  the  board  being  named  by  the 
majority  interests.  Or  if  the  object  of  the  trust  were  to  secure 
an  efficient  and  non-partisan  board,  the  trustees  might  be  in- 
structed merely  to  cast  the  vote  of  the  stock  held  by  them  for 
such  persons  as  in  their  judgment  would  be  suitable  and  accept- 
able to  the  interests  involved.  The  trust  agreement  might  also 
provide  the  manner  in  which  the  trustees'  stock  is  to  be  voted 
in  matters  of  general  interest,  or  it  might  be  forbidden  to  vote 
on  these  matters,  or  its  vote  under  such  circumstances  might 
be  left  to  the  discretion  of  the  trustees. 

Whatever  the  instructions,  the  stock  must  be  voted  as  a 
unit  by  the  trustees,  in  accordance  therewith,  and,  provided 


">  See  Book  IV.  Form  104. 


47Q  CORPORATE  LAW  [Bk.  I- 

the  conditions  of  the  trust  be  proper,  the  courts  will  enforce 
compliance. 

§  517.    The  Stock  in  Trust 

The  stock  included  in  a  voting  trust  is  actually  transferred 
to  the  trustees  and  is  by  them  taken  out  in  their  own  names. 
Trustees'  receipts  are  given  to  the  parties  depositing  stock,  these 
receipts  being  negotiable  in  form  and  representing  the  equitable 
ownership  of  the  stock  held  in  the  trust,  q  litjfiJ  ban  j'jbnu  lofi 

The  trustees  are  authorized  to  collect  and  receive  any  divi- 
dends and  profits  accruing  on  the  stock  held  by  them,  but  must 
pay  over  the  same  in  due  proportion  to  the  equitable  owners  of 
the  trusteed  stock.  Often  the  trustees,  for  purposes  of  con- 
venience, direct  the  corporation  to  pay  the  dividends  to  the 
holders  of  the  trust  certificates. 

.,ki  The  trust  agreement  also  provides  the  method  of  dissolution 
of  the  trust  upon  the  expiration  of  the  specified  time  limit,  and 
any  other  desired  features  or  details.  In  order  to  avoid  any 
possibly  illegal  suspension  of  the  rights  of  alienation  in  the  stock 
held  in  trust,  the  agreement  may  provide  that  at  any  time,  by 
consent  of  all  the  parties  in  interest,  the  trust  may  be  terminated. « 

When  it  is  desired  to  control  but  a  single  election,  the  use  of 
proxies  is  the  most  convenient  method  by  which  this  may  be 
accomplished.  These  being  revocable  and  of  limited  duration, 
are  not  available  for  more  permanent  purposes. 

§  518.    Legal  Status 

New  York  and  Maryland  are  the  only  states  in  which  the 
voting  trust  is  expressly  sanctioned  by  statute.  In  New  York 
this  was  done  in  1901,  when  an  amendment  to  the  General  Cor- 
poration Law  was  passed,  providing : 

A  stockholder  may  by  agreement  in  writing,  transfer  his  stock 
to  any  person  or  persons  for  the  purpose  of  vesting  in  him,  or  them 


•Williams  v.  Montgomery,  148  N.  Y.  519  (1896). 


Ch.  s6]  VOTING  TRUSTS  471 

the  right  to  vote  thereon  for  a  time  not  exceeding  five  years  upon 
terms  and  conditions  stated,  pursuant  to  which  such  person  or 
persons  shall  act;  every  other  stockholder,  upon  his  request  there- 
for, may,  by  a  like  agreement  in  writing,  also  transfer  his  stock  to 
the  same  person  or  persons  and  thereupon  may  participate  in  the 
terms,  conditions  and  privileges  of  such  agreement;  the  certificates 
of  stock  so  transferred  shall  be  surrendered  and  canceled  and 
certificates  therefor  issued  to  such  transferee  or  transferees.  .  .  f)tg  ^ 

The  Maryland  statute  was  passed  in  1908  and  follows  the 
New  York  statute. 8   ;'  ^''      .';--' ^^'■"•.  ^V,H'^"  ;;,^' ;',_;-•' ;v  =  ';"  ; 

Under  these  statute?  k  du'pllBate  of  tlie  Votiiig  triist  agi-eemeiit 
must  be  kept  on  file  in  the  principal  business  office  of  the  cor- 
poration, open  to  the  inspection  of  any  stockholder  during 
business  hours. 

Prior  to  the  passage  of  the  statute,  voting  trusts  existed  in 

New  York  and  were  regarded  favorably  by  the  courts.    Since 

its  passage   the   conditions  prescribed  by   the   statute   would 

■  probably  have  to  be  followed  in  detail  to  establish  an  enforceable 

trust. 

In  New  Jersey,  Massachusetts,  California,  Alabama,  New 
Hampshire,  and  other  states, »  although  no  statutes  on  this  sub- 
ject exist,  the  courts  have  rendered  decisions  favoring  similar 
arrangements  and  intimating  that  where  the  trust  was  for  a 
proper  purpose  and  for  a  reasonable  time,  and  did  not  contem- 
plate any  advantage  from  which  other  stockholders  of  the  same 
corporation  were  excluded,  it  was  not  contrary  to  any  principles 
of  law  or  equity.  •*-^^'-^ 

In  some  courts  there  seems  to  be  a  strong  feeling  against  thfe 
plan.  In  a  comparatively  recent  case  the  Supreme  Court  of 
Illinois  took  the  position  that  the  plan  was  illegal  and  objection- 
able.   The  court  said: 

The  power  to  vote  for  directors  can  be  exercised  only  by  stock- 
holders in  person  or  by  proxy,  and  they  cannot  be  deprived  or 


7  Gen.  Corp.  Law  (N.  Y.),  {  25 
•Md.  Code,  Art.  23,  |  102 


•Chapman  v.  Bates,  61  N.  J.  Eg.  6s8  '(1900):  Brightman  v.  Bates,  I7S  Mass.  105  (1910); 
Carnegie  Trust  Co.  v.  Security  Life  Ins.  Co.,  iii  Va.  11  (1910). 


478  CORPORATE  LAW  [Bk.  I- 

deprive  themselves  of  this  power.  Stockholders  cannot  evade  the 
duty  imposed  upon  them  by  law  of  using  their  power  as  stock- 
holders for  the  welfare  of  the  corporation,  and  the  general  interest 
of  its  stockholders.  A  stockholder  may  refuse  to  exercise  his  right 
to  vote  and  participate  in  stockholders'  meetings,  but  he  cannot 
deprive  himself  of  the  power  to  do  so." 

§  519.    Illegal  Voting  Trusts 

The  primary  requisite  of  a  legally  defensible  and  enforceable 
voting  trust  is  an  object  not  illegal  in  itself,  or  calculated  to 
injure  or  discriminate  against  other  stockholders  of  the  same 
corporation.  The  voting  trust  must  also  be  reasonable  as  to  its 
duration  and  terms,  and  its  possible  advantages  should  be  open  to 
all  stockholders  of  the  particular  corporation. 

Any  voting  trust  formed  to  promote  a  monopoly,  or  to  domi- 
nate the  corporation  in  the  interests  of  another  corporation,  or 
to  deprive  other  stockholders  of  any  of  their  rightful  powers, 
would  undoubtedly  be  held  illegal  in  any  jurisdiction. 


// 1 


520.    Restriction  of  Stock  Sales 

i,  The  voting  trust  as  a  means  of  restricting  the  sales  of  the 
stock  held  under  its  provisions  is  of  doubtful  efficacy.  It  un- 
questionably prevents  the  transfer  of  the  actual  stock  during 
the  life  of  the  trust,  and  thereby  prevents  the  transfer  of  any 
of  the  stockholders'  rights  that  would  accompany  delivery  of 
the  stock.  On  the  other  hand,  the  trustees'  receipts,  or  certifi- 
cates, are  transferable,  and  if  the  object  of  restricting  the  sale 
is  to  maintain  the  market  price  of  the  stock,  or  to  give  prefer- 
ence to  the  sale  of  treasury  or  other  special  stock,  the  sale  of 
the  trustees'  certificates  might  interfere  with  these  purposes 
almost  as  effectually  as  would  the  sale  of  the  stock  itself.  The 
end  desired  may  be  effected  in  other  ways.^i 


>"  Luthy  V.  Ream,  270  111.  170  (191S) 
"  S«e  »  553- 


CHAPTER  LVII 
HOLDING  COMPANIES 

§  521.    General 

A  holding  company,  in  the  modern  sense  of  the  term,  is  a 
corporation  formed  for  the  express  purpose  of  controUing  other 
corporations  by  the  ownership  of  a  majority  of  their  stock.  1 

The  advantages  of  a  holding  company  may  be  enumerated  as 
follows: 

1.  It  furnishes  a  readily  available  and  effective  method  of  con- 
trolling several  corporations  for  a  common  object. 

2.  It  may  be  employed  to  perpetuate  corporate  control. 
Financiers  holding  the  control  of  corporations  may  transfer  their 
shares  to  a  holding  corporation.     Death  or  disagreement  will  not 

_Q  then  affect  the  control.  In  many  cases  also  a  holding  corporation 
may  take  the  place  of  a  voting  trust,  which  always  is  limited  as  to 
time. 

3.  The  holding  company  permits  the  capitalization  of  con- 
trolling stock  interests.     The  control  of  a  corporation  having  a 
capital  of  twenty  million  dollars — as  an  illustration — requires  a        , 
permanent  investment  of  more  than  ten  million  dollars,  assuming 

the  stock  worth  par.     If  a  holding  corporation  is  formed  with  a 
capital  equal  to  the  investment,  the  shares  may  be  transferred  to  it 
and  forty-nine  per  cent  of  its  stock  sold.     The  original  controlling 
stockholders,  by  retaining  control  of  the  holding  corporation,  retain       j 
control  of  the  original  corporation.^  , 

4.  It  may  be  used  to  form  an  effective  organization  of  "Parent 
Company"  and  subsidiaries,  for  conducting  various  enterprises      > 

{ j,-^ ,  that  require  representatives  in  many  states. 

"''Under  the  common  law,  which  did  not  permit  one  corporation 
to  invest  in  the  stock  of  another,  holding  corporations  were 


»  See  Book  II,  {{  44-48;  also  Book  III,  Ch.  XXVII,  "Holding  Companies." 
'  Noyes  on  Intercorporate  Relations,  {  28s;  see  also  14  Corpus  Juris,  p.  284. 

473 


474  CORPORATE  LAW  [Bk.  I- 

impossible  and  any  attempt  of  a  corporation  to  control  another 
corporation  by  holding  a  majority  of  its  stock  would  have  been 
held  ultra  vires. 

The  charter  of  a  corporation  is  the  measure  of  its  powers. 
It  can  exercise  only  such  powers  as  are  conferred  upon  it,  either  in 
express  terms  or  by  necessary  implication,  in  the  law  of  its  creation. 
The  purchase  of  stock  in  another  corporation  involves  a  partici- 
pation in  a  new  and  distinct  enterprise.     A  corporation  can  make 
such  a  purchase  only  when  expressly  authorized  to  do  so  by  the 
,  statute,  or  when  the  power  can  be  implied  as  incidental  to  the 
'  powers  specifically  granted.' 

But  as  the  powers  of  corporations,  created  by  legislative  act,  are 
limited  to  such  as  the  act  expressly  confers,  and  the  enumeration  of 
these  implies  the  exclusion  of  all  others,  it  follows  that,  unless  ex- 
press permission  be  given  to  do  so,  it  is  not  within  the  general 
powers  of  a  corporation  to  purchase  the  stock  of  other  corporations 
for  the  purpose  of  controlling  their  management.* 

Corporations  have  certain  incidental  powers  of  acquiring 
and  holding  stock,  as  discussed  in  the  section  which  follows. 
The  general  right  to  purchase  and  hold  the  stock  of  other  cor- 
porations, under  which  the  holding  corporation  is  possible,  is, 
however,  derived  from  legislative  enactment,  either  by  virtue  of 
statutes  expressly  conferring  on  specific  corporations  the  power 
to  buy  and  hold  the  stocks  of  other  corporations,  or  in  a  few 
states  under  the  operation  of  statutes  permitting  the  formation 
of  corporations  for  any  legitimate  purpose. ^ 

In  many  cases  companies  are  incorporated  in  those  states 
that  permit  special  provisions  authorizing  the  holding  of  stock  of 
other  corporations,  in  order  to  secure  such  right  definitely. 

§  522.    Incidental  Powers  to  Hold  Stock 

In  many  cases  corporations  have  power  to  take  and  hold 
stock  in  other  corporations  as  a  power  incidental  to  their  main 

»  Noyes  on  Intercorporate  Relations,  ii  264,  274;  People  v.  Pullman  Co.,  17s  111.  125 
(1898);  64  L.  R.  A.  366;  People  v.  Chicago  Gas  Trust  Co.,  130  111.  268  (1889);  Hyams  v.  C.  & 
H.  Mining  Co.,  221  Fed.  529,  537  (1915). 

*  De  La  Vergne  Co.  v.  Savings  Institution,  175  U.  S.  40,  54  (1899). 

»  Dittman  v.  Distilling  Co.,  64  N.  J.  Eq.  537  (1903);  Market  St.  Ry.  Co.  v.  Hellman, 
109  Cal.  S7I  (1895)- 


Ch.  57]  HOLDING  COMPANIES  475 

purpose.  For  instance,  certain  corporations,  like  the  great 
insurance  companies  which  in  the  regular  course  of  business 
have  large  sums  for  investment,  are  very  properly  allowed  to 
invest  these  in  safe  stocks.  Also  in  almost  all  cases  corporations 
are  allowed  to  take  corporate  stock  to  save  a  debt.  They  may 
also  take  stock  as  collateral  to  secure  an  obligation,  which  in  the 
usual  course  of  business  may  bring  about  their  ownership  of 
such  collateral. 

Where  a  corporation  may  lawfully  consolidate  with  another 
corporation,  it  may  acquire  the  stock  of  this  other  corporation 
as  a  proper  step  to  such  consolidation.  But  a  corporation 
authorized  to  acquire  and  hold  stocks  of  other  corporations 
cannot  in  this  way  control  companies  in  states  where  such 
stockholding  is  unlawful. s  Also  in  some  cases  it  has  been  held 
that  a  corporation  may  take  stock  in  another  corporation  when 
this  other  corporation  will  promote  some  of  its  specified  purposes, 
as  when  a  street-car  company  takes  stock  in  a  hotel  or  amusement 
park  on  or  near  its  lines,  or  a  manufacturing  company  takes 
stock  in  a  power  development  company  from  which  it  will  obtain 
power. 

§  523.    Authorization  to  Hold  Stock  .^ 

New  Jersey  was  the  first  state  to  enact  statutes  specifically 
empowering  corporations  organized  under  its  laws  to  hold  the 
stock  of  other  corporations.  This  law  was  first  adopted  in  the 
year  i888,  and  read  as  follows :  ' 

Any  corporation  may  purchase,  hold,  sell,  assign,  transfer, 
mortgage,  pledge  or  otherwise  dispose  of  the  shares  of  the  capital    ' ' 
stock  of,  or  any  bond,  securities,  or  evidences  of  indebtedness     'b 
created  by  any  other  corporation  or  corporations  of  this  or  any 
other  state,  and  while  owner  of  such  stock  may  exercise  all  the       '6 
j,[,,  rights,  powers  and  privileges  of  ownership,  including  the  right  to 
[    vote  thereon.' 

•liill  V.  Nisbet,  100  Ind.  341  (1884);  Coler  v.  Tacoma  Ry.  and  Power  Co.,  65  N.  J.  Eq. 
347  (1903). 

'  See  Gen.  Corp.  Law  of  New  Jersey,  J  51. 


476  CORPORATE  LAW  [Bk.  I - 

The  enactment  of  this  law  by  New  Jersey  paved  the  way 
for  the  great  industrial  combinations.  Theretofore  such  com- 
binations had  been  attempted  by  the  appointment  of  a  board  of 
trustees  in  whose  hands  was  placed  a  majority  of  the  stock  of  the 
corporation  to  be  controlled,  these  trustees  then  electing 
boards  of  directors  which  managed  their  respective  corpora- 
tions in  the  common  interest.  This  arrangement  was  declared 
illegal  and  was  abandoned  for  the  holding  corporation  under 
the  New  Jersey  law." 

In  1913,  however,  in  an  effort  to  check  the  opportunities  for 
monopolistic  combination,  holding  companies  were  abolished  by 
a  drastic  piece  of  legislation  known  as  "The  Seven  Sisters." 
Later  and  by  degrees  all  of  these  acts  were  repealed  or  super- 
seded, and  now  all  that  is  prohibited  is  the  holding  of  the  stock 
of  other  corporations  to  restrain  competition  or  to  create  a 
monopoly.  The  statute  as  it  now  stands  insures  to  corporations 
the  usual. incidental  powers  to  hold  stock  of  other  corporations. 9 

The  federal  decisions  declaring  certain  of  these  holding  cor- 
porations illegal  are  not  directed  against  the  laws  under  which 
they  were  formed,  but  against  the  purposes  of  the  corporations. 

Delaware  and  Maine  have  enacted  statutes  similar  to  the 
earlier  statute  of  New  Jersey,  giving  corporations  the  unlimited 
power  to  buy,  hold,  and  sell  stocks;  and  in  New  York  these 
privileges  may  be  enjoyed  if  so  provided  in  the  charter.  Under 
the  Maine  statute  it  has  been  held  that  a  corporation  organized 
under  the  law  regulating  the  incorporation  of  general  business 
corporations,  could  not  acquire  stock  in  companies  organized 
to  do  insurance  business,  thus  doing  indirectly  what  it  could  not 
do  directly. 10 

§  524.    What  Holdings  Carry  Control 

Contrary  to  popular  opinion,  it  is  rarely  necessary  to  hold 
51%    of    the    outstanding    stock    of    a    corporation    in    order 

•  State  V.  Standard  Oil  Co.,  49  Ohio  St.  137  (1892);  People  v.  North  River  Sugar  Refining 
Co.,  121  N.  Y.  582  (1890). 

»  Gen.  Corp.  Law  of  New  Jersey,  as  amended  (1920),  §  1S4. 
1°  Central  Life  Securities  Co.  v.  Smith,  236  Fed.  170  (1916). 


Ch.  57]  HOLDING  COMPANIES  477 

to  elect  a  majority  of  the  directors,  and  through  them  to  elect 
the  officers  and  control  the  corporation.  Where  all  the  stock 
is  held  in  a  few  hands,  as  in  a  close  corporation,  the  case  is  differ- 
ent, but  even  here  anyone  holding  or  controlling  half  the  stock 
can,  if  he  once  obtains  a  majority  of  the  board,  hold  his  control 
indefinitely.  A  majority  against  him  cannot  be  obtained,  and 
if  a  deadlock  should  arise  over  the  election  of  directors,  no  new 
directors  could  be  elected  without  his  consent,  and  his  directors, 
already  in  office,  would  hold  over  until  some  agreement  satis- 
factory to  him  was  reached. 

With  the  usual  corporation  with  scattered  holdings,  a  much 
smaller  proportion  than  half  the  stock  is  sufficient  to  control. 
In  an  action  under  the  Sherman  Anti-Trust  Act,  the  Supreme 
Court  held  that  the  purchase  of  46%  of  the  stock  of  a  competing 
railroad  was  ample  to  control  its  operations,  thereby  effecting  a 
combinationinrestraintoftrade.il     ..-    ■■..,    i.  .,    •  -.    njL.ii;!::- 

The  president  of  one  of  the  largest  railroad  systems  in  the 
United  States  is  authority  for  the  statement  that  S5  pcr  cent  of  the 
stock  which  has  voting  power  is  sufiicient  to  control  any  important  JJ'-. 
railway,  always  excepting  instances  where  great  blocks  of  stock  are  1 ; . 
centralized  in  a  few  hands.  He  added  that  those  in  control  of  a 
property  could  always  count  upon  a  large  proportion  of  the  stock- 
holders supporting  them  as  a  matter  of  course,  because  such  holders 
were  too  weak  or  too  lazy  to  engage  in  any  independent  movement 
of  their  own. 

In  the  case  of  banks  and  trust  companies,  33  per  cent  holdings 

■'•"     are  nearly  always  sufficient  to  protect  an  existing  management. 

.  ^  That  is  the  basis  usually  followed  by  new  interests  in  attempting  to 
buy  up  properties,  and  with  the  trust  companies  especially  such 
holdings  have  almost  invariably  been  sufficient  to  force  recognition 
from  an  unwilling  management.  One  bank  president  of  this  city 
has  been  known  to  own  personally  40  per  cent  of  the  stock  of  his 
own  bank,  which  was  unusually  heavily  capitalized.     With  such 

-h      holdings  and  those  of  his  friends,  the  present  owners  could  not  pos-   j  /, 
sibly  be  dislodged.    The  president  of  another  bank,  following  a     • 
different  method,  has  taken  care  to  see  that  its  stock  is  distributed 


"  United  States  v.  Union  Pac.  R.  R.  Co.,  226  U.  S.  61,  96  (1912). 


478  CORPORATE  LAW  [Bk.  I- 

as  widely  as  possible,  so  that  today,  with  a  comparatively  small 
capitalization,  the  bank  is  owned  by  at  least  two  thousand  different 
stockholders,  who  could  hardly  be  combined  against  the  manage- 
ment, i* 

It  is  reported  that  when  the  control  of  the  Western  Union 
Telegraph  Company  passed  to  the  Bell  Telephone  interests,  it 
was  effected  by  transfer  of  but  20%  of  the  outstanding  stock. 

§  525.    Its  Function  in  Industrial  Combination 

The  holding  corporation  has  occupied  a  position  of  great 
importance,  it  being  the  means  by  which  many  of  the  great 
industrial  combinations  were  effected  and  controlled.  Some- 
times these  corporations  were  confined  strictly  to  the  function 
of  holding  companies,  as  was  the  case  with  the  Northern  Securi- 
ties Company  which  was  formed  for  the  sole  purpose  of  holding 
sufficient  stock  of  the  Great  Northern  Railway  Company  and 
the  Northern  Pacific  Railway  Company  to  control  the  two 
corporations  and  combine  their  interests.  Usually,  however, 
such  a  corporation  was  given,  in  addition,  ample  powers  to  carry 
on  directly  any  business  or  industry  in  the  line  of  the  proposed 
combination.  Then  it  could  operate  by  controlling  the  majority 
of  the  stock  of  its  component  corporations,  or  by  buying  up  the 
manufacturing  plants  engaged  in  the  particular  industry,  or  by 
initiating  new  industrial  operations  on  its  own  account,  or  by 
doing  all  of  these  things. 

As  already  suggested,  the  holding  corporation  itself  could 
be  controlled  by  the  ownership  of  but  50%  or  51%  of  its  stock, 
and  so  long  as  the  parties  in  control  hold  this  amount,  they 
could  part  with  any  additional  stock  without  interfering  with 
their  control  of  the  holding  corporation  and  through  it  of  the 
subsidiary  corporations.  This  device  made  it  possible  for  those 
who  were  on  the  inside  to  control  much  capital  with  a  compara- 
tively small  investment  on  their  own  part." 

"  Editorial  New  York  Evening  Post. 

>'  See  I  Cook  on  Corp.,  {  317;  Noyes  on  Intercorporate  Relations,  {  285  el  seq.;  Robotham 
V.  Prudential  Insurance  Co.,  64  N.  J.  Eq.  673  (1903). 


Cb.  S7]  HOLDING  COMPANIES  479 

§  526.    Limitations  on  Use  of  Holding  Companies 

The  holding  corporation  is  the  instrument  by  which  'most  of 
the  great  industrial  combinations  have  been  effected,  and  has 
Deen  generally  recognized  as  the  proper  legal  means  to  this  end. 
Most  of  these  great  industrial  combinations  and  many  of  the 
smaller  ones  as  well  have,  however,  come  to  grief  through  the 
enforcement  of  the  Sherman  Anti-Trust  Law. 

At  the  present  time  a  holding  company  organized  in  one  state 
may  control  corporations  organized  under  the  laws  of  other 
states.i*  It  is  within  the  power  of  any  state  objecting  to  this, 
to  pass  laws  to  prevent  foreign  holding  corporations  from  con- 
trolling corporations  formed  under  the  laws  of  such  states;  or 
the  courts  may  declare  such  control  illegal  and  therefore  impos- 
sible, is  With  a  view  to  simplifying  corporate  relations,  it  is 
probable  that  such  action  on  the  part  of  the  states  would  be  of 
advantage.  The  same  end  might  be  achieved  by  means  of  a 
statute  denying  the  right  to  vote  at  corporate  elections  to  all 
stock  except  that  owned  by  natural  persons  in  their  own  right. 
This  would  effectually  prevent  the  operation  of  the  holding  cor- 
poration. 

In  the  Northern  Securities  case,  the  United  States  courts  held 
the  attempt  to  prevent  competition  between  two  opposing 
interstate  railways  by  means  of  a  holding  corporation  illegal.is 
In  the  famous  cases  against  the  Standard  Oil  Company  and  the 
American  Tobacco  Company  the  Supreme  Court  held  that  the 
use  of  holding  companies  as  a  means  of  controlling  competing 
companies  where  such  control  resulted  in  a  violation  of  the 
Sherman  Anti-Trust  Law,  was  illegal. i^ 

The  Clayton  Act  of  October  15,  1914,  makes  the  law  very 
specific  as  to  corporations  engaged  in  interstate  commerce,  and 
forbids  the  acquisition  by  one  corporation  of  the  whole  or  any 


"  Island  Heights,  etc.,  Co.  v.  Brooks  &  Brooks,  88  N.  J.  L.  613  (1916). 
'»  Central  L.  S.  Co.  v.  Smith,  236  Fed.  170,  176  (1916). 
"  See  Northern  Securities  Co.  v.  United  States,  193  U.  S.  197  (1904). 
"Standard  Oil  Co.  v.  United  States,  221  U.  S.  i   (1911);  United  States  v.  American 
I'obacco  Co.,  221  U.  S.  106  (1911). 


48o  CORPORATE  LAW  [Bk.  I- 

part  of  the  stock  of  another  corporation,  "where  the  effect  may 
be  to  substantially  lessen  competition  between  the  corporation 
whose  stock  is  so  acquired  and  the  corporation  making  the  ac- 
quisition, or  to  restrain  such  commerce  in  any  section  or  com- 
munity, or  tend  to  create  a  monopoly  of  any  line  of  commerce." 

It  may  be  said  that  at  this  time  any  arrangement  of  holding 
companies,  or  any  other  combination  of  corporations  to  prevent 
competition,  restrain  trade,  or  enhance  prices,  is  illegal  and  will 
be  dissolved  by  the  courts.  In  a  remarkable  case  in  New 
Jersey,! 8  minority  stockholders  sought  to  enjoin  the  directors  of 
the  Prudential  Life  Insurance  Company  from  carrying  out  an 
arrangement  by  which  the  Fidelity  Trust  Company  was  to  con- 
trol the  Prudential  Company,  and  the  Prudential  Company  in 
its  turn  was  to  control  the  Fidelity  Trust  Company.  Under  this 
plan,  at  the  next  ensuing  election  which  was  that  of  the  Trust 
Company,  the  Prudential  directors,  voting  a  majority  of  its 
stock,  would  have  put  themselves  in  charge  of  the  affairs  of  the 
Trust  Company.  Then  when  the  time  came  for  the  Prudential 
election,  these  same  directors,  exercising  the  Trust  Company 
control,  would  in  like  manner  have  put  themselves  in  charge  of 
its  aflfairs,  and  thereafter  the  interlocking  board  thus  formed 
would  have  been  self-perpetuating,  and  the  enormous  assets  of 
the  Prudential  Insurance  would  have  been  controlled  by  the 
board  in  perpetuity.  Kt^m.jr 

In  the  course  of  his  argument,  counsel  for  the  directors 
asserted  that  under  the  laws  of  New  Jersey  the  following  plan 
would  be  entirely  legal: 

One  man  controls  a  company  of  $io,ooo,coo  capital.  He  may 
form  a  new  company  with  a  capital  of  $5,100,000  to  hold  a  majority 
of  the  stock.  He  may  then  sell  all  but  $2,600,000  of  the  stock  in 
company  No.  2  and  transfer  his  remaining  stock  to  a  new  company 
with  a  capital  of  $2,600,000.  He  may  then  sell  to  company  No.  3 
all  but  $1,400,000  and  transfer  that  to  a  new  company.  This 
process  may  go  on  until  the  power  of  the  whole  chain  of  corpora- 


wRobotham  v.  Prudential  Insurance  Co.,  64  N.  J.  Eq.  673  (1903). 


Ch.  S7J  HOLDING  COMPANIES  481 

tions  is  vested  in  the  holder  of  a  few  thousand  dollars  of  stock  in  the   .  r, 
ultimate  company,  and  the  same  chain  can  be  used  for  an  unlimited 
number  of  companies.     '       ■-' 

■  Vice-Chancellor  Stevenson,  before  whom  the  case  was  heard, 
apparently  did  not  sympathize  with  this  view  of  the  possibilities 
of  holding  companies  under  the  New  Jersey  law,  and  expressed 
his  views  with  some  emphasis.  The  court  also  granted  the 
injunction  asked  for,  thereby  indicating  that  the  mutual  control 
of  each  other  by  two  corporations  is  not  under  existing  laws  a  legal 
possibility. 

^" '  In  any  case  of  abuse  of  power  by  means  of  a  holding  cor- 
poration, the  courts  would  undoubtedly  afford  relief. is 

§  527.    Parent  Companies 

'^■"■'  A  useful  variant  of  the  holding  company  is  frequently  em- 
ployed with  advantage  in  the  exploitation  of  inventions.  A 
parent  corporation,  in  which  the  patent  rights  for  such  inventions 
are  vested,  is  formed  in  some  selected  state  where  the  power  to 
hold  the  stock  of  other  corporations  may  be  had.  Subordinate 
companies  are  then  formed  in  the  several  states  or  other  terri- 
torial districts,  and  to  these  companies  rights  in  the  invention 
are  assigned  for  their  respective  districts,  the  parent  company 
usually  reserving  or  acquiring  a  controlling  interest  in  each 
subordinate  company.  The  patent  rights  may  be  sold  to  the 
subcompanies  absolutely,  or  with  reservation  of  royalties,  or 
perhaps  a  mere  license  may  be  issued.  The  subordinate  com- 
pany then  operates  in  its  own  territory  as  an  independent  com- 
pany but  under  the  general  direction  of  the  parent  company,  this 
direction  becoming  immediate  and  absolute  in  case  of  necessity. 
Under  this  plan  the  parent  corporation  makes  certain  the 
proper  fulfilment  of  its  contracts  with  the  subordinate  companies, 
and  insures  the  harmonious  conduct  of  the  general  business. 20 

"See  Farmers'  Loan  &  Trust  Co.  v.  N.  Y.,  etc.,  R.  Co.,  150  N.  Y.  410  (1896);  Nile*  v. 
N.  Y.  C.  &  H.  R.  R.  Co.,  69  App.  Div.  (N.  Y.)  144  (1902);  con/ro,  Windmuller  v.  Distilling  Co., 
114  Fed.  491  (1902). 

2°  For  further  discussion  of  this  subject,  see  Book  II,  {  48;  also  People  v.  Am.  Bell  Tele- 
phone Co.,  117  N.  Y.  241  (1889). 


482  CORPORATE  LAW  [Bk.  I- 

§  528.    Powers  of  a  Corporate  Stockholder 

Where  a  corporation  has  the  right  to  hold  the  stock  of  other 
corporations,  it  has  all  the  rights  and  privileges  that  an  indi- 
vidual would  have.  Such  stock  is  personal  property  of  the 
corporation,  is  liable  to  taxation  as  such,  and  all  its  corporate 
rights  and  privileges  are  maintained  in  full  vigor.  It  participates 
to  the  full  in  any  dividends  declared  by  the  corporation  from 
which  it  issued,  and  is  entitled  to  full  representation  and  voting 
rights  at  any  stockholders'  meeting  of  that  corporation.  Such 
stock  would  be  voted,  either  in  person  or  by  proxy,  by  the 
trustee  or  official  in  whose  name  it  was  held,  or,  if  held  in  the 
name  of  the  corporation,  by  such  person  as  was  formally  desig- 
nated thereto  by  the  corporation.  Such  vote  would  be  cast 
under  the  general  instructions  of  the  board  of  directors  of  the 
holding  corporation,  but  unless  matters  of  much  importance 
were  to  be  considered,  no  detailed  instructions  would  be  given, 
all  this  being  left  to  the  discretion  of  the  person  who  represented 
the  corporation.  If  matters  of  much  importance  were  to  be 
considered,  the  representative  might  be  instructed  with  pre- 
cision as  to  his  position  and  his  vote. 


.od(T 


CHAPTER  LVIII 

PROTECTION  OF  MINORITY  STOCKHOLDERS 

§  529.     General 

The  corporate  rights  of  minority  stockholders  are  at  the 
best  much  circumscribed,  and  those  that  do  exist  are  frequently 
disregarded  and  are  then  difficult  of  enforcement.  Not  infre- 
quently, actions  of  the  directors  infringing  minority  rights  are 
not  discovered  by  the  minority  until  too  late  for  prevention  or 
protective  action,  and  legal  redress  is  as  a  rule  slow,  costly, 
and  inadequate.  Such  protection  as  may  be  secured  to  the 
minority  in  the  organization  of  the  corporation  is  therefore  a 
matter  of  importance. 

.  ;  When  the  parties  in  control  of  an  incorporation  are  willing 
to  recognize  the  rights  of  the  minority  stockholders,  or  are 
compelled  thereto  by  the  conditions,  it  is  quite  possible  for  the 
minority  to  secure  efficient  protection  for  such  rights  as  are 
properly  theirs.  Unfortunately  the  interests  which  control  at 
the  time  a  corporation  is  organized  are  too  often  indifferent  or 
actually  inimical  to  the  rights  of  the  minority  stockholders,  and 
these  then  receive  no  consideration,  save  such  as  is  compelled 
by  statute  law  or  by  respect  for  the  sensibilities  of  the  investing 
public. 

§  530.    Rights  of  Minority  at  Common  Law 

Under  the  common  law — which  still  prevails  save  where 
and  as  superseded  or  modified  by  statute  law — the  rights  of 
minority  stockholders  were  not  extensive.  They  were  entitled 
to  be  present  and  participate  at  stockholders'  meetings.  They 
were  entitled  to  inspect  the  corporate  stock  books  during  the 
usual  hours  of  business  and  copy  the  names  therein  if  they  so 

483 


484  CORPORATE  LAW  [Bk.  I- 

desired.  They  also  had  the  right  under  reasonable  conditions 
to  inspect  the  books  of  account.  Also  under  the  common  law 
a  few  important  matters,  such  as  amendment  of  the  charter 
and  the  sale  of  the  entire  corporate  assets,  required  authoriza- 
tion by  unanimous  vote  of  the  stockholders,  and  this  require- 
ment gave  the  minority  a  certain  veto  power  in  such  matters. 
At  stockholders'  meetings  the  minority  might  assist  in  the  de- 
liberations, but  the  majority  had  absolute  power  to  adopt  by- 
laws and  to  elect  the  entire  board  of  directors.  The  minority 
might  not  even  have  a  representative  present  at  board  meetings 
save  by  grace  of  the  majority. 

§  531.    Modem  Abridgments  of  Minority  Rights 

As  already  intimated,  minority  rights  under  the  common 
law  were,  at  the  best,  somewhat  slender.  At  common  law  the 
minority  had  the  right  at  reasonable  times  to  inspect  the  books 
and  accounts  of  the  corporation.  This  right  has  been  so  narrowed 
down  by  latter-day  statutes  and  decisions  that  it  is  in  many 
states  negligible.  In  New  Jersey  it  is  customary  to  limit  this 
privilege  still  further  to  such  inspection  as  the  directors  may 
prescribe.  Even  the  stock  and  transfer  books  may  be  seen  only 
under  restrictions. 

As  to  books  of  account,  this  change  of  custom  is  probably 
necessary.  If  it  were  otherwise,  business  competitors  might 
avail  themselves  of  the  formerly  easily  acquired  right  of  inspec- 
tion of  the  books  to  obtain  information  and  trade  secrets  to  the 
injury  of  the  corporation.^  Also,  with  the  many  stockholders 
and  the  complex  accounts  of  modern  corporations,  the  right  if 
freely  exercised  would  interfere  with  the  regular  transaction  of 
business.  Vh-mi^I  m> 

While  this  is  true,  some  substitute  for  the  stockholders'  in- 
spection of  the  books  of  account  should  be  provided  that, 
without  injury  to  the  corporation,  would  give  to  the  stockholders 
proper  information  as  to  the  status  of  the  corporate  business. 

•'     ' /w  re  De  Vengoechea,  86  N.  J.  L.  35  (1914)-  )iiUii(J.    !.»>  iltioii  liliJdW 


Ch.  s8]  PROTECTION  OF  MINORITY  485 

To  deny  it  entirely  is  a  flagrant  and  unjustifiable  disregard  of 
the  rights  of  those  whose  property  is  at  stake. 

The  abridgment  of  the  stockholders'  right  to  inspect  the 
stock  and  transfer  books  is  to  be  viewed  with  distrust.  There 
would  seem  to  be  no  proper  reason  for  concealing  from  a  stock- 
holder the  identity  of  his  fellow  stockholders.  The  right  to 
make  a  list  of  these  stockholders  is  properly  denied  him  if  such 
list  is  for  stock-selling  purposes,  for  sale  to  other  parties,  for 
general  circularization,  or  for  similar  purposes,  but  should  not 
be  refused  if  the  list  is  desired  for  proper  purposes. 

Again,  the  right  to  make  by-laws  was  f  ormerly  a  prerogative 
of  the  stockholders  alone,  and  these  by-laws  usually  imposed 
certain  proper  restraints  and  limitations  upon  the  directors. 
Now,  in  New  Jersey  and  a  few  other  states,  by  charter  pro- 
vision it  is  possible  and  not  uncommon  to  give  the  directors 
absolute  power  to  repeal  by-laws  passed  by  the  stockholders, 
and  to  substitute,  if  they  so  desire,  by-laws  of  their  own  of 
exactly  opposite  effect.  This  was  a  concession  to  the  needs  of 
the  "trusts"  with  their  centralization  of  power  and  their  entire 
subordination  of  the  individual  stockholder,  and  is  perhaps  the 
most  dangerous  of  all  the  innovations  upon  the  old  rules,  as  it 
virtually  releases  the  directors  from  all  necessity  for  compliance 
with  the  wishes  of  the  stockholders,  and  leaves  in  their  hands 
the  unrestrained  management  of  the  corporate  affairs. 

It  will  be  understood  without  discussion  that  any  change  in 
the  law  acting  to  increase  the  powers  of  the  directors,  or  to 
remove  or  prevent  limitations  thereon,  distinctly  augments  the 
power  of  the  majority.  The  board  is  elected  by  the  majority, 
and  any  restraining  influences  that  exist  upon  the  power  of  this 
board  which  represents  the  majority  must  be  found  in  the 
charter,  by-laws,  and  statutes.  If,  then,  the  statutes  are  re- 
laxed, charter  limitations  omitted,  and  the  board  itself  given 
the  power  to  make  and  amend  by-laws,  the  power  of  the  board 
as  the  representative  of  the  majority  is  greatly  increased,  and 
the  minority  interests  become  in  effect  a  negligible  quantity. 


486  CORPORATE  LAW  [Bk.  I- 

Also  the  charter  may  be  more  easily  amended  than  formerly. 
In  New  Jersey  such  amendment  may  be  accomplished  by  a 
two-thirds  vote  of  the  stockholders,  in  New  York  by  a  three- 
fifths  vote,  and  in  Delaware  by  a  bare  majority  in  interest. 
This  latter  is  a  somewhat  remarkable  relaxation  of  the  former 
rule,  and  apparently  permits  a  mere  majority  to  change  the 
entire  nature  of  the  corporate  business,  as  for  example,  to  divert 
capital  invested  for  the  purpose  of  developing  a  publishing 
business  into  the  exploitation  of  a  mining  claim.  It  is  doubtful 
whether  material  change  in  the  charter  should  be  allowed  under 
any  circumstances,  unless  by  the  practically  unanimous  vote  of 
all  concerned. 

In  consequence  of  these  tendencies  the  present  condition  of 
the  minority  stockholder,  rniless  special  provision  is  made  for 
his  protection,  is  even  less  satisfactory  than  it  formerly  was 
under  the  common  law, 

§  532.    Measures  to  Protect  the  Minority 

The  legitimate  ends  sought  by  the  minority  are  honesty, 
efficiency,  and  reasonable  publicity  of  management— a  manage- 
ment for  the  good  of  all  and  not  one  primarily  in  the  interests 
of  the  majority. 

The  means  that  may  be  employed  to  secure  these  ends  are 
of  two  general  classes,  the  one  consisting  of  such  arrangements, 
modifications,  or  restrictions  of  the  voting  power  as  to  secure 
to  the  minority  at  least  a  reasonable  representation  on  the 
board  of  directors;  the  other  consisting  of  provisions  in  charter 
or  by-laws  restraining  and  regulating  the  powers  of  the  board 
and  prescribing  safe  rules  for  the  conduct  of  the  business. 

The  first-mentioned  method  is  the  most  effectual  for  the 
protection  of  the  minority  interests.  The  usual  cases  of  oppres- 
sion or  fraud  on  the  part  of  the  majority  occur  in  the  absence 
of  minority  representation  on  the  board.  If  the  minority  have 
one  or  more  directors  on  the  board,  the  majority  will  still,  as  a 
matter  of  course,  control,  but  it  is  in  the  highest  degree  improb- 


Ch.  58]  PROTECTION  OF  MINORITY  487 

able  that  this  control  will  be  exercised  to  the  injury  of  minority 
interests.  If  any  such  attempts  are  made,  the  minority  stock- 
holders through  their  representatives  on  the  board  will  be  fully 
cognizant  of  the  proposed  action,  may  enter  such  immediate 
protests  and  make  such  representations  as  they  see  fit,  and,  if 
such  prejudicial  action  is  persisted  in,  may  take  prompt  legal 
action  to  protect  their  interests. 

Without  this  board  representation,  charter  and  by-law  pro- 
visions for  the  protection  of  the  minority  are  apt  to  be  of  but 
little  effect.  With  board  action  free  from  supervision  and  with 
the  assistance  of  counsel  skilled  in  evasion  of  the  law,  such  un- 
supported provisions  may  be  easily  overcome  or  avoided.  With 
an  intelligent  minority  representation  on  the  board,  such  in- 
fringements of  minority  rights  would  not  usually  even  be 
contemplated. 

The  usual  measures  for  the  protection  of  minority  interests 
are  considered  in  the  following  sections  of  the  present  chapter. 

§  533*    Cumulative  Voting 

Cumulative  voting  is  one  of  the  most  effectual  means  of 
securing  minority  representation  on  the  board  of  directors.  So 
highly  are  the  results  of  this  system  esteemed  .that  its  use  in  cor- 
porate elections  is  prescribed  by  constitutional  provisions  in 
Pennsylvania,  Illinois,  California,  and  a  number  of  other  states. 
In  New  York,  New  Jersey,  and  some  other  states  it  may  be 
used  if  so  provided  in  the  corporate  charter.  The  Constitution 
of  the  state  of  Pennsylvania  outlines  the  system  with  much 
conciseness,  as  follows: 

In  all  elections  for  directors  or  managers  of  a  corporation,  each 
member  or  shareholder  may  cast  the  whole  number  of  his  votes  for 
one  candidate  or  distribute  them  upon  two  or  more  candidates  as 
he  may  prefer. 

The  New  York  statutes  go  into  the  matter  more  fully: 

The  certificate  of  incorporation  of  any  stock  corporation  may 
provide  that  at  all  elections  of  directors  of  such  corporation  each 


488  CORPORATE  LAW  [Bk.  I- 

stockholder  shall  be  entitled  to  as  many  votes  as  shall  equal  the 
number  of  his  shares  of  stock  multiplied  by  the  number  of  directors 
to  be  elected,  and  that  he  may  cast  all  of  such  votes  for  a  single 
director  or  may  distribute  them  among  the  number  to  be  voted  for, 
or  any  two  or  more  of  them  as  he  may  see  fit,  which  right,  when 
exercised,  shall  be  termed  cumulative  voting.* 

Under  this  system  the  majority  control  and  manage  the 
corporation  absolutely,  but  the  minority  stockholders,  if  their 
holdings  are  at  all  material,  can  always  elect  one  or  more  direc- 
tors to  represent  them.  If  they  elect  capable  men,  there  is  but 
little  danger  that  the  minority  interests  will  suffer. 

To  obtain  the  best  results  from  cumulative  voting,  the 
minority  must  be  organized  to  some  extent  at  the  time  of  the 
annual  election,  and  should  delegate  by  proxy  to  some  few 
trusted  representatives  the  casting  of  their  ballots. 

To  cast  these  aggregated  votes  to  the  best  advantage  some- 
times requires  nice  calculation.  For  instance,  in  a  corporation 
with  a  board  of  five  directors  and  loo  shares  of  voting  stock, 
each  share  will  have  the  right  to  cast  5  votes,  or  a  total  for  all 
the  voting  stock  of  500  votes.  In  such  case  any  person  or  per- 
sons controlling  17  shares  can  cast  85  votes,  and  if  this  total 
vote  is  cast  for  a  single  candidate  this  candidate  would  infallibly 
be  elected.  The  aggregate  of  the  other  votes  cast  would  be  415, 
but  no  matter  how  they  were  divided  among  the  other  candi- 
dates, the  candidate  with  85  votes  could  not  be  defeated.  If 
evenly  divided  among  the  five  aspirants  for  board  membership, 
each  would  receive  83  votes,  but  the  minority  candidate  with 
85  votes  would  have  a  plurality  of  the  votes  cast,  and  would 
under  any  circumstances  have  enough  votes  to  insure  his  elec- 
tion.   Some  preliminary  calculation  is  always  advisable. 

There  are  no  material  objections  to  the  system  of  cumulative 
voting,  and  it  should  be  adopted  wherever  possible.  Its  in- 
creasing use  is  a  practical  testimonial  to  its  value.  It  must, 
however,  be  used  with  intelHgence,  or  the  results  are  sometimes 


«  Gen.  Corp.  Law.  N.  Y.,  5  24. 


Ch.  58]  PROTECTION  OF  MINORITY  489 

surprising.  On  occasion  an  unsuspecting  majority  have  so  scat- 
tered their  votes  that  a  compact,  well-handled  minority  have 
actually  gained  control  of  the  board.  In  other  words,  the 
majority  threw  themselves  into  a  minority  by  scattering.  For 
instance,  in  the  example  given  above,  if  the  minority,  instead 
of  controlling  but  17  shares,  controlled  45  shares  of  stock,  they 
would  be  able  to  cast  225  votes  as  against  275  votes  cast  by  the 
majority.  The  minority  might  then  very  safely  divide  their 
votes  among  three  candidates,  with  the  assurance  that  they 
would  elect  at  least  two  directors  and  might  elect  the  third. 
The  majority  would  have  votes  enough  to  elect  three  directors, 
but  if  they  thoughtlessly  scattered  those  votes  among  four  or 
five  candidates,  the  three  minority  candidates,  with  over  70 
votes  each,  would  be  elected  and  would  control  the  board. 
Such  an  election,  though  somewhat  unexpected  in  its  results,  is 
legal  and  would  be  upheld  wherever  cumulative  voting  is  prop- 
erly employed.3 

§  534.    Classification  of  Stock 

Where  definite  divisions  of  interest  exist  among  the  stock- 
holders, or  intending  stockholders,  at  the  beginning  of  the  coirt 
porate  organization,  classification  of  stock,  where  allowable, 
may  be  employed  with  entire  confidence  that  each  class  will 
receive  due  representation  on  the  board.  Such  classification  is 
permitted  in  most  states,  and  should  be  secured  by  charter  pro-, 
vision  where  possible;  elsewhere  by  by-laws  adopted  before 
stock  is  issued.  By-laws  of  this  nature,  so  adopted,  become  in 
effect  a  contract  with  those  purchasing  stock  and  hence  are  not 
susceptible  of  repeal  save  by  consent  of  all  interests.'* 

Under  such  an  arrangement  stock  may  be  divided  into  any 
classes  desired,  equal  or  unequal  in  amount.  To  each  of  these 
classes  may  be  assigned  one  or  more  directors,  and  so  long  as 
the   corporate  organization   exists  unchanged,   each  of   these 

« See  i  237. 

*  Kent  V.  Quicksilver  Mining  Co.,  78  N.  Y.  159,  178  (1879);  Loewenthal  v.  Rubber  Rec. 
Co.,  52  N.  J.  Eq.  440  (1894). 


40  CORPORATE  LAW  [Bk.  I- 

classes  will  elect  its  own  directors  to  the  board.    This  arrange-: 
ment  is  very  effective.  ^  > 

§  535.    Voting  Trusts 

The  general  subject  of  voting  trusts  has  already  been  con- 
sidered.^  It  is  referred  to  here  only  as  a  method  of  protecting 
minority  rights  where  these  interests  are  in  a  position  to  demand 
such  protection  before  entering  the  corporation.  This  may 
occur  where  stock  in  a  corporation  is  offered  for  property,  or 
where  a  partnership  is  to  be  incorporated  with  some  of  the 
partners  holding  comparatively  small  interests. 

In  such  event  the  proposed  investment  or  arrangement  may 
be  acceptable  to  the  parties  concerned,  even  though  it  places 
them  in  a  hopeless  minority,  if  they  can  be  assured  of  represen- 
tation on  the  board,  or  that  an  acceptable  management  will  be 
elected  and  retained  for  at  least  a  reasonable  length  of  time. 
In  any  such  case  the  desired  end  may  be  effectually  secured  by 
means  of  the  voting  trust. 

In  this  connection  it  may  be  noted  that  a  mere  agreement 
between  parties  holding  stock,  that  such  stock  shall  be  voted 
for  certain  persons  or  in  a  prescribed  manner,  will  not  be  enforced 
by  the  courts  even  though  this  agreement  be  embodied  in  a 
formal  contract.  Under  some  circumstances  damages  might  be 
obtained  for  breach  of  such  a  contract,  but  the  contract  itself 
could  not  be  enforced  and  damages  would  usually  be  very 
diflScult  to  prove.  ^ 

§  536.     Special  Arrangements 

Many  other  arrangements  for  the  protection  of  the  minority 
or  of  particular  interests  are  possible,  depending  upon  the  cir- 
cumstances, the  statutory  provisions  of  the  state  of  incorpora- 
tion, and  the  decisions  of  its  courts. 


•  See  J  221;  also  {  547,  which  explains  how  the  plan  may  be  used  when  a  partnership  is 
incorporated. 

•  See  Ch.  LVI,  "Voting  Trusts." 

'  Gage  V.  Fisher,  s  N.  D.  297  (189s). 


Ch.  58]  PROTECTION  OF  MINORITY  491 

In  those  states  where  special  provisions  may  be  inserted  in 
the  charter,  it  is  entirely  possible,  in  the  absence  of  express 
constitutional  and  statutory  prohibitions,  to  decrease  the  pro- 
portionate vote  of  the  stockholder  as  his  holding  increases,  or  to 
deny  the  voting  right  absolutely  after  a  certain  maximum  vote 
has  been  reached.  For  instance,  it  may  be  provided  that  each 
stockholder  shall  cast  one  vote  for  each  share  of  stock  held  by 
him  up  to  a  total  of  10  shares;  that  on  stock  in  excess  of  this 
amount  up  to  100  shares,  he  shall  have  one  vote  for  each  5 
shares;  that  on  all  stock  in  excess  of  100  shares  he  shall  have 
one  vote  for  each  10  shares.  This  is  the  voting  provision  of  the 
English  Companies  Act  which  has  some  merits.  Any  other 
apportionment  of  the  voting  power  may  be  made,  or  it  may  be 
provided  that  after  some  maximum  vote  has  been  reached,  as 
for  instance  10  votes  for  10  shares  held,  no  further  vote  shall 
be  cast  by  such  stockholder  no  matter  what  his  holding. 

It  is  also  possible  to  place  the  number  of  votes  necessary  to 
elect  a  director  so  high  that  under  any  ordinary  circumstances 
directors  cannot  be  elected  save  by  agreement.  For  instance,  if 
a  three-fourths  vote  of  the  outstanding  voting  stock  were  neces- 
sary to  elect,  it  would  be  but  seldom  that  the  majority  could 
elect  without  minority  assistance.  Then  they  must  either  allow 
the  management  to  remain  without  change,  as  will  be  the  case 
if  there  is  no  election,  or  unite  with  the  minority  to  elect.  If 
this  were  necessary  they  would  hardly  propose  anyone  objec- 
tionable to  the  minority  element.  This  plan  presupposes  an 
existing  management  acceptable  to  all  the  stockholders. 

§  537.    Annual  Audits 

In  the  larger  corporations  the  auditing  of  the  books  of 
account  is  a  very  important  feature  of  the  corporate  operations 
and,  if  properly  conducted,  may  be  made  to  eliminate  any  neces- 
sity for  the  inspection  of  such  books  by  the  rank  and  file  of  the 
stockholders.  Such  auditing  may  be  annual,  quarterly,  or  held 
at  irregular  intervals,  and,  if  made  by  proper  parties,  serves 


498  CORPORATE  LAW  [Bk.  I- 

both  as  a  check  on  the  management  and  a  verification  of  their 
accounts.  The  results  of  these  audits  give  the  stockholders  the 
general  information  in  regard  to  the  business  that  they  have  a 
right  to  demand,  and,  as  intimated,  thereby  remove  the  necessity 
for  examination  of  the  accounts  by  these  latter.  It  is,  of  course, 
imperative  that  the  professional  accountants  employed  as  audi- 
tors be  absolutely  reliable  and  thoroughly  qualified  for  their 
work. 

§  538.    Charter  Limitations 

In  New  York,  New  Jersey,  and  some  other  states,  limitations 
on  the  power  of  the  majority  may  be  inserted  in  the  charter. 
At  the  inception  of  the  enterprise  the  minority  are  not  infre- 
quently in  a  position  to  demand  the  inclusion  of  such  limitations 
as  a  condition  precedent  to  their  participation  in  the  corpora- 
tion. Even  if  otherwise,  an  era  of  good  feeHng  generally  exists 
at  this  stage  of  the  enterprise,  and  reasonable  concessions  may 
then  be  obtained  which  later  would  not  be  possible.  The 
minority  have  a  right  to  ask  safeguards  as  a  condition  of  their 
investing. 

An  instance  is  afforded  by  the  charter  of  one  of  the  prominent 
industrial  trusts  in  which  the  following  provision  is  found:  "It 
is  hereby  provided  that  it  shall  require  a  majority  of  seventy- 
five  per  cent  of  the  outstanding  voting  stock  to  amend  the 
charter,  to  amend  the  by-laws,  or  to  elect  directors  in  this 
company," 

Such  a  provision  is  directly  in  the  interests  of  the  minority. 
In  this  case  it  may  have  been  conceded  voluntarily,  but  prob- 
ably its  adoption  was  demanded  by  some  of  the  smaller  but 
necessary  component  corporations  as  one  of  the  conditions  of 
their  entrance  into  the  combination.  Under  such  a  provision 
no  changes  could  be  made  in  charter,  by-laws,  or  the  board  of 
directors  against  the  wishes  of  a  minority  controlling  26% 
of  the  voting  stock.  Under  such  circumstances  a  minority 
judiciously  handled  could  always  protect  its  interests.     This 


Ch.  58]  PROTECTION  OF  MINORITY  493 

arrangement  cannot  be  had  in  New  York  as  the  statute  specifies 
that  directors  shall  be  elected  "by  a  plurality  of  the  votes  at 
such  election."  .!>:<{  riori // 

As  damage  to  minority  interests  or  the  wrecking  of  cor- 
porations is  almost  invariably  caused  by  improvident  contracts, 
unwarrantable  salaries,  or  excessive  indebtedness,  charter  limi- 
tations upon  the  power  of  the  board  in  these  directions  are  of 
frequent  occurrence.  Some  flexibility  is  usually  given  to  these 
restrictions  by  provision  that  their  limits  may  be  exceeded  by 
a  unanimous  vote  of  the  board,  or  by  a  two-thirds  or  three- 
fourths  vote  of  the  outstanding  voting  stock,  or  by  some  similar 
provision. 

,.'hr  Where  these  limitations  exist,  it  is  important  that  some  such 
flexibility  be  provided,  as  otherwise  the  interests  of  the  corpora- 
tion might  on  occasion  suffer  severely.  The  limits  of  charter 
provisions  cannot  be  legally  exceeded  by  the  corporation,  either 
by  action  of  the  directors  or  stockholders,  except  as  specifically 
allowed  by  the  charter  itself,  and  business  opportunities  of 
obvious  advantage  to  the  corporation  might  be  lost  for  lack  of 
the  power  to  meet  their  terms  or  conditions. 

It  is  also  possible  to  provide  in  the  charter  that  the  minority 
may  have  reasonable  access  to  the  books  and  records  of  the 
corporation,  and  any  other  desired  privileges  not  in  conflict 
with  the  statutes  may  be  so  secured. » 

§  539.    Legal  Remedies 

Prevention  of  wrong  is  better  than  any  remedy,  but  a  knowl- 
edge of  their  rights  and  the  remedies  that  the  law  gives  for  in- 
fringement of  their  rights  is  sometimes  of  much  advantage  to 
minority  stockholders.  The  usual  methods  of  wronging  minority 
stockholders,  such  as  paying  inordinate  salaries,  withholding 
dividends,  selling  or  leasing  corporate  property  below  its  worth, 
running  the  corporation  into  debts  which  it  cannot  mqet,  and 
similar  fraudulent  and  oppressive  transactions,  are  all  illegal 

»  See  Ch.  XXVI,  "Charter  —Special  Provisions." 


^494  CORPORATE  LAW  [Bk.  I- 

and  tortuous.  For  all  of  these  wrongs  the  law  will  give  redress 
if  those  who  suffer  will  seek  it. 

When  salaries  are  wrongfully  increased  the  courts  will  com- 
pel restitution,  and  in  such  case  the  whole  of  the  inordinate 
salary  must  be  returned,  not  merely  the  excess.  Directors  are 
trustees  and  cannot  use  their  power  as  such  to  enrich  them- 
selves. Neither  can  this  just  rule  be  evaded  by  each  director's 
not  voting  on  his  own  salary  but  letting  it  be  fixed  by  his  brother 
directors.  9  Directors,  like  promoters,  will  be  compelled  to  ac- 
count for  any  secret  profit  which  they  may  make  in  any  trans- 
action in  which  the  corporation  is  interested. lo 

The  directors  control  the  declaration  of  dividends.  "When 
a  corporation  has  a  surplus,  whether  a  dividend  shall  be  made, 
and  if  made,  how  much  it  shall  be,  and  when  and  where  it  shall 
be  payable,  rest  in  the  fair  and  honest  discretion  of  the  directors 
uncontrollable  by  thecourts."ii  But  if  this  discretion  is  not 
honest  and  fair,  and  dividends  are  withheld  to  discourage  minor- 
ity stockholders  and  induce  them  to  sell  their  stock  at  low 
prices,  the  courts  will  interfere  on  behalf  of  the  minority.12 

In  a  New  York  case  the  court  said:       rij  jaan 

'  I* 
This  is  one  of  those  cases  where  a  majority  of  stockholders  have 
entered  into  a  combination  to  control  the  affairs  of  the  corporation 
for  their  own  benefit  and  in  fraud  of  the  rights  of  the  minority. 
Such  a  combination  will  always  be  rebuked  by  a  court  of 
equity.  .  .  . 

Directors  of  a  corporation  have  no  right  to  vote  salaries  to  one 
,  ^   another  as  mere  incidents  of  their  office,  as  was  done  here." 

Another  device  for  robbing  minority  stockholders  is  to  make 
improvident  contracts,  usually  with  some  other  organization 
with  which  the  offending  directors  are  connected.    Many  such 


»  Davids  v.  Davids,  13s  App.  Div.  (N.  Y.)  206  (1909);  Jacobson  v.  Brooklyn  Lumber  Co., 
184  N.  Y.  152  (1906);  Luthy  v.  Ream,  270  111.  170  (1915). 

">  Billings  V.  Shaw,  209  N.  Y.  265  (1913). 

i>  Williams  v.  W.  U.  Telegraph  Co.,  93  N.  Y.  162,  191  (1883). 

'•  Hiscock  V.  Lacey,  9  Misc.  Rep.  (N.  Y.)  S78  (1894);  Belfast,  etc.,  Co.,  v.  R.  R.  Co.,  77, 
Me.  445  (188s). 

"  Fitchett  V.  Murphy,  46  App.  Div.  (N.  Y.)  181  (1899);  Bixler  v.  Summerfield,  19S 
111.  147  (1902). 


Ch.  s8]  PROTECTION  OF  MINORITY  495 

cases  have  come  under  the  condemnation  of  the  courts.^*      In 
such  a  case  the  Supreme  Court  of  the  United  States  said : 

,  All  arrangements  by  directors  of  a  railroad  company,  to  secure 
an  undue  advantage  to  themselves  at  its  expense,  by  the  formation 
of  a  new  company  as  an  auxiliary  to  the  original  one,  with  an  under- 
standing that  they,  or  some  of  them,  shall  take  stock  in  it,  and,  that 
valuable  contracts  shall  be  given  to  it,  in  the  profits  of  which,  they 

(j  ,i,as  stockholders  in  the  new  company,  are  to  share,  are  so  many        . 
unlawful  devices  to  enrich  themselves  to  the  detriment  of  the  stock- 
holders and  creditors  of  the  original  company,  and  will  be  con- 
demned   whenever    properly    brought    before    the    courts    for 
consideration." 

A  ij  . 

rSuch  transactions  being  fraudulent  cannot  be  authorized  or 
ratified  by  a  majority  of  the  stockholders.ifi 

When  the  corporation  is  wrecked  by  purposely  running  it 
into  debt,  necessitating  a  receivership  and  subsequent  reorgan- 
ization, out  of  which  the  wreckers  in  some  form  profit,  it  is 
usually  difficult  to  prove  the  wrongdoing.  Bad  management  in 
good  faith  is  so  common  that  it  is  not  easy  to  draw  the  line  and 
show  in  any  particular  case  that  the  mismanagement  was 
intentional. 

Where  the  directors  do  not  use  ordinary  care  and  diligence 
in  the  discharge  of  their  duties,  they  are  liable  for  the  damage 
caused  by  their  negligence."  In  practice,  however,  it  may  be 
very  difficult  to  prove  such  negligence  as  will  entitle  the  com- 
plaining stockholders  to  damages.  In  one  notable  case  the 
United  States  Supreme  Court  evidently  allowed  its  sympathies 
to  warp  its  judgment.^s 

The  minority  stockholders  may  also,  under  certain  condi- 
tions, obtain  redress  against  the  majority  stockholders.  As  the 
directors  are  the  managers  of  the  corporate  business,  they  are 


"  Sage  V.  Culver,  147  N.  Y.  241  (1895);  Schwab  v.  Potter  Co.,  194  N.  Y.  409  (1909)- 
«  Warden  v.  The  Railroad  Co.,  103  U.  S.  651  (1880). 

'•  Dana  v.  Morgan,  219  Fed.  313  (1914);  PoUitz  v.  Wabash  R.  R.  Co.,  207  N.  Y.  113.  127 
(1912). 

"  3  Cook  on  Corp.,  {  702,  and  cases  cited;  Chick  v.  Fuller,  114  Fed.  22  (1902). 
"Briggs  V.  Spaulding,  141  U.  S.  132  (1891). 


496  CORPORATE  LAW  [Bk.  I- 

usually  the  persons  responsible  for  the  infringement  of  the 
minority  stockholders'  rights.  However,  it  is  not  infrequently 
the  case  that  another  corporation  or  group  of  men  obtain  con- 
trol of  the  corporation  and  proceed  to  employ  it  to  further  their 
own  interests.  In  such  cases  it  has  been  held  that  those  who. 
control  the  majority  of  the  stock  occupy  a  fiduciary  relation 
towards  the  minority,  and  that  acts  in  their  own  interest  to  the 
detriment  of  the  minority  stockholders  are  wrongs  for  which 
the  court  will  give  relief,  i' 

The  practical  difficulty  is  that  the  archaic  and  clumsy  pro- 
cedure of  our  courts  makes  litigation  so  slow  and  so  expensive 
that  the  ordinary  citizen  cannot  afford,  in  most  cases,  to  seek 
the  redress  to  which  he  is  entitled.  By  the  theory  of  the  law 
he  may  right  his  wrong,  but  in  practice  the  cost  and  delay  of 
litigation  make  it  impossible. 


i»  Boyd  V.  N.  Y.  &  H.  R.  Co.,  220  Fed.  174  (1915);  Hyams  v.  Calumet  &  Hecia  Mining 
Co.,  221  Fed.  529  (1915);  Union  Pac.  R.  Co.  v.  Frank,  226  Fed.  906  (191S);  McManus  v. 
Durant,  168  App.  Div.  (N.  Y.)  643  (i9iS). 


<£V/     jfl 


3ii. 


^trfT 


CHAPTER  LIX 
INCORPORATING  A  PARTNERSHIP* 

§  540.    General 

The  incorporation  of  a  partnership  involves  problems  differ- 
ing from  those  of  the  incorporation  of  a  new  enterprise.  These 
problems  vary  with  the  conditions  and  requirements  of  the  par- 
ticular partnership. 

oi  If  the  partners  are  willing  to  adopt  the  simplest  and  most 
obvious  corporate  arrangements;  if  they  will  capitalize  at  the 
actual  values;  issue  all  the  capital  stock  in  payment  for  the 
values  transferred  to  the  corporation;  allot  this  full-paid  stock 
to  the  various  partners  in  the  proportion  of  their  partnership 
interests,  and  thereafter  let  matters  take  their  natural  corporate 
course,  the  duties  of  the  incorporating  counsel  are  not  onerous. 
Usually,  however,  the  parties  to  such  an  incorporation  are  not 
willing  to  commit  themselves  so  irrevocably  to  the  operations  of 
the  unmodified  corporate  system.  They  are  accustomed  to 
the  conditions  of  the  partnership,  and  they  wish  these  approxi- 
mated as  nearly  as  may  be  under  the  new  regime.  1 

Possibly  all  the  partners,  without  regard  to  investment,  may 
be  participating  equally  in  the  management;  or  one  partner, 
with  a  relatively  small  investment,  may  be  the  leading  spirit 
and  practically  in  control;  or  a  silent  partner,  taking  no  active 
part  in  the  management,  may  have  a  preponderant  investment. 
In  any  of  these  cases,  the  ordinary  operations  of  the  corporate 
system  would  work  a  radical  change,  and  it  is  not  to  be  supposed 
that  the  partners  would  agree  to  the  entire  abolition  of  the  con- 
ditions under  which  perhaps  they  have  achieved  success.  On 
the  contrary,  they  usually  desire  to  continue  the  existing  condi- 

.  ;  I  1  See  also  Book  III,  Ch.  XVII,  "Incorporation  of  a  Partnership." 

497 


498  CORPORATE  LAW  [Bk.  I- 

tions.  This  may  be  done  with  much  precision,  for  nowhere  does 
the  flexibility  of  the  corporate  system  appear  to  better  advantage 
than  in  its  ready  adjustment  to  the  varying  needs  of  partnership 
incorporations. 

§  541.    Name 

The  partnership  name  should  in  itself  represent  a  consider- 
able trade  value  that  would  be  lost  if  it  were  dropped  on  incor- 
poration. To  avoid  this,  the  name  of  the  partnership  is  usually 
adopted,  as  nearly  as  may  be,  as  the  name  of  the  new  corpora- 
tion. In  those  states  where  it  is  permissible,  the  partnership 
name  is  not  infrequently  taken  without  modification  as  the 
corporate  designation.  This  practice  is,  however,  open  to 
objection,  as  there  is  then  nothing  in  the  corporate  name  to 
indicate  that  the  concern  is  a  corporation,  and  parties  doing 
business  with  it  might,  unless  informed  of  its  corporate  nature, 
be  able  to  hold  the  stockholders  as  partners. 

Such  a  possibility  largely  eliminates  the  most  advantageous 
single  feature  of  incorporation — its  limited  Hability — and  to 
retain  this  feature,  while  still  preserving  the  actual  form  of  the 
partnership  name,  the  word  "Incorporated"  or  the  abbreviation 
"Inc."  is  frequently  added.  This  usually  appears  in  small 
letters  after  the  name,  sometimes  in  parentheses,  and  effectually 
prevents  any  danger  of  partnership  liability. 

In  some  states  the  word  "Company"  must  form  part  of  every 
corporate  name,  and  in  these  states  the  usual  practice  when  a 
partnership  is  incorporated  is  to  adopt  the  partnership  name 
with  the  prescribed  word  following — "Smith  &  Jones"  becoming 
on  incorporation  "Smith  &  Jones  Company."  This  practice 
is  very  common  in  all  the  states,  whether  required  by  law  or 
otherwise,  and  is  generally  preferable  to  the  use  of  the  unmodi- 
fied firm  name,  or  its  use  in  connection  with  the  word  "Incor- 
porated." ,  In  New  York  and  a  few  other  states,  the  word 
"Incorporated,"  its  abbreviation  "Inc.,"  or  other  words  indicat- 
ing incorporation  must  be  used  in  the  name  to  distinguish  clearly 


Ch.  59J  INCORPORATING  A  PARTNERSHIP  499 

the  corpora  lion  from  an  individual  or  partnership  business,  and 
the  word  "Company"  cannot  be  used. 

Another  common  modification  of  the  firm  name  is  to  sub- 
stitute a  hyphen  for  the  connecting  word  and  add  "Company" — 
"Smith  &  Jones"  then  becoming  the  "Smith- Jones  Company." 
In  most  of  the  states  the  prefix  "The"  either  may  or  may  not 
be  made  part  of  the  corporate  name,  though  in  a  few  states  its 
use  is  obligatory.  Owing  to  the  additional  length  given  the 
corporate  name  by  its  use,  and  its  exceeding  awkwardness  in 
certain  legal  constructions,  the  word  "The"  is  better  omitted 

unless  there  are  special  reasons  for  its  retention.  .  ' 

> 

§542.     Capitalization 

If  after  incorporation  the  partnership  business  is  to  go  on 
under  the  corporate  form  with  only  the  former  partners  inter- 
ested, no  stock  being  sold  to  outsiders,  the  simplest  and  possibly 
most  satisfactory  basis  of  capitaHzation  is  the  actual  value  of 
the  assets  turned  into  the  new  corporation,  without  allowance 
for  good-will,  trade-name,  or  any  other  intangible  assets.  Then, 
on  incorporation  each  partner  will  participate  in  the  stock  by 
which  this  capitaHzation  is  represented,  dollar  for  dollar,  to 
the  amount  of  his  existing  partnership  investment. 

Under  this  plan  the  capital  stock  of  the  new  company  is 
kept  at  a  comparatively  low  figure,  taxation  is  to  some  extent 
avoided,  while  the  respective  proportionate  interests  of  the 
different  partners  are  accurately  preserved.  As  will  be  readily 
seen,  no  very  exact  estimate  of  the  value  of  the  business  is  nec- 
essary under  this  arrangement.  The  capital  stock  merely  serves 
as  a  convenient  method  of  adjusting  the  proportionate  interests 
of  the  partners,  and,  no  matter  what  its  amount,  these  interests 
are  still  represented  in  proper  proportion. 

If,  however,  new  members  are  to  be  taken  into  the  incor- 
porated business,  or  any  of  the  partners  expect  to  sell  stock,  or 
it  is  anticipated  that  at  any  time  in  the  near  future  stock  will 
change  hands,  the  proper  valuation  and  capitalization  of  the 


SOO  CORPORATE  LAW  [Bk.  I- 

business  become  matters  of  great  importance.  Then  the  value 
of  the  good-will  should  be  added  to  the  property  values;  also 
any  other  intangible  assets,  such  as  trade-names,  trade-marks, 
and  copyrights,  should  be  included  at  a  fair  figure.  All  of  these 
are  valuable  assets  and  are  legitimately  represented  in  the 
capitalization  of  the  business.  Contemplated  profits  are  not  a 
proper  basis  for  capitalization  ;2  but  a  valuation  of  a  plant 
based  upon  the  earnings  for  the  previous  year,  capitalized  at  6% 
interest,  has  been  held  proper.^ 

Any  desired  property  may,  of  course,  be  reserved  to  the 
partnership.     If  thei^partners  wish  to  retain  a  portion  of  the 
cash  on  hand,  OBt^rtain^ortions  of  the  firm  realty  or  other 
property,  or  thi^Kr^^ift^  accounts  better  in  their  own  handsel 
the  whole  mat<t^"is,t^'^eir  discretion.     They  may  retain  whal^  "^  ^ 
they  will  anQ''tta^s'frK^at  they  will.  "0  z  a  "^^ 

The  U^fra^p'a^'p^^izsition  is  also  a  matter  of  conditions  ai^lJVi  g  i 
discre\^Tli-y^^<:^;p^  be  all  common  stock,  or  preferred  sto^Jn  a  '" 
and^J)6nH^^a^jPbe  added.  The  matter  rests  entirely  wicJi'  \: 
the  par^ejs.  ^If  it  is  decided  to  issue  bonds,  the  stock  cap?*-  >  i  - 
talizatiov  will  naturally  be  reduced  by  just  that  amount,  ff  ni  ^  • 
preferred  stock  is  issued,  the  common  stock  will  be  reduc^^^  3  ' 
by  that  amount,  but  the  total  capitahzation  will  remainiZ^ 
the  same. 

In  the  incorporation  of  a  partnership,  no-par-value  stock 
may  at  times  be  used  to  great  advantage.  Thus  preferred  stock 
may  be  used  to  give  the  actual  investors  of  capital  proper  com- 
pensation for  the  use  of  their  money,  and  no-par- value  stock  be 
used  to  represent  their  contingent  interest,  or  to  represent  their 
equal  or  proportionate  interest  in  profits.  Other  methods  of 
using  this  modern  device  will  suggest  themselves.* 

If  additional  capital  is  needed  for  the  business  of  the  new 
corporation  and  stock  must  be  sold  to  secure  it,  the  amount  of 
capitalization  determined  by  the  total  value  of  the  partnership 


2  See  V.  Heppenheimer,  69  N.  J.  Eq.  36  (1905). 

«  Railway  Review  v.  G.  D.  &  M.  Tool  Co.,  84  N.  J.  Eq.  321  (1914). 

«  See  Chs.  XIV,  XV,  and  XVI,  treating  of  no-par-value  stock  and  its  use. 


Ch.  59]  INCORPORATING  ^.  PARTNERSHIP  501 

assets — including  good-will — would  naturally  be  increased  by 
the  amount  of  stock  to  be  sold. 

§  543.    Incorporation  and  the  Income  Tax 

It  is  necessary  to  consider  carefully  what  effect  incorporation 
is  likely  to  have  on  the  taxes  to  be  paid  the  federal  government. 
The  excess  profits  tax  in  former  years  at  times  penalized  the 
corporate  form,  and  in  its  amended  form  still  discriminates  be- 
tween partnerships  and  corporations.  Of  the  excess  profits  tax 
and  its  effects  in  this  direction,  David  F.  Houston,  ex-Secretary 
of  the  Treasury,  says: 

fi-  This  tax  attaches  to  business  transacted  only  on  the  one  form 

.     of  organization — the  corporate  form.    It  applies  only  to  corpora- 
tions and  gets  its  name  from  the  fact  that  the  law  exempts  corporate 
incomes  equal  to  8  per  cent  of  the  invested  capital  plus  $3,000. 
The  net  income  above  these  deductions  and  not  in  excess  of  20  per 
cent  of  the  invested  capital  is  taxed  20  per  cent  and  the  net  income     " 
over  and  above  this  is  taxed  40  per  cent.     Such  is  the  excess 
profits  tax.    The  corporation  also  pays  a  normal  income  tax  of     ,,( 
10  per  cent  and  its  stockholders  pay  supertaxes  on  its  distributed    , .  ; 
profits.    Businesses  not  conducted  on  corporate  form,  but  com- 
petitive in  many  cases  with  corporations,  such  as  sole  proprietors 
and  partnerships,  which  are  more  numerous  than  corporations,  do  ■'^''' 

,'j.'    not  pay  the  excess  profits  tax.    They  pay  the  normal  income 

1;;     taxes  and  surtaxes  on  their  entire  profits,  whether  distributed  or 

undistributed.    The  excess  profits  tax  was  intended  to  be  an  ify, 
.  ^,  equivalent  for  the  surtax  levied  upon  the  undistributed  or  re-   .. 
invested  profits  of  sole  proprietors  and  partnerships.   But  in  reality 
it  does  not  work  out  this  way.    It  has  proved  to  be  inequitable  as 
between  corporations  and  other  forms  of  business. 

,N  ()J  'In  1918  members  of  a  well-known  partnership  paid  nearly 
Im    $1,125,000  more  in  taxes  than  they  would  have  paid  as  a  corpora- mi<\ 
tion,  and  all  their  competitors  were  corporations.  t  virirj 

As  a  rule,  however,  corf)orations  pay  a  heavier  tax.    In  191 7  a     ,. 
partner  in  a  small  business  entered  the  government  service,  and  for 
convenience,  the  business  was  incorporated.     It  paid  nearly  4}^ 
times  as  much  on  its  earnings  in  191 8  as  it  would  have  paid  if  it    '' 
had  not  been  incorporated.    This  tax  also  works  inequitably  as 
among  corporations.    A  conservatively  managed  corporation  is 


CORPOTTAIE  LAW  [Bk.  I- 

penalized.  If,  however,  it  is  generously  capitalized,  its  exemption 
based  on  the  8  per  cent  of  its  capital  wiU  be  large  and  it  may  escape 
with  little  or  no  excess  profits. 

The  tax  is  complex  and  difficult  of  administration.  In  any 
particular  case,  it  would  not  be  safe  to  incorporate  without 
taking  expert  advice  in  regard  to  the  effect  on  taxations  of  the 
proposed  capitalization. s 

§  544.    Exchange  of  Property  for  Stock 

The  value  of  the  partnership  business  and  property  having 
been  determined,  and  the  capitalization  of  the  corporation  fixed 
at  this  total  value,  the  business  as  a  going  concern  will  be  offered 
to  the  new  corporation  in  exchange  and  full  pa)anent  for  all  its 
capital  stock.  This  offer  should  be  by  formal  written  proposi- 
tion, usually  signed  by  one  of  the  partners  with  the  firm  name, 
but  sornetimes  signed  by  all  the  partners. 

This  proposition  is  usually  accepted  without  demur,  the  new 
corporation  authorizing  the  issue  of  its  capital  stock  in  payment 
for  the  property.  The  capital  stock  will  then  be  issued  in 
accordance  with  the  terms  of  the  proposition,  and  the  partner- 
ship business  and  property  as  tendered  will  be  transferred  to  the 
corporation,  usually  by  formal  bill  of  sale,  though  sometimes  by 
mere  delivery  of  possession.  The  partnership  books  of  account 
will  be  closed  by  proper  entries  showing  the  transfer  to  the 
corporation,  and  proper  corporate  books  will  be  opened.  This 
completes  the  transaction  as  between  the  partnership  and  the 
corporation. 

The  corporation  then  owns  the  business  as  transferred  to  it, 
but  the  partnership  still  exists  with  the  stock  as  its  sole  asset, 
unless  some  of  the  partnership  property  has  been  reserved  from 
the  sale  to  the  corporation.  The  distribution  of  this  stock  among 
the  partners  in  accordance  with  previous  agreements,  or  usually 
in  proportion  to  their  respective  firm  interests,  completes  the 


'  To  appreciate  the  intricacy  of  the  problem,  the  reader  should  study  an  article  on  thi 
subject  in  Administration  for  October,  1921,  by  H.  H.  Baily  of  the  University  of  Illinois. 


Ch.  59]  INCORPORATING  A  PARTNERSHIP  SOjj: 

usefulness  of  the  partnership.  It  may  then  be  continued  in  a 
quiescent  condition,  be  dissolved  by  formal  agreement,  or 
merely  be  allowed  to  lapse.  If  no  partnership  property  was 
reserved  and  the  stock  received  by  the  firm  is  distributed,  and 
there  are  no  special  reasons  for  its  continuation,  dissolution  by 
formal  agreement  is  the  better  practice,  avoiding  any  possibility 
of  subsequent  entanglements  or  liabilities.  If  it  is  desired  to 
avoid  any  possibility  of  future  liability  under  the  old  firm,  formal 
notice  should  be  given,  by  mail  or  publication,  of  the  incorpora- 
tion of  the  business  and  the  dissolution  of  the  partnership. 

§  545.     Stock  Adjustments 

In  an  ordinary  partnership,  when  the  investments  are  equal 
or  nearly  so,  the  stock  received  in  exchange  for  the  partnership 
property  is  usually  all  common  stock,  with  or  without  par  value, 
and  is  distributed  among  the  partners  in  proportion  to  their 
respective  investments  in  the  old  partnership.  If,  however, 
special  conditions  are  to  be  met,  this  arrangement  may  be  varied 
almost  indefinitely. 

At  times  preferred  stock  is  desired  by  the  partners  to  repre- 
sent a  portion,  at  least,  of  the  property  transferred  by  them  to 
the  corporation.  Such  stock  has  the  advantage  of  its  fixed 
preferential  dividend  that  must  be  paid  if  any  profits  are  made, 
and,  so  far  as  permitted  by  the  state  laws,  it  may  be  given  any 
other  powers  or  privileges  deemed  necessary. 

At  other  times  the  partners  will  perhaps  prefer  to  have  a 
portion  of  the  payment  for  property  transferred  to  the  corpora- 
tion in  the  form  of  bonds.  Corporate  taxation  is  usually  thereby 
avoided,  though  personal  taxation  may  be  proportionately 
increased.  Beyond  this,  bonds  are  a  safe  and  very  convenient 
form  of  corporate  security  to  hold  if  the  incorporated  business  is, 
in  whole  or  in  part,  going  into  new  hands. 

By  the  use  of  common  stock,  with  or  without  par  value, 
preferred  stock  of  varying  powers  and  privileges,  and  bonds, 
almost  any  requirements  of  a  partnership  to  be  incorporated 


_ — —  CORPORATE  LAW  [Bk.  I- 

may  be  satisfactorily  met.  For  instance,  a  silent  partner's 
interest  might  be  properly  provided  for  by  a  preferred  stock, 
drawing  a  preferential  dividend  equal  to  the  rate  of  interest 
theretofore  paid  upon  this  partner's  investment,  or  participating 
otherwise  in  profits  to  the  same  extent  as  the  investment  did 
before.  This  preferred  stock  might  be  allowed  to  vote,  or  if  it 
were  not  desirable  that  the  silent  partner  should  participate  in 
the  management,  the  voting  right  might  be  denied,  or  his  entire 
interest  might  be  provided  for  by  an  issue  of  bonds  which  would 
draw  a  fixed  interest  without  regard  to  profits,  but  could  not  vote. 
Or  if  one  partner's  investment  were  much  larger  than  that 
of  other  partners',  but  equality  in  management  were  desired  in 
the  new  corporation,  the  excess  interest  of  the  one  partner  might 
be  provided  for  by  non-voting  preferred  stock,  by  a  bond  issue, 
or  perhaps  by  an  issue  of  common  stock  without  the  voting 
right.  In  the  latter  case  such  partner  would  participate  in  all 
profits  on  the  basis  of  the  full  amount  of  stock  held  by  him,  but 
would  not  vote  on  the  excess  portion.  If  his  excess  investment 
were  in  bonds,  he  would  vote  and  participate  in  dividends  on 
the  basis  of  the  amount  of  stock  actually  received  by  him,  but 
would  receive  in  addition  the  fixed  amount  of  interest  called  for 
by  his  bonds.  Also,  at  some  specified  date  he  would  receive 
payment  of  the  face  of  his  bonds,  his  excess  investment  under 
these  conditions  constituting  a  preferred  claim  against  the  cor- 
porate property.  Under  the  preferred  stock  plan,  he  would 
participate  in  profits  to  the  full  on  his  quota  of  common  or  no- 
paj-value  stock,  but  on  this  preferred  stock  would,  as  usually 
arranged,  participate  in  profits  only  to  the  extent  of  his  preferred 
dividend.  The  final  redemption  of  such  preferred  stock  might 
or  might  not,  according  to  the  arrangement,  take  precedence 
over  any  liquidation  of  the  common  stock  or  no-par-value  stock. 

§  546.    Board  of  Directors 

If  the  partners  take  the  amount  of  stock  in  the  new  corpora- 
tion to  which  their  respective  partnership  interests  entitle  them, 


Ch.  sq]  incorporating  a  PARTNERSfflP  505 

and  let  the  selection  of  the  board  take  its  natural  course  there- 
after, the  matter  is  simple.  Usually,  however,  the  partners  wish 
an  equality  of  power  in  the  board,  or  a  specified  representation, 
or  a  classification,  or  some  other  special  arrangement,  and  the 
composition  and  method  of  electing  the  board  of  directors  fre- 
quently becomes  the  most  difficult  question  arising  in  the  incor- 
poration of  a  partnership.  i^  ' 

Where  equality  of  power  is  desired,  each  partner  will  usually 
designate  one  or  more  directors,  so  that  the  completed  board  will 
contain  an  equal  number  of  representatives  for  each  partner. 
Where  the  partnership  consists  of  three  or  more,  the  usual 
practice  is  to  make  the  number  of  directors  equal  to  the  number 
of  partners,  elect  all  the  partners,  or  the  chosen  representatives 
of  any  partners  not  wishing  to  appear  on  the  board,  and  then 
make  provision  for  the  maintenance  of  the  board  so  constituted. 

Where  there  are  two  partners  the  matter  is  less  easily  ar- 
ranged. Three  is  the  minimum  number  of  directors  usually 
allowed,  and  the  necessity  of  having  a  third  director  who  really 
has  the  deciding  vote  in  any  point  of  difference  makes  the  situa- 
tion difficult.  Sometimes  a  confidential  clerk,  or  a  mutual 
friend,  or  the  wife  of  one  of  the  partners  is  chosen,  but  in  event 
of  any  difference  the  result  is  apt  to  be  very  unsatisfactory.  If 
possible,  a  mutual  friend  of  character  and  standing  may  be 
elected,  with  the  understanding  that  he  is  not  to  be  involved  or 
troubled  in  any  way  unless  serious  differences  arise,  when  he  will 
virtually  act  as  an  arbitrator.  Another  plan  is  to  have  some 
indifferent  person  accept  the  office  and  immediately  resign, 
leaving  the  third  position  vacant  with  the  two  partners  in  con- 
trol to  fight  out  any  differences,  just  as  they  would  have  done 
in  the  days  of  the  partnership.  If  this  plan  were  objectionable 
on  account  of  the  incomplete  condition  of  the  board,  the  mem- 
bership of  the  directorate  might  be  fixed  at  four,  each  partner 
being  elected  to  the  board  and  designating  an  additional  member. 
In  such  case  it  may  be  wise  to  provide  for  arbitration  in  case  bf 
a  deadlock. 


5o6  '■iVr-A      CORPORATE  LAW  [Bk.  I- 

§  547.    Maintenance  of  Agreed  Management       ,f^^^  .,rf*  ^.f  r  ,-,; 

When  the  composition  and  manner  of  election  of  the  board 
of  directors  has  once  been  decided,  some  means  of  securing  the 
permanency  of  the  agreed  arrangement  is  usually  desirable.  If 
mere  representation  of  the  minority  interest  on  the  board  is 
desired,  this  may  usually  be  secured  by  the  adoption  of  cumula- 
tive voting.  In  some  states,  however,  cumulative  voting  is  not 
permissible  and  in  many  cases  more  than  minority  representa- 
tion is  desired.  Other  means  must  then  be  adopted.  Some  of 
these  are  as  follows: 

I.  By  Voting  Trust. — The  voting  trust  is  often  the  most 
satisfactory  means  of  preserving  the  agreed  status  of  corporate 
management,  the  members  of  the  old  partnership  usually  con- 
stituting the  membership  of  the  trust. 

The  objections  to  the  voting  trust  for  such  a  purpose  are  its 
limited  duration,  and  the  fact  that  the  stock  owned  by  the  part- 
ners is  itself  locked  up  in  the  trust  and,  for  purposes  of  sale  or 
other  use,  must  be  represented  by  trustees'  certificates  instead 
of  the  usual  stock  certificates. 

If  In  New  York  and  Maryland  the  life  of  a  voting  trust  is  by 
statute  expressly  limited  to  five  years,  and  it  is  doubtful  whether 
the  arrangement  could  be  enforced  or  continued,  save  by  mutual 
consent,  for  a  longer  period.  In  states  where  there  is  no  legis- 
lative provision  in  regard  to  the  voting  trust,  it  is  probable  that 
a  trust  for  the  purpose  of  maintaining  an  agreed  management 
would  be  sustained  for  any  reasonable  period,  as  ten  or  even 
more  years.  ,,n; 

In  case  of  the  formation  of  a  voting  trust,  the  actual  assign- 
ment of  the  stock  to  the  trustees  cannot  be  avoided,  as  irre- 
vocable proxies  would  be  practically  impossible  under  the  usual 
conditions.  The  owners  of  the  stock  must  therefore  content 
themselves  with  trustees'  certificates.  For  holding  and  for 
some  other  purposes  these  certificates  would  not  be  objec- 
tionable. For  selling  or  for  use  as  collateral  they  would  not 
be  so  available  as  the  stock  itself. 


Ch.  59]  INCORPORATING  A  PARTNERSHIP  507 

2.  By  Voting  Requirements. — In  most  states  where 
special  charter  provisions  are  allowed,  it  may  be  provided  that 
any  desired  majority  shall  be  necessary  for  the  election  of  direc- 
tors, and  this  majority  may  be  made  so  large — even  up  to  the 
unanimous  vote  of  all  the  outstanding  voting  stock — that  the 
agreed  status  of  the  board  can  be  disturbed  only  by  the  active 
consent  of  all  interested  parties.  Deadlocks  may  occur  at  times 
under  such  a  provision,  but  their  only  effect  would  be  to  leave 
the  board  in  statu  quo,  thus  maintaining  the  agreed  arrangement 
but  dispensing  with  the  election. 

It  would  be  but  rarely  advisable  or  wise  to  require  unanimous 
consent  to  the  election  of  directors.  The  same  ends  may  be 
practically  secured  by  a  two-thirds  or  three-fourths  majority, 
and  the  danger  of  factious  opposition  by  holders  of  a  small 
number  of  shares  is  thereby  avoided. 

It  is  to  be  noted  that  under  this  arrangement,  in  event  of 
the  death  or  resignation  of  a  director,  the  interests  for  which  such 
director  stood  would  not  be  represented  on  the  board  and  could 
regain  such  representation  only  by  consent  of  sufficient  stock 
to  make  up  an  electing  majority.  This  objection  to  the  plan  is 
under  some  conditions  fatal. 

3.  By  Classification  of  Stock. — The  classification  of  stock 
offers  a  very  permanent  method  of  maintaining  a  representative 
directorate.  Each  partner's  stock  may  be  constituted  a  class 
with  some  convenient  arbitrary  designation,  as  "Class  A," 
"Class  B,"  or  "Class  i,"  "Class  2,"  etc.,  and  each  one  of  these 
classes  be  endowed  with  the  right  to  elect  one  or  more  directors. 
If  desired,  one  class  may  be  allotted  a  greater  number  of  directors 
than  others,  though  usually  each  class  is  allowed  equal  power  as 
to  the  election  of  directors. 

For  instance,  in  the  incorporation  of  a  partnership  with 
property  and  other  assets  of  the  estimated  value  of  $ioo»ooo, 
of  which  $50,000  belongs  to  one  partner,  $30,000  to  a  second, 
and  $20,000  to  a  third,  it  might  be  desired  that  the  same  equal 
participation  in  the  managerrient  that  characterized  the  partner- 


5o8  CORPORATE  LAW  (Bk.  I- 

ship  should  be  continued  in  the  corporation.  This  might  be 
effected  with  absolute  certainty  by  capitalizing  at  the  esti- 
mated value  and  dividing  this  stock  into  three  classes,  $50,000 
in  the  first,  $30,000  in  the  second,  and  $20,000  in  the  third; 
giving  to  each  class  the  right  to  elect  one-third  of  the  membership 
of  the  board,  and  issuing  to  each  partner  the  class  of  stock  which 
represents  his  partnership  interests.  Then,  notwithstanding 
their  very  unequal  interests  in  the  business,  each  would  elect 
one-third  the  total  number  of  directors.  If  it  were  not  desired 
to  secure  this  absolute  equality  in  the  management  of  the 
business  but  merely  to  insure  representation  to  the  two  minority 
partners,  this  stock  might  be  classified  as  before  on  any  appor- 
tionment deemed  expedient,  the  first  class  being  given,  say, 
three  directors  of  a  board  of  five,  and  the  second  and  third  classes, 
one  each. 

Under  this  system  the  interests  holding  any  one  class  are 
absolutely  sure  that,  so  long  as  they  hold  their  stock  intact, 
or  hold  a  clear  majority  of  j/,they  can  elect  their  allotted  member- 
ship of  the  board,  and  that  in  no  other  way  than  by  the  purchase 
of  at  least  a  majority  of  their  stock  can  this  representation  be 
wrested  from  them.  It  is  obvious  that  the  plan  is  capable 
of  considerable  variation  to  fit  special  cases. 

A  modification  of  this  plan  where  equal  representation  is 
desired,  is  to  divide  the  voting  stock  of  the  corporation  equally 
among  the  partners,  and  then  issue  preferred  stock  without  the 
voting  power  to  cover  the  excess  investment  of  any  particular 
partner.  Also,  where  more  capital  is  desired,  such  non-voting 
preferred  stock  may  be  sold  without  interfering  with  the  original 
division  of  power. « 

§  548.    Officers 

In  the  conversion  of  a  partnership  into  a  corporation,  little 
difficulty  is  experienced  in  the  selection  of  officers,  as  the  partners 
usually  take  these  positions;   their  previous  habits,  duties,  and 

•  See  {{  221.  534.  .  li.fj 


Ch.  59)  INCORPORATING  A  PARTNERSHIP  509 

positions  in  the  firm  designating  with  more  or  less  precision  the 
official  position  for  which  each  is  best  fitted. 

It  may  be  noted,  however,  if  there  is  difficulty  in  the  assign- 
ment of  the  official  positions,  that  outside  of  a  few  matters 
specified  or  implied  by  the  statutes  of  some  states,  the  powers 
and  duties  of  officers  may  be  fixed  absolutely  by  charter  or 
by-laws.  The  power  of  the  president  may  be  restricted  in 
any  way  the  conditions  seem  to  demand,  any  desired  limita- 
tions may  be  placed  upon  the  power  of  the  treasurer,  the 
secretary  may  be  assigned  any  powers  or  duties  within  or  without 
the  usual  range,  and  any  or  all  of  these  officers  may  be  made  as 
dependent  upon,  or  as  independent  of,  the  board  and  of  their 
fellow  officers  as  may  be  deemed  expedient. 

Usually  it  is  not  the  part  of  wisdom  to  vary  the  customary 
powers  and  relations  of  the  corporate  officers,  but  occasionally 
in  the  adjustment  of  partnership  relations  under  the  corporate 
form  such  changes  may  be  made  to  advantage. 


^'t 


CHAPTER  LX 

THE  MANAGEMENT  OF  CLOSE  CORPORATIONS 

§  549.    Close  Corporations  and  Their  Conduct 

As  a  rule,  when  partnerships  are  incorporated  all  the  stock 
is  issued  to,  and  held  by,  the  former  partners,  who  are  also 
officers  and  directors  of  the  new  corporation.  The  corporation 
is  then  owned  by,  and  in  fact  composed  of,  these  few  persons. 
Such  a  corporation  in  which  all  the  stock  is  held  by  a  few  per- 
sons who  are  also  officers  and  directors  of  the  corporation,  is  a 
typical  "close"  corporation. 

The  conduct  of  a  close  corporation  can  be,  and  usually  is, 
more  informal  than  that  of  the  ordinary  corporation  with  a 
number  of  stockholders.  Especially  is  this  the  case  with  incor- 
porated partnerships  where  the  members  of  the  new  corporation 
are  friends  and  associates  of  long  standing  and  are  accustomed 
to  working  together.  1 

The  business  of  a  close  corporation  of  this  nature  is  conducted 
with  the  same  informality  as  that  of  an  ordinary  partnership. 
The  directors  and  officers  are  chosen  at  the  time  of  organization , 
and  it  is  usually  understood  that  this  organization  is  to  be  per- 
manent. If  owing  to  death  or  withdrawal  a  vacancy  occurs,  a 
special  meeting  of  the  board  is  very  easily  called  to  elect  a  suc- 
cessor. The  various  duties  are  assigned  to  the  different  officers 
on  the  basis  of  their  duties  under  the  partnership.  About  some 
matters  all  will  confer;  other  matters  will  be  decided  by  special 
officers  who  have  them  particularly  in  hand.  Frequently  some 
one  man  dominates  everything  and  directs  the  business  just  as 
he  did  before  in  the  partnership. 


'  See  preceding  chapter,  "Incorporating  a  Partnership." 

Sio 


Ch.  6o]  ,  CLOSE   CORPORATIONS  511 

§  550*    The  Apportionment  of  Profits 

The  profits  of  a  close  corporation  may  be  apportioned  with 
the  same  "absence  of  formality.  Usually  by  agreement  certain 
salaries  are  attached  to  the  various  ofiicial  positions,  and  most 
of  the  profits  are  taken  out  in  this  manner.  As  the  amount  paid 
in  salaries  diminishes  by  that  much  the  income  of  the  corpora- 
'tion  and  thus  avoids  the  payment  of  state  and  federal  income 
taxes,  there  is  in  every  close  corporation  a  strong  temptation  to 
raise  the  salaries  of  the  principal  officers  to  the  maximum  figure. 
As  the  profits  of  a  close  corporation  are  usually  largely  the  re- 
turns for  personal  ability  and  business  skill,  there  is  often  good 
ground  for  the  payment  of.  liberal  salaries.  The  tax  officials  will, 
however,  properly  interfere  if  the  salaries  exceed  fair  payment 
for  the  services  rendered  and  are  obviously  being  used  to  evade 
the  payment  of  taxes.  At  some  future  time  it  is  likely  that 
there  may  be  more  definite  rules  on  this  subject  than  exist  at 
present.  Now  it  is  hard  to  decide  in  each  case  what  is  legally 
and  ethically  justifiable. 

From  the  practical  standpoint,  the  free  and  easy  conduct 
of  the  ordinary  close  corporation  is  not  open  to  serious  criticism. 
Nor,  so  long  as  all  goes  well  and  no  stockholder  objects,  and  no 
creditors  remain  unpaid,  is  there  any  legal  objection. 

§  551  •     Judicial. Approval  of  Informal  Management 

How  far  the  courts  sustain  this  informal  conduct  of  close 
corporations  is  shown  by  the  following  cases: 

In  Hall  v.  Herter  Brothers,2  a  partnership  had  incorporated 
with  five  incorporators,  consisting  of  the  two  partners,  the  father 
of  one  partner,  the  brother  of  the  other,  and  a  salesman  who 
had  been  with  the  partnership  for  some  time — a  typical  close 
corporation.  Judge  Alton  B.  Parker,  in  discussing  the  very 
informal  procedure  of  the  corporation,  said:  "Now,  when  there 
are  so  few  interested  in  the  management  of  a,  corporation, 
ordinary  business  may  be  transacted  without  the  formality  of 

'  8j  Hun  (N.  Y.)  19,  22  (1894) 


512  CORPORATE  LAW  ,  [Bk.  I- 

resolutions.  It  may  be  done  by  conversation  without  formal 
votes." 

In  the  Massachusetts  case  of  Melledge  v.  Boston*  lion  Com- 
pany,3  the  court  said:  ''Where  a  corporation  consists  of  a  small 
number  of  persons,  like  a  partnership,  they  may  transact  all 
their  business  by  conversation  without  formal  votes." 

In  Little  v.  Garrabrant,^  a  corporation  consisted  of  Richard 
Worthington  holding  lo  shares,  his  wife  holding  139  shares,  her 
housekeeper  holding  50  shares,  and  a  nephew  holding  i  share. 
"From  the  beginning  to  the  end  all  of  the  family  expenses,  rent, 
fire  insurance,  taxes,  together  with  their  contributions  to  charity 
and  church  and  missionary  societies,  were  paid  out  of  moneys 
of  the  Worthington  Company  by  checks  drawn  against  its 
account  in  the  bank  or  from  the  proceeds  of  checks  thus  drawn." 
Nevertheless  the  court  held  that  there  was  no  illegality  in  this 
exceedingly  loose  method  of  doing  business,  and  that  creditors 
who  became  such  after  the  time  of  this  distribution  could  not 
complain.  Creditors  who  were  such  at  the  time  might  have 
objected  to  the  very  irregular  disbursement  of  the  corporate 
funds,  but  creditors  who  became  such  later  could  not. 

In  the  case  of  Groh  Sons  v.  Groh,5  where  a  brewery  owned 
by  the  Groh  family  had  become  incorporated,  the  court  said: 

As  between  the  owners  and  holders  of  all  the  stock  of  a  corpora- 
tion, it  must  in  principle  follow  that  the  members  of  such  corpora- 
tion entitled  to  receive  dividends  may  agree  among  themselves, 
either  by  conversation  or  otherwise,  to  appropriate  of  the  funds  of 
the  corporation  a  specified  sum,  as  agreed  upon,  and  distribute  the 
same,  and  the  stockholders,  upon  receipt  of  it,  will  acquire  good 
title  thereto  as  against  the  other  members  of  the  corporation.  It 
amounts  to  a  mere  division  of  the  property  by  agreement  of  all 
the  parties  in  interest,  and  as  between  them  it  is  perfectly  good 
and  may  not  be  attacked  where  the  act  does  not  impair  the  rights  of 
third  parties. 


»  5  Gush.  158,  179  (1849). 

« 90  Hun  (N.  Y.)  404;  affd.,  iS3  N.  Y.  66i  (1897). 

680  App.  Div.  (N.  Y.)  8s  (1903);  see  also  Eureka  Iron  Works  v.  Bresnahan,  60  Mich. 
332   (1886);  Lemars  Shoe  Store  Co.  v.  Manufacturing  Co.,  89  III.  App.  245   (1899). 


Ch.  60]  CLOSE  CORPORATIONS  513 

The  decision  in  this  case  was  afterward  reversed;  not,  how- 
ever, because  of  this  very  informal  method  of  declaring  divi- 
dends, but  on  other  grounds. 

§  552.    Minimum  Number  of  Stockholders  in  a  Corporation 

In  the  consideration  of  close  corporations,  the  minimum  num- 
ber of  stockholders  required  to  form  a  legal  corporation  is  a 
matter  of  importance.  The  minimum  of  incorporators  in  most 
of  the  states  is  three  and  this  fixes  the  original  number  of  stock- 
holders, but  there  is  usually  no  statutory  requirement  that  this 
number  of  stockholders  shall  be  maintained.  It  is  but  seldom 
that  a  corporation  has  less  than  three  stockholders,  but  there  is 
no  legal  objection  to  one  person  owning  all  the  stock  of  a  cor- 
poration, save  in  those  states  where  directors  must  be  stock- 
holders. There  would,  however,  be  practical  difficulties  in  the 
conduct  of  a  corporation  with  but  one  stockholder,  and  in  any 
such  case  it  would  be  expedient  to  put  at  least  the  nominal 
ownership  of  one  or  more  shares  of  the  stock  in  the  names  of 
other  parties.  This  would  qualify  these  others  for  board  posi- 
tions and  would  also  enable  them  to  assist  in  holding  meetings. 
In  England  it  has  been  held  that  one  stockholder  cannot  con- 
duct a  meeting  by  himself,  but  in  this  country  the  reverse  has 
been  held.^ 

In  most  of  the  states  three  directors  are  prescribed  by  the 
statutes,  and  if  the  directors  must  also  be  stockholders,  this  in 
itself  necessitates  at  least  three  stockholders.  It  is  always 
possible  to  comply  with  any  legal  or  practical  requirements  for 
additional  stockholders  by  placing  the  nominal  or  actual  owner- 
ship of  one  or  more  shares  of  stock  in  the  names  of  suitable 
parties. 

§  553*    Restricting  the  Sale  of  Stock 

The  stock  of  a  close  corporation  is  usually  not  for  sale.  On 
the  other  hand,  a  stranger  would  not  usually  desire  to  buy 

•  Sharp  V.  Dawes,  2  Q.  B.  Div.  26  (1876);  In  re  Sanitary  Carbon  Co.,  12  W.  N.  223 
(1877);  contra,  Morrill  v.  Little  Falls  Mfg.  Co.,  S3  Minn.  371  (1893). 


514  CORPORATE  LAW  [Bk.  I- 

stock  in  a  close  corporation,  as  the  stockholders  in  control,  if 
they  were  disposed  to  resent  the  intrusion  of  the  newcomer, 
could  combine  in  many  ways  to  make  his  holding  unsatisfactory. 
To  make  assurance  doubly  sure,  however,  special  arrangements 
are  often  made  to  prevent  the  sale  of  stock  in  close  corporations 
to  strangers.' 

The  most  common  method  of  attempting  this  is  the  passage 
of  a  by-law  prohibiting  the  sale  of  stock  to  anyone  not  already 
a  stockholder,  or  prohibiting  the  sale  of  stock  unless  with  the 
consent  of  the  directors,  or  unless  it  has  first  been  offered  to  the 
directors  at  a  price  not  greater  than  that  at  which  it  is  subse- 
quently offered  or  sold  to  outsiders.  Such  by-law  provisions 
are  usually  illegal  and  incapable  of  enforcement,  as  the  policy 
of  the  law  is  opposed  to  any  restrictions  upon  the  free  transfer 
of  stock.  If  a  stockholder,  in  defiance  of  the  terms  of  such  a 
by-law,  should  sell  his  stock,  the  purchaser  could  force  the  cor- 
poration to  recognize  him  as  a  stockholder  and  to  issue  him 
certificates  in  his  own  name. 

If,  however,  any  such  restriction  were  printed  on  the  stock 
certificate,  it  would,  regardless  of  its  legal  force,  make  the  stock 
extremely  difficult  to  sell  and  would  thus  indirectly  accomplish 
the  desired  end.  Few  people  care  to  purchase  rights  which  may 
require  tedious  and  expensive  process  of  law  for  their  en- 
forcement. 

In  one  case  a  by-law  was  framed  providing  that  no  transfer 
would  be  recognized  by  the  corporation  unless  the  written  con- 
sent thereto  of  the  three  directors  of  the  corporation  was  in- 
dorsed on  the  certificate.  This  by-law  was  embodied  in  the  cer- 
tificate, and  a  blank  form  of  directors'  consent  was  printed  on 
the  back  with  places  for  the  signatures  of  the  three  directors. 
In  practice  this  effectually  prevented  the  sale  of  the  stock;  but 
if  anyone  had  in  defiance  of  the  provision  purchased  the  stock 
without  the  consent  of  the  directors,  he  could  have  forced  the 
corporation  to  recognize  his  rights  as  a  stockholder. 

'  See  Book  II,  §  56. 


Cli.  60]  CLOSE  CORPORATIONS  515 

Stockholders  may,  however,  mutually  agree  to  give  each 
other  an  option  to  purchase  their  stock  at  a  specified  price,  or 
at  an  appraised  price,  or  at  a  price  not  greater  than  that  at 
which  it  afterwards  might  be  sold.  In  any  such  case  the  con- 
tract is  legal  as  between  the  stockholders;  but  if  in  violation  of 
his  agreement  a  stockholder  sold  his  stock,  the  purchaser  would 
take  it  unaffected  by  this  fact.  The  seller  might  be  held  liable 
in  damages  to  the  other  parties  but  the  sale  would  stand. 

In  a  New  York  case  four  parties,  wishing  to  perpetuate  the 
successful  management  of  a  valuable  business,  agreed  that  in 
event  of  the  death  of  any  of  the  parties,  or  in  event  of  any  party 
wishing  to  sell,  the  other  parties  should  have  a  thirty-day  option 
on  his  stock  at  $125  per  share.  When  one  of  the  parties  died,  his 
executor  refused  to  carry  out  the  contract.  Suit  was  brought 
to  compel  specific  performance  and  the  contract  was  upheld. « 

There  is  a  Hne  of  cases  in  Massachusetts  and  New  Hampshire 
in  which  by-laws  restricting  the  alienation  of  stock  have  been 
sustained  as  between  the  parties  to  the  contract — i.e.,  the  stock- 
holders who  purchased  stock  knowing  of  and  agreeing  to  the 
by-law  restrictions — on  the  general  ground  that,  while  such  a 
by-law  might  be  contrary  to  public  policy  as  it  applied  to  the 
rights  of  outsiders,  it  was  valid  as  a  contract  between  the 
stockholders.  ^ 


•Scruggs  V.  Cotterill,  67  A.  D.  (N.  Y.)  583  (1902);  Costello  v.  Brewing  Co.,  69  N.  H. 
40s  (1898). 

»  Trust  Co.  V.  Abbott,  162  Mass.  148  (1894).  This  case  is  discussed  in  27  L.  R.  A.  271; 
Blue  Mt.,  etc.,  Asso.  v.  Boirr)V/e>  71  N.  H.  6p  (1901). . 

'J'/'  '•  ■■•'-•    ■■•' '    ■■■"'•    ■■  '■■■■■■      ■■'  ''<  ■  -  ■■■.-■. 


bnoy 

.'  b'j^i^ui-qijj 


CHAPTER  LXI 

CONSOLIDATION,  REORGANIZATION  AND 
DISSOLUTION! 

§  554.    Forms  of  Consolidation 

The  methods  by  which  corporations  may  be  practically  uni- 
fied are  as  follows: 

1.  Consolidation  of  one  or  more  corporations  by  statutory 

procedure. 

2.  Purchase  by  a  corporation  of  the  entire  assets  of  one  or 

more  other  corporations. 

3.  Lease  by  a  corporation  of  the  entire  property  of  one  or 

more  other  corporations,  usually  for  a  'specified  amount 
or  a  guaranteed  dividend. 

4.  Purchase  by  a  corporation  of  a  stock  control  in  one  or 

more  other  corporations. 

5.  Combination,  usually  by  means  of  a  holding  company. 2 

The  terms  consolidation,  combination,  merger,  and  amalga- 
mation are  loosely  applied  to  any  of  the  foregoing  plans  for 
joining  the  interests  of  two  or  more  corporations.  Strictly 
speaking,  a  consolidation  is  the  combination  or  merging,  by 
procedure  prescribed  by  the  statutes,  of  two  or  more  corpora- 
tions into  a  single  new  organization  embracing  the  respective 
interests  and  property  of  the  merged  corporations.'  Such  con- 
solidation without  statutory  authority  is  ultra  vires,  i.e.,  beyond 
the  corporate  powers,  and  hence  void,  unless  authorized  by 
unanimous  vote  of  all  the  stockholders. 


•  See  Book  II,  Ch.  XVIII,  "Combinations,"  Ch.  XL,  "Reorganizations";  also  Book  III, 
Part  VI,  "Reorganization,  Receivership  and  Dissolution." 

'  Noyes'  Intercorporate  Relations,  §  i. 

•  Green's  Brice's  Ultra  Vires  (2nd  Edition),  §  631. 

516 


Ch.  6i]  CONSOLIDATION  AND   DISSOLUTION  517 

In  any  case  where  it  is  desired  to  unify  corporate  businesses, 
careful  study  of  all  the  circumstances  and  local  statutes  should 
be  made  before  deciding  on  the  method  to  be  followed,  in  order 
on  the  one  hand  to  avoid  violation  of  existing  law,  and  on  the 
other,  hand  to  secure  the  most  effective  possible  combination. 
The  assistance  of  skilled  counsel  is  always  necessary  to  accom- 
plish this. 

§  555.    Statutory  Consolidation 

In  nearly  all  the  states  laws  are  provided  for  the  consolida- 
tion of  non-competing  railroads.  Not  so  many  have  statutes 
authorizing  consolidation  of  business  corporations.  Such  stat- 
utes, when  they  exist,  are  usually  made  to  apply  only  to  cor- 
porations engaged  in  the  same  or  similar  business.  Under  such 
provisions  a  gas  company  and  an  electric  light  company  have 
been  held  competent  to  consolidate. 

Where  there  are  statutes  providing  for  consolidation,  it  is 
usually  specified  that  a  majority  or  two-thirds  or  three-fourths 
of  the  stockholders  of  each  railroad  must  vote  in  favor  of  such 
action;  and  in  many  of  the  states  dissenting  stockholders  may 
require  the  corporation  to  purchase  their  stock  at  an  appraised 
valuation.  If  there  is  no  statutory  form  for  consolidation,  it 
may,  unless  in  some  way  prohibited,  always  be  authorized  by 
the  unanimous  vote  of  all  the  stockholders. 

The  usual  procedure  for  statutory  consolidation  is  as  follows : 

,i)if/to?»>  I  Agreement  as  to  terms  by  directors  of  the  consolidating 
ju .  aliwi      corporations. 

2.  Submission  of  directors'  agreement  to  the  stockholders 
.vyrj:',''      oi  each  company  at  a  duly  assembled  meeting, 
"lo  Y  J^'  Assent  of  the  stockholders  to  the  directors'  agreement  by 
sH)  )o       3.  required  vote. 
_iJf^f4,  Filing  of  certified  copies  of  the  agreement  and  the  vote 

in  its  favor  in  the  same  offices  in  which  the  original 
^^  certificate  of  incorporation  of  each  of  the  consoUdated 

corporations  was  filed. 


Si8  CORPORATE  LAW  [Bk.  I- 

Ordinary  business  corporations  rarely  combine  under  the 
statutory  provisions,  as  it  is  usually  simpler  to  unite  by  some 
other  method. 

§  556.    Consolidation  by  Purchase  of  Assets  '       '  ** 

When  all  the  stockholders  consent,  a  business  corporation — 
as  distinguished  from  a  public  utilities  corporation — may  sell 
its  entire  assets  for  the  stock  of  another  corporation.  The  first 
corporation  may  then  dissolve  and  divide  its  assets — which  con- 
sist of  the  stock  of  the  other  corporation — among  its  stockhold- 
ers. The  purchasing  corporation  then  continues  both  its  own 
business  and  the  business  of  the  dissolved  corporation,  the 
stockholders  of  the  defunct  corporation  now  holding  their  pro- 
portionate interest  in  the  operating  corporation. 

This  is  the  simplest  and  best  method  of  effecting  a  consolida- 
tion. The  only  obstacle  to  its  use  is  found  in  the  fact  that  one 
dissenting  stockholder  can  interpose  and  prevent  the  consum- 
mation of  the  plan.  In  such  case  it  is  often  possible  to  buy  out 
any  dissenters  and  carry  out  the  consolidation  as  proposed. 

A  public  utilities  corporation  having  a  franchise  derived  from 
the  public  is  not  free  to  sell  it  at  pleasure.  In  such  cases  con- 
solidation must  be  effected  in  some  other  way. 

§  557-    Consolidation  by  Lease  of  Property 

A  lease  of  the  entire  property  of  a  prosperous  corporation 
may  be  made  only  by  unanimous  consent  of  all  its  stockholders, 
and  consolidation  by  means  of  a  lease  contract  is  therefore 
available  only  where  consolidation  could  be  effected  by  sale  of 
the  corporate  assets  as  already  discussed. 

A  corporation  that  is  in  a  failing  condition  may,  however, 
lease  its  property  by  action  of  its  directors,  or  of  a  majority  of 
its  stockholders  when  such  lease  is  for  the  best  interests  of  the 
creditors  and  stockholders,*  and  in  this  case  a  practical  consoli- 
dation by  means  of  a  lease  is  possible.  ^'^^  ^^*  ' 

•■,i:-,rt'i-,- 

<  Skinner  v.  Smith,  134  N.  Y.  240  (1892);  Bartholomew  v.  Derby  Rubber  Co.,  69  Conn. 
521  {1897). 


Ch.  6i]  CONSOLIDATION  AND  DISSOLUTION  519 

In  many  cases  railroads  are  empowered  to  lease  their  prop- 
erties, and  such  action  may  be  authorized  by  majority  vote  of  the 
stockholders.  A  practical  consolidation  by  means  of  a  lease  is 
then  possible. 5 

Where  a  vaHd  lease  of  a  corporation's  entire  property  is  made, 
the  lessor  corporation's  only  active  business  operations  are  then 
the  reception  of  its  rentals  and  the  apportionment  of  these 
among  its  stockholders  as  dividends.  In  some  cases  property  is 
leased  on  the  basis  of  a  guaranty  of  a  certain  dividend  on  the 
stock  of  the  lessor  corporation. 

§  558.     Consolidation  by  Purchase  of  Controlling  Interest 

When  it  is  desired  to  unify  the  operations  of  two  or  more 
corporations,  it  may  be  done  by  the  common  ownership  of  a 
controlhng  interest  in  each  corporation.  This  controlling  inter- 
est may  be  in  the  hands  of  an  individual,  a  syndicate,  or  a  hold- 
ing corporation. 

The  approved  form  is  by  means  of  a  holding  corporation, 
formed  under  the  laws  of  New  Jersey,  New  York,  Maine,  Dela- 
ware, or  some  other  state  where  corporations  are  empowered  to 
hold  the  stock  of  other  corporations.  This  "holding  company" 
buys  up  a  majority  of  the  stock  of  the  companies  which  it  is 
desired  to  unite.  At  the  next  annual  elections  of  these  controlled 
corporations  boards  of  dummy  directors  are  elected,  who  man- 
age the  different  combined  corporations  along  common  and 
non-conflicting  lines  in  accordance  with  the  instructions  of  the 
holding  corporation. 6  The  plan  was  for  a  time  a  very  effective 
method  of  forming  a  trust.  ^ 

§  559*    Combinations 

This  is  a  very  general  term  embracing  pooUng  agreements, 
trusts,  the  different  forms  of  holding  companies,  and  general 


»  Dady  v.  Georgia,  etc.,  Ry.,  112  Fed.  838  (1900). 
•  See  Ch.  LVII,  "Holding  Companies." 
'  For  present  stattis,  see  i  526. 


$20  CORPORATE  LAW  [Bk.  I- 

associations  to  prevent  competition,  maintain  prices,  and  limit 
production.  The  original  plan  of  a  board  of  trustees  holding 
controlling  interests  in  the  corporations  to  be  combined  was  held 
illegal. 8  Partnership  agreements  between  corporations  have  like- 
wise been  held  illegal. 

The  federal  statutes  and  the  statutes  of  almost  every  state 
prohibit  and  provide  for  punishment  of  combinations  in  restraint 
of  trade  or  for  purposes  of  preventing  competition.  It  is  diffi- 
cult or  impossible  at  the  present  time  to  form  any  legal  com- 
bination to  regulate  prices, 

§  560.    Trade  Associations 

Since  it  has  become  legally  impossible  to  form  any  sort  of  a 
combination  to  maintain  prices  or  limit  competition,  many  lines 
of  business  have  united  in  trade  associations.  These  associations 
are  based  on  the  theory  that: 

Knowledge  regarding  bids  and  prices  actually  made  is  all  that 
is  necessary  to  keep  prices  at  reasonably  stable  and  normal  levels.* 

Their  operation  is  thus  described : 

In  order  that  they  might  know  as  definitely  as  possible  what 
the  supply  and  demand  of  the  market  would  be,  they  decided  to 
have  their  secretary  compile,  at  regular  intervals,  statistics  that 
would  show  exactly  how  the  market  stood.  The  members  severally 
agreed  to  furnish  to  the  secretary  confidentially  the  information 
about  production,  orders,  and  shipments  that  was  necessary  in 
order  to  compose  these  reports.  The  secretary  was  not  to  make 
public  the  private  information  received  from  members  but  was  to 
issue  all  statistics  in  summaries.^" 

There  are,  it  is  said,  over  1,000  of  these  associations  in 
operation  to-day.  So  long  as  they  confine  their  activities  to 
merely  keeping  their  members  informed  as  to  trade  conditions 
and  happenings,  they  violate  no  law,  but  in  some  cases  it  is 


'State  V.  Standard  Oil,  49  Ohio  137  (1892);  People  v.  North  River  Sugar  Refining  Co., 
121  N.  Y.  582  (1890). 

'  The  New  Competition,  by  Arthur  Jerome  Eddy  (rgis),  p.  126. 
•0  Trade  Associations,  by  Emmett  Hay  Naylor  (1921),  p.  10.        Jc/'iK  ''i.,"'«'-'''j.'>'i'j  ■ 


Ch.  6i]  CONSOLIDATION  AND  DISSOLUTION  521 

probable  they  have  gone  beyond  this  and  have  laid  themselves 
open  to  the  charge  of  restraming  competition  and  maintaining 
prices.  Some  form  of  trade  association  is  inevitable  and  these 
associations  doubtless  have  a  future  before  them. 

Since  the  foregoing  was  written,  the  United  States  Supreme 
Court  has  rendered  a  decision  adverse  to  the  open  price  com- 
petition plan  of  the  American  Hardwood  Manufacturers'  Asso- 
ciation. This  is  the  first  case  that  has  come  before  the  Supreme 
Court  in  which  the  legal  questions  as  to  the  practices  of  organ- 
izations known  as  "open  price  associations"  have  been  consid- 
ered. [In  it  the  Supreme  Court  sustained  the  permanent  injunc- 
tion granted  by  the  lower  courts  restraining  329  hardwood 
manufacturers  from  compiling,  exchanging,  and  discussing  prices, 
production,  stocks,  and  market  conditions. 
jjf{,The  court  in  its  decision  held  that  the  plan  "constituted  a 
joint  conspiracy  to  restrict  lumber  production  in  the  country 
and  keep  prices  up."  The  decision  seems  to  be  far-reaching  and 
will  probably  make  it  absolutely  impossible  for  industrial  groups 
to  study  their  economical  problems,  and  pool  their  information 
through  market  letters.  It  is  probable  that  all  of  the  trade 
associations  in  the  country  at  the  present  time  are  doing  things 
condemned  by  this  decision. 

It  is  to  be  noted  that  in  this  case  both  Justice  Brandeis  and 
Justice  Holmes  delivered  carefully  written  dissenting  opinions. 
Justice  Holmes  stated  that  in  his  opinion  the  decision  prohibited 
the  distribution  of  information  as  to  stocks,  production,  or  the 
discussion  of  prices,  and  even  the  exchange  of  opinions  as  to 
prices  in  the  future.  It  would  seem  that  the  decision  was  un- 
fortunate in  that  it  places  the  smaller  manufacturers  and  pro- 
ducers at  a  disadvantage  as  compared  with  their  larger  rivals. 
In  the  case  of  the  United  States  Steel  Corporation  the  courts 
were  of  the  opinion  that  it  was  not  unlawful  to  vest  in  a  single 
corporation  the  control  of  50%  of  the  steel  industry  of  the 
country,  but  now  it  is  held  that  the  smaller  steel  corporations 
which  exchange  statistical  information  to  equalize  their  com- 


522  CORPORATE  LAW  [Bk.  I- 

petitive  disadvantage  are  doing  that  which  is  illegal.  This  would 
seem  directly  to  encourage  the  formation  of  large  corporate 
combinations. 

§  561.    A  Possible  Solution 

It  would  seem  possible  for  experts  in  each  line,  possibly  the 
officers  of  existing  trade  associations,  to  form  their  own  indi- 
vidually conducted  bureaus  of  information,,  to  collect  and  dis- 
tr  bute  trade  information  along  particular  lines  to  those  willing 
to  pay  them  for  their  services.  Such  bureaus  of  information 
exist  in  many  directions  already,  and  it  would  not  seem  that 
there  could  be  any  legal  objection  to  such  an  arrangement.  In 
so  far  as  trade  associations  are  operated  to  collect  and  dissemi- 
nate trade  information,  to  record  past  transactions  and  give 
accounts  of  the  trend  of  trade  activities  in  various  parts  of  the 
country,  these  private  bureaus  could  probably  take  their  place. 

§562.    Reorganization  n  ^^L>h  IUh 

Reorganization  is  generally  employed  as  a  !rtieans  of  rehabili- 
tating a  corporation  that  has  failed  or  become  financially  em- 
barrassed or  entangled,  when  its  name,  property,  franchises, 
trade-marks,  or  good-will  are  still  worth  saving.  The  term  is 
loosely  applied  to  various  forms  of  consolidation,  new  incorpora- 
tions, and  similar  arrangements. 

Reorganization  is  not  uncommon  in  the  case  of  railroads  and 
other  public  service  corporations.  The  franchises  of  these  cor- 
porations must  usually  be  operated  or  they  are  lost,  and  stock- 
holders and  creditors  are  as  a  rule  better  satisfied  to  have  the 
corporation  continue  in  some  reorganized  form  under  which  they 
still  have  an  interest  or  recognized  claim,  even  though  reduced, 
than  to  permit  the  corporate  assets  to  be  sold  for  the  inade- 
quate prices  of  a  forced  sale,  or  the  franchise  to  lapse  for  non- 
user. 

Reorganization  is  also  not  infrequent  in  the  case  of  insolvent 
or  embarrassed  business  corporations  when  the  creditors  consent 


Ch.  6ii  CONSOLIDATION  AND  DISSOLUTION  523 

to  some  adjustment  or  arrangement  of  their  claims  that  will 
permit  the  corporate  business  to  continue.  The  reorganization 
in  such  case  may  be  limited  to  a  mere  issue  of  additional  stock 
or  bonds,  or  may  extend  so  far  as  to  be  in  effect  a  new  in- 
corporation. 

If  such  reorganization  is  not  possible  and  the  business  of  the 
embarrassed  corporation  is  of  sufficient  value,  the  usual  plan 
pursued  is  for  all  or  the  principal  stockholders  of  the  old  cor- 
poration to  form  a  new  and  entirely  distinct  corporation.  The 
property  and  business  of  the  embarrassed  corporation  are  then 
allowed  to  go  to  forced  sale  and  are  bought  in  as  nearly  in  their 
entirety  as  possible  by  the  new  corporation.  This  latter  then 
takes  a  clear  title  to  these  assets  and  conducts  the  business 
thereafter  free  from  all  claims  of  creditors  or  stockholders  of 
the  old  corporation.  A  similar  procedure  is  sometimes  improp- 
erly employed  in  order  to  "freeze  out"  small  or  objectionable 
stockholders  the  corporation  being  deliberately  involved  or 
allowed  to  be  involved  for  the  purpose. 

§  563.    Dissolution 

A  corporation  may  be  dissolved  by  the  expiration  of  the 
term  for  which  the  charter  was  granted.  This  does  not,  how- 
ever, often  happen.  If  the  corporation  is  active  and  prosperous, 
some  form  of  reorganization  or  extension  of  the  corporate  exis- 
tence is  effected  before  the  expiration  of  its  charter  period.  If 
it  is  not  profitable,  it  is  usually  dissolved  or  allowed  to  lapse 
long  before  its  charter  term  expires. 

A  corporation  may  also  be  dissolved  by  insolvency.  In  such 
case  a  receiver  may  be  appointed  to  dispose  of  its  assets  and 
divide  the  proceeds  among  its  creditors,  or  the  corporation  may 
be  allowed  to  go  into  bankruptcy  and  its  affairs  be  wound  up  by 
a  trustee.  Even  though  a  corporation  is  insolvent,  it  may  be 
rescued  from  dissolution  by  an  abatement  of  the  creditors' 
claims,  or  by  the  contribution  of  additional  capital  by  stock- 
holders or  others. 


524  CORPORATE  LAW  ,  <  Vj  [Bk.  I- 

A  corporation  may  always  be  dissolved  and  its  affairs  be 
wound  up  by  proper  procedure  if  all  its  stockholders  consent. 
In  many  states  a  majority  of  the  stockholders — and  in  some 
states  less  than  a  majority — may  dissolve  the  corporation  under 
some  circumstances  by  prescribed  statutory  procedure.  ; 

•-"' '  Corporations  destitute  of  assets  are  sometimes  practically 
dissolved,  or  allowed  to  lapse  by  simply  ceasing  to  transact 
business.  Such  corporations  are  not  technically  out  of  existence 
and  in  some  cases  their  officers  are  still  subject  to  liabilities. 
The  procedure  is,  however,  easy  and  inexpensive  and  many 
corporations  end  in  this  manner  regardless  of  the  possible  lia- 
bilities of  their  officials. 


M 


Part  XIII — ^Allied  Forms  of  Organization 


CHAPTER  LXII 

JOINT-STOCK  COMPANIES  AND  PARTNERSHIP 
ASSOCIATIONS 

§  564.    Joint-Stock  Companies 

In  the  United  States  an  unincorporated  joint-stock  company 
with  its  capital  divided  into  transferable  shares  may  be  formed 
in  the  same  manner  as  an  ordinary  partnership,  merely  by 
agreement  of  the  parties.  Except  in  the  state  of  New  York,  no 
license  is  necessary,  no  public  registry  is  prescribed,  nor  are 
formalities  of  any  kind  required.  Such  an  association  may  issue 
transferable  certificates  of  stock,  and  may  provide  against  ter- 
mination by  reason  of  the  death,  withdrawal,  or  insolvency  of 
one  or  mbre  of  its  members.  The  association  may  designate 
agents  to  attend  to  its  business  and  then  only  these  authorized 
agents  can  do  business  for  it.  The  members  cannot  act  for  it 
and  bind  it  as  in  an  ordinary  partnership.  The  members  of  such 
a  common  law  joint-stock  company  are,  however,  subject  to  full 
partnership  liability.^ 

In  New  York  any  joint-stock  association  doing  business  in 
the  state  must,  within  60  days  after  its  formation,  and  thereafter 
in  each  January,  file  with  the  secretary  of  state  and  with  the 
county  clerk  a  written  certificate  giving  its  name,  date  of  organ- 

»  Bates  on  Partnership,  {  72;  Famum  v.  Patch,  60  N.  H.  294  (1880);  Carter  v.  McClure, 
08  Tenn.  109  (1897);  Hoadley  v.  Commissioners,  105  Mass.  519  (1870);  Bank  v.  Dean,  124 
Mass.  81  (1878);  Edwards  v.  Warren  Linoline,  etc.,  Works  and  Trustee,  168  Mass.  564  (1897); 
Taber  v.  Breck,  192  Mass.  3SS  (1906):  Frost  v.  Walker,  60  Me.  468  (1872);  Wadsworth  v. 
Duncan,  164  111.  360  (1897);  Phillips  v.  Blatchford,  137  Mass.  sio  (1884);  Roberts  v.  Anderson, 
326  Fed.  7  (191S). 

525 


526  CORPORATE  LAW  [Bk.  I- 

ization,  number  of  stockholders,  names  and  residences  of  its 
officers,  and  its  place  of  business.  The  statutes  empower  it 
under  certain  circumstances  to  hold  real  property  in  the  name  of 
its  president,  and  it  may  mortgage  such  real  estate  by  the  same 
procedure  as  is  required  of  a  corporation.  These  organizations 
have  come  up  before  the  courts  of  New  York  from  time  to  time 
and  it  has  been  repeatedly  held  that  "a  joint-stock  company  is 
a  partnership  with  some  of  the  powers  of  a  corporation. "2 

The  Court  of  Appeals  said  of  the  National  Express  Company : 

The  company  was  formed  as  a  joint-stock  company  or  associa- 
tion in  1853  by  a  written  agreement  of  eight  individuals  with  each 
other,  the  whole  force  and  effect  of  which,  in  constituting  and 
creating  the  organization,  rested  upon  the  common  law  rights  of 
the  individuals  and  their  power  to  contract  with  each  other.  The 
relation  they  assumed  was  wholly  the  product  of  their  mutual 
agreement,  and  dependent  in  no  respect  upon  the  grant  or  authority 
of  the  state.  It  was  entered  into  under  no  statutory  license  or 
permission,  neither  accepting  nor  designed  to  accept  any  franchise 
from  the  sovereign,  but  founded  wholly  upon  the  individual  rights 
of  the  associates  to  join  their  capital  in  an  enterprise  ir^  a  relation 
similar  to  that  of  a  partnership.^  ;  . 

§  565.    Disadvantages  of  the  Form 

The  joint-stock  company  form,  while  advantageous  in  many 
respects,  is  not  extensively  used,  for  the  following  reasons : 

1.  The  members  of  the  company  are  individually  liable  for 
its  entire  obligations. 

2.  While  the  company  can  do  business  under  its  company 
name,  it  cannot  hold  real  property  or  convey  the  same  by  its 
collective  name,  the  conditions  requiring  any  deed  or  encum- 
brance of  real  property  to  be  executed  by  every  member  of  the 
company,  unless  such  real  property  is  taken  and  held  by  some 
agent  or  officer  as  trustee  for  the  company,  when  conveyances  or 
encumbrances  must  be  executed  by  this  trustee. 

3.  The  joint-stock  company  must  bring  suit  in  the  names  of 

2  Hibbs  V.  Brown,  190  N.  Y.  167  (1907);  Matter  of  Jones,  172  N.  Y.  575  (1902). 

3  People  V.  Coleman,  133  N.  Y.  279  (1892). 


Ch.  62]  JOINT-STOCK  COMPANIES  527 

the  individuals  composing  it  and,  if  it  is  sued,  only  those  mem- 
bers who  are  served  with  process  can  be  held. 

•'^  In  New  York  it  is  provided  that  any  joint-stock  company  or 
association  may  sue  or  be  sued  in  the  name  of  the  president  or 
treasurer,  and  individual  members  shall  not  be  sued  until  exe- 
cution against  the  company  has  been  returned  unsatisfied.  This 
provision  seems  to  apply  to  all  New  York  copartnerships  of  seven 
or  more.    It  is  not  found  in  other  states.^ 

Several  of  the  leading  express  companies  of  the  country  are 
organized  as  joint-stock  companies  and  the  arrangement  seems 
to  have  worked  well.  These  companies  have  been  before 
the  court  many  times  and  the  cases  will  be  found  instructive. s 

§  566.    When  the  Form  Can  Be  Used 

The  common  law  joint-stock  company  has  advantages  over 
the  ordinary  partnership  that  should  commend  it  in  some  cases 
at  least,  and  particularly  where  the  publicity  and  liability  to 
taxation  of  the  corporate  form  are  objectionable.  In  many 
businesses  the  danger  of  partnership  liability  is  too  remote  to 
trouble  the  members,  and  in  such  cases  the  joint-stock  organiza- 
tion secures  the  same  transferability  and  divisibility  of  interests 
as  does  the  corporation,  and  also  avoids  the  interruption  often 
caused  by  the  death  of  a  partner.  The  joint-stock  company 
could  not  usually  be  employed  where  stock  is  to  be  sold  to 
investors,  as  these  would  not  risk  the  partnership  liability 
involved.  It  could,  however,  be  used  in  many  cases  as  a  sub- 
stitute for  the  close  corporation.  In  such  case  the  articles  of 
association  should  be  carefully  prepared,  as — "The  articles  of 
association  of  an  unincorporated  joint-stock  company  bear  the 
same  relation  to  it  that  the  charter  bears  to  an  incorporated 
company.  They  regulate  the  duties  of  the  officers  and  the 
duties  and  obligations  of  the  members  of  such  a  company  among 
themselves.  "6 


<  Taft  V.  Ward,  io6  Mass.  518  (1871).     In  the  report  of  this  case  a  full  outline  of  the 
articles  of  association  of  the  New  England  Express  Co.  is  given. 

^        'Chapman  v.  Barney,  129  U.  S.  677  (1888);  Express  Co.  v.  State,  $5  O.  St.  69  (1896). 
-     «  Bray  v.  Farwell,  81  N.  Y.  600  (1880). 


528  CORPORATE  LAW  [Bk.  I- 

§  567.    Partnership  Associations 

In  Pennsylvania  and  Michigan  the  statutes  provide  for  the 
organization  of  what  are  termed  "partnership  associations." 
These  have  nothing  in  common  with  the  voluntary  associations 
of  Massachusetts.  They  differ  from  a  corporation  only  in  the 
following  particulars: 

1.  Interests  in  a  partnership  association  may  be  transferred 
as  provided  by  the  rules  and  regulations  of  each  association — 
in  most  cases,  the  association  adopts  the  plan  of  stock  certificates 
— but  in  case  of  a  transfer  the  transferee  must  be  elected  a  mem- 
ber of  the  association  before  he  can  vote  or  participate  in  the 
management.  If  he  is  not  elected,  the  interest  already  trans- 
ferred to  him  must  be  bought  out  at  an  agreed  price,  or  in  default 
of  such  an  agreement  an  appraiser  appointed  by  the  court  will 
appraise  the  same. 

2.  Originally  no  special  fees  or  taxes  were  imposed  upon  these 
associations  in  the  state  where  they  were  formed;  but  now  in 
both  Pennsylvania  and  Michigan  organization  fees  similar  to 
organization  fees  of  corporations  are  prescribed. 

In  Pennsylvania,  when  a  partnership  association  is  to  be 
formed,  a  statement  answering  in  a  general  way  to  a  certificate 
of  incorporation  must  be  made  by  three  or  more  persons  and  filed 
with  the  recorder  of  deeds  for  the  county.  The  filing  fees  are 
nominal,  but  a  bonus  of  3^  of  1%  upon  the  amount  of  the  capi- 
tal stock  must  be  paid  to  the  state  treasurer. 

In  Michigan  partnership  associations  were  first  authorized  in 
1877,  and  the  provisions  were  as  simple  as  in  Pennsylvania. 

In  1903  the  legislature  amended  the  law,  and  now  the  pro- 
cedure for  the  formation  of  a  voluntary  association  is  similar  to 
that  for  the  organization  of  a  corporation.  As  stated  by  the 
statute,  three  or  more  persons  desiring  to  secure  limited  lia- 
bility must  sign  and  acknowledge  a  statement  or  articles  of 
association  giving  their  full  names  and  the  amount  of  capital 
subscribed  by  each;   the  total  capital  and  when  and  where  to 


Ch.  62]  PARTNERSHIP  ASSOCIATIONS  529 

be  paid;  the  character  of  the  business;-  its  location;  the  name 
of  the  association  followed  by  the  word  "limited";  its  duration, 
not  exceeding  20  years;  and  the  names  of  the  officers.  This 
statement  is  to  be  recorded  in  the  offices  of  the  secretary  of 
state  and  of  the  county  clerk  and  a  fee  of  1/20  of  1%  is  to  be 
paid  on  organization.  Thereafter  annual  reports  are  to  be 
made.  In  Michigan,  for  the  protection  of  the  minority,  cumu- 
ative  voting  has  been  provided  for  in  the  election  of  managers. 

§  568.    Opinions  of  the  Courts  on  Partnership  Associations 

In  Pennsylvania  the  court  characterized  associations  of  this 
nature  as  "quasi-corporations,"  stating  that  "technically  they 
were  not  corporations  but  had  many  of  the  features  of  a  cor- 
poration," and  held  that  in  ascertaining  their  legal  status  both 
the  law  of  corporations  and  the  law  of  partnerships  should  be 
resorted  to  according  to  the  particular  feature  under  con- 
sideration. ^ 

In  Michigan  partnership  associations  are  governed  by  the 
law  of  corporations  rather  than  by  the  law  of  limited  partner- 
ships.« 

In  a  case  in  one  of  the  federal  courts  it  was  held  that  they 
were  in  effect  corporations.    The  court  said: 

But  these  associations  authorized  by  the  Pennsylvania  act  of 
1874  possess  every  attribute  deemed  essential  to  the  existence  of  a 
corporation.  ,  .  .  When  organized,  they  constitute  a  new  ar- 
tificial person,  endowed  with  the  power  of  suing  and  being  sued, 
and  of  acquiring,  holding  and  conveying  property  in  its  artificial 
character.  Created  by  compliance  with  the  constating  law,  they 
can  be  dissolved  only  in  the  way  pointed  out  by  that  law.  In- 
dividual liability  for  corporate  debts,  beyond  unpaid  subscription 
to  the  capital  stock,  does  not  exist.' 

This  decision  was  later  overruled  by  the  Supreme  Court  of 


'Carter  v.  Producers'  Oil  Co..  182  Pa.  St.  S5i.  S63  (1897). 

•Rouse,  etc.,  Co.  v.  Detroit,  etc.,  Co.,  in  Mich.  251  (1896);  s.  c,  38  L.  R.  A.  794;  Wood 
V.  Sloman,  150  Mich.  177  (1907);  Armstrong  v.  Stearns,  156  Mich.  597  (1009). 
•Andrews  Bros.  v.  Voungctown  Coke  Co.,  Ltd.,  86  Fed.  585.  S90  (1898). 


530  CORPORATE  LAW  [Bk.  I- 

the  United  States,  which  refused  to  consider  a  partnership 
association  under  Pennsylvania  laws  as  being  anything  more 
than  a  joint-stock  company. lo 

In  Massachusetts  also,  the  Supreme  Court  refused  to 
treat  these  partnership  associations  otherwise  than  as  ordinary 
joint-stock  companies  and  held  that  a  Pennsylvania  partnership 
association  could  not  be  sued  under  its  associate  name  in  the 
courts  of  Massachusetts,  and  approved  the  doctrine  that  "at 
common  law  a  joint-stock  company  formed  for  business  pur- 
poses, is  considered  in  this  commonwealth  merely  as  a  partner- 
ship, "n 

Partnership  associations  may  be  useful  in  the  respective 
states  which  provide  for  their  formation,  but  their  legal  status 
elsewhere  is  too  uncertain  for  their  use  by  businesses  operating 
in  other  states.  If  the  states  of  Pennsylvania  and  Michigan 
had  lowered  their  corporate  fees  and  taxes,  and  thus  made  the 
corporation  form  more  generally  available  and  attractive,  they 
would  have  served  all  practical  ends  better  than  by  the  creation 
of  a  new  form  of  nondescript  business  organization. 

§  569.    Syndicates  and  Joint  Adventures 

A  syndicate  is  defined  as  an  association  of  individuals  formed 
for  the  purpose  of  conducting  and  carrying  out  some  par- 
ticular business  transaction,  ordinarily  of  a  financial  character, 
in  which  the  members  are  mutually  interested.  It  is,  as  respect- 
ing the  persons  composing  it,  a  partnership,  and  the  legal  obliga- 
tions assumed  by  the  members  are,  as  between  themselves,  sub- 
stantially the  same  as  those  of  an  ordinary  partnership.  12 

A  joint  adventure  is  simply  a  partnership  limited  in  scope 
and  duration  by  the  fact  that  it  applies  to  but  a  single  business 
transaction.  The  liability  of  the  co-adventurers  is  equal,  and 
as  to  third  parties  is  entirely  independent  of  the  amount  ad- 


>«  Great  So.  Hotel  Co.  v.  Jones,  177  U.  S.  449  (1899). 

»  Edwards  v.  Warren  Linoline,  etc.,  Works  and  Trustee,  168  Mass.  564  (1897). 
"  37  Cyc,  p.  661;  Hambleton  v.  Rhind,  84  Md.  456  (1897);  Hossack  v.  Ottawa  Develop- 
ment Assn.,  244  111.  274  (1910). 


Ch.  62]  PARTNERSHIP  ASSOCIATIONS  53 1 

vanced.  The  members  of  such  a  partnership  may,  of  course, 
make  any  agreement  between  themselves  they  choose  as  to  their 
respective  investments,  interests,  and  liabihties,  but  this  does 
not  affect  their  Hability  to  third  parties. 

The  members  of  a  syndicate  would  undoubtedly  be  held 
liable  to  third  parties  as  partners  if  the  enterprise  became  abso- 
lutely insolvent.  As  most  syndicates  are  formed  for  financial 
investments  or  underwritings,  and  either  involve  no  obligations 
in  excess  of  the  amounts  contributed,  or,  if  otherwise,  have 
well-defined  and  well-understood  liability  as  to  the  syndicate 
transactions,  and  as  the  members  of  such  syndicates  are  usually 
men  or  concerns  of  wealth  and  standing,  the  question  of  part- 
nership liability  rarely  arises.  If  there  were  any  danger  of  such 
liability  it  could  probably  be  avoided  by  organization  under  a 
declaration  of  trust  with  express  exclusion  of  individual  Hability. 


CHAPTER  LXIII 

EXPRESS  TRUSTS  AS  A  FORM  OF  BUSINESS 
ORGANIZATION 

§  570.    What  a  "Trust"  Is 

In  law  a  trust  is  created  whenever  property  is  placed  in  the 
possession  of  one  or  more  persons  in  trust,  to  hold  it  and  pay- 
over  the  profits  to  designated  beneficiaries.  It  originated  in 
the  desire  of  men  to  set  aside  property  for  the  benefit  of  their 
wives  or  children,  in  such  shape  that  the  principal  would  be 
preserved  intact  and  the  income  only  would  be  used  for  the 
beneficiaries.  Those  who  held  the  property  thus  set  aside,  were 
designated  as  trustees. 

A  trust  of  this  kind  could  be  created  by  deed  or  by  will.  The 
rights  of  the  beneficiaries,  the  duties  of  the  trustees,  and  the 
rules  for  safeguarding  the  estate  held  in  trust  were  gradually 
worked  out  by  the  courts  of  equity  into  a  fair,  well-balanced 
system.  Trust  estates  were  frequently  created  for  the  benefit 
of  charitable  and  educational  institutions.  At  times  when  money 
was  loaned,  the  property  by  which  it  was  secured  was  trans- 
ferred by  a  deed  of  trust  to  trustees,  who  in  case  of  default  sold 
the  property  and  divided  the  receipts  among  the  creditors. 
Where  railroads  and  large  corporations  issue  bonds  secured  in 
this  way  by  deed  of  trust,  the  functions  of  the  trustee  or  trus- 
tees become  in  some  cases  very  extensive  and  of  vital  importance 
to  the  holders  of  bonds.  In  cases  of  bankruptcy,  if  the  business 
needed  care,  trustees  were  appointed  to  conduct  it,  wind  it  up, 
and  divide  the  surplus.  In  some  of  these  cases  it  was  sought  to 
hold  the  trustees  who  were  running  a  bankrupt  business  and  the 
creditors  for  whose  benefit  it  was  being  run,  liable  as  partners. 

53^ 


Ch.  63]  EXPRESS  TRUSTS  533 

This  the  EngHsh  courts  refused  to  do.^     The  courts  in  this 
country  have  followed  the  English  courts  in  their  decisions.2 

§  571.    What  an  "Express  Trust"  Is 

A  trust  is,  as  just  stated,  an  arrangement  by  which  a  person 
known  as  the  "trustee"  holds  property  for  the  benefit  and  ad- 
vantage of  another,  known  as  the  "beneficiary"  or,  in  legal 
phrase,  as  the  cestui  que  trust. 

An  express  trust  is  a  trust  created  by  an  instrument  in 
writing  called  a  "declaration  of  trust,"  "trust  agreement,"  or 
"deed  of  trust";  or  it  may  be  created  by  will. 

The  parties  to  a  trust  are:  (i)  the  creator,  (2)  the  trustee, 
and  (3)  the  beneficiary  or  cestui  que  trust. 

The  property  or  subject  matter  may  be  real  estate  or  money, 
goods,  chattels,. or  choses  in  action.  Anything  may  be  the  sub- 
ject of  a  trust  that  can  be  held  legally. 

Wherever  the  legal  estate  or  interest  is  in  one  person  and 
the  equitable  interest  is  in  another,  a  trust  exists.  It  is  called 
a  "trust"  because  it  is  founded  on  trust  and  confidence  in  the 
trustee,  that  he  will  carry  out  the  wishes  of  the  creator  of  the 
trust  as  expressed  in  the  will  or  trust  instrument. 

A  trust  is  not  a  contract,  but  in  a  court  of  equity  a  trust  can 
be  enforced,  and  hence  all  litigation  concerning  trusts  is  con- 
ducted in  the  courts  of  equity  or  chancery. 

§  572.    Legal  and  Equitable  Title  to  the  Property 

An  essential  feature  of  a  trust  is  the  vesting  of  the  legal  title 
to  the  property  involved  in  the  trustee.  If  it  is  real  estate, 
every  feature  of  ownership,  title  on  public  records,  actual  pos- 
session, UabiUty  for  taxes,  right  to  sue  for  trespass,  etc.,  is  in 
the  trustee.     No  one  else  has  power  to  sell,  mortgage,  or  lease. 


'  Cox  V.  Hickman,  8  H.  of  L.  Cases  268  (i860);  Smith  v.  Anderson,  L.  R.  is,  Ch.  D.  247, 
284  (1879). 

•Hart  V.  Seymour,  147  111.  S98  (1893);  Mallory  v.  Russell,  71  Iowa  63  (1887);  Mason  y. 
Pomeroy,  151  Mass.  164  (1890);  Mayo  v.  Moritz,  151  Mass.  481  (1890);  Johnson  v.  Lewis, 
6  Fed.  27  (1881);  Taylor  v.  Davis,  no  U.  S.  330  (1884);  Lackett  v.  Rumbaugh,  4s  Fed.  23-29 
(1891);  Wells-Stone  Mercantile  Co.  v.  Grover,  7  N.  D.  460  (1898);  41  L.  R.  A.  252;  Spotswood 
y.  Morris,  12  Idaho  360  (1906);  s.  c,  6  L,  R.  A.  (N.  S.)  665. 


534  CORPORATE  LAW  [Bk.  I- 

Every  element  of  legal  possession  is  in  him.     If  there  are  several 
trustees,  and  one  dies,  the  title  passes  to  the  survivors. 

As  the  legal  title  is  in  the  trustee,  so  is  the  beneficial  interest 
entirely  in  the  one  for  whose  benefit  the  trust  was  created. 
Being  an  equitable  title,  any  dispute  concerning  its  terms  or 
interference  with  the  rights  of  the  beneficiary  will  have  to  be 
settled  in  a  court  of  equity  instead  of  in  a  court  of  law. 

§  573*    Who  May  Create  a  Trust 

It  may  be  broadly  said  that  everyone  who  is  competent  to 
make  a  will  or  to  enter  into  a  contract  is  competent  to  create  a 
trust.  Ownership  of  property  and  power  to  transfer  it  are  all 
that  is  required  to  make  a  trust.  If  any  solvent  person  has  full 
title  to  property  and  has  capacity  to  contract,  he  can  transfer 
the  legal  title  to  a  trustee  to  hold  in  trust. 

A  person  who  is  insolvent  could  not  create  a  trust  that  would 
put  his  assets  out  of  reach  of  his  creditors.  A  person  incompe- 
tent to  contract  by  reason  of  minority,  lunacy,  or  some  other 
incapacity,  could  not  as  a  rule  create  a  trust  that  would  bind 
him.     The  trust  so  created  would  be  voidable 

Married  women  are  practically  under  no  disabilities  in  this 
country  and  may  create  trusts  at  their  discretion. 

§  574.    Who  May  Be  a  Trustee 

The  following  statement  from  an  English  work  sums  up  the 
qualifications  necessary  for  a  trustee:  "A  person  to  be  appointed 
trustee  should  be  (i)  a  person  capable  of  taking  and  holding  the 
legal  estate,  and  (2)  possessed  of  legal  capacity  and  natural 
ability  to  execute  the  trust,  and  (3)  domiciled  within  the  juris- 
diction of  the  court.  "8  The  last  item  is  a  statement  of  the  gen- 
eral requirement  that  trustees  must  be  citizens  of  the  state  in 
which  the  trust  estate  is  situated. 

The  selection  of  a  person  to  hold  property  in  trust  involves 


'  Lewin  on  Trusts,  p.  27. 


Ch.  63]  EXPRESS  TRUSTS  535 

putting  faith  an«i3  confidence  in  "his  integrity:  literally,  the 
creator  trusts  him  with  the  property.  Because  of  this  he  is  termed 
the  "trustee"  and  the  arrangement  is  called  "a  trust,"  meaning 
thereby  the  obligation  resting  on  a  person  to  whom  property 
has  been  given  for  a  particular  purpose,  to  apply  the  property 
for  that  purpose. 

§  575*    Use  of  Express  Trusts  in  Restraint  of  Trade 

When  the  large  industries  first  undertook  to  combine  and 
control  their  respective  businesses,  they  organized  under  the 
form  of  an  express  trust.  A  controlling  stock  interest  in  each 
corporation  was  transferred  to  a  board  of  trustees,  who  elected 
directors  subservient  to  them,  and  in  this  way  the  trustees 
dominated  the  industries.  The  first  great  monopolies,  the  Stand- 
ard Oil  Trust,  the  Sugar  Trust,  and  the  Bay  State  Gas  Company, 
were  each  organized  as  an  express  trust,  in  which  a  board  of 
trustees  took  over  the  stocks  of  the  constituent  companies  and 
issued  trust  certificates  to  the  owners.  Thereafter,  until  the 
courts  declared  such  organizations  illegal,  these  boards  of  trus- 
tees were  in  control  of  their  respective  industries.  The  courts 
decided  that  trusts  of  this  nature  were  illegal,  not  because  of 
any  objection  to  their  form  of  organization,  but  because  their 
objects  were  illegal. 

nt  When  the  trust  form  was  forbidden  to  these  monopolies, 
holding  corporations  or  large  owning  corporations  were  resorted 
to,  but  the  name  "trust"  persisted  and  is  still  used  to  designate 
the  great  monopolistic  corporations.  This  is  as  illogical  as  it 
would  be  to  call  large  partnerships  "corporations,"  and  has 
accordingly  resulted  in  much  confusion  of  popular  thought. 

By  reason  of  this  illegal  use  of  the  trust  form,  the  word 
"trust"  has  incurred  a  certain  enduring  but  entirely  undeserved 
odium.  It  is  necessary  that  its  actual  and  legal  meaning  should 
be  realized,  if  we  are  to  understand  how  it  may  be  used  as  a 
useful  form  of  organization  for  the  conduct  of  ordinary  and 
entirely  lawful  businesses.  bgluGuM  W4>ll»u.l 


536  CORPORATE  LAW  [Bk.  I- 

§  576.    Modem  Use  of  Express  Trusts  in  Business 

In  Massachusetts  prior  to  191 2,  the  corporation  laws  made 
no  provision  for  the  organization  of  real  estate  companies.  To 
secure  the  advantages  of  the  corporate  organization  so  far  as 
might  be  possible,  those  desiring  to  handle  real  estate  created 
an  express  trust,  by  executing  a  written  declaration  of  trust. 
The  parcels  of  real  estate  or  funds  to  purchase  the  property 
desired  were  placed  in  the  possession  of  the  trustees,  who  were 
given  full  powers  to  hold  and  deal  with  the  trust  estate  so 
created.  Those  who  executed  the  declaration  of  trust  were 
named  as  beneficiaries,  and  their  interests  were  represented  by 
transferable  trust  certificates.  Any  profits  were  to  be  appor- 
tioned among  the  beneficiaries  according  to  their  interests.  It 
was  provided  that  neither  the  trustees  nor  the  beneficiaries  were 
to  be  liable  for  any  debts  or  obligations  of  the  estate.  The 
trustees  took  the  places  of  the  directors  in  an  ordinary  corpora- 
tion, and  the  beneficiaries  took  the  places  of  the  stockholders. 

It  seemed  to  work  well  in  Massachusetts  in  handling  real 
estate,  and  its  use  was  gradually  extended  to  other  lines  of  busi- 
ness. Later  it  was  taken  up  in  other  parts  of  the  country  and 
employed  for  various  kinds  of  business  enterprises.  To  what 
extent  this  has  been  done  is  not  possible  to  ascertain,  because, 
as  it  is  a  private  arrangement  between  the  parties,  no  public 
record  is  required  save  in  a  few  of  the  states.  Unless  such  an 
association  gets  into  legal  difficulties  there  is  usually  no  data 
concerning  it  available  to  the  public. 

§  577.    Associations  Organized  as  Express  Trusts 

The  following  list  shows  some  of  the  better  known  concerns 
organized  under  the  trust  form: 

The  Mackay  Companies  (Postal  Telegraph) 

Great  Northern  Iron  Ore  Properties 

Texas  Pacific  Land  Trust 

Amoskeag  Manufacturing  Company 

Ludlow  Manufacturing  Associates  * 


Ch.  63]  EXPRESS  TRUSTS  537 

Massachusetts  Gas  Companies 

Chicago  City  and  Connecting  Railways  Collateral  Trust 

Chicago  Elevated  Railways  Collateral  Trust 

North  American  Pulp  and  Paper  Company 

Masonic  Temple  Trust  (Chicago) 

Montgomery  Ward  Warehouse  Associates 

Pepperell  Manufacturing  Company 

Massachusetts  Lighting  Companies 

New  Hampshire  Electric  Railways 

Within  the  last  few  years  this  form  of  organization  has  been 
used  extensively  in  Texas,  Oklahoma,  and  the  other  oil  regions 
of  the  South  and  Middle  West  for  the  purpose  of  exploiting  oil 
properties.  Most  of  these  enterprises,  being  purely  speculative, 
come  to  grief  and  those  who  have  invested  in  them  lose  their 
money.  This  tends  to  bring  the  express  trust  into  disrepute. 
It  is  obvious  that  these  failures  should  not  be  attributed  to  the 
form  of  organization,  as  the  investors  would  have  fared  no 
better  had  they  bought  shares  in  a  corporation  engaged  in  the 
same  risky  business. 

§  578.    Varied  Nomenclature  Applied  to  These  Associations 

The  fact  that  the  express  trust  as  a  form  of  business  organiza- 
tion is  yet  new  is  shown  by  the  different  names  under  which 
it  is  known.  The  latest  and  most  complete  work  as  yet  pub- 
lished on  the  subject  is  entitled  "Trust  Estates  as  Business 
Companies."*  The  objection  to  this  is  that  the  word  "estate" 
is  so  generally  used  to  designate  the  property  accumulated  by 
an  individual,  that  it  gives  a  false  impression  of  the  express 
trust. 

In  Massachusetts  such  associations  have  always  been  called 
"voluntary  associations,"  which  is  an  unsatisfactory  descrip- 
tion in  that  it  fails  to  differentiate  them  from  joint-stock  com- 
panies or  incorporations. 

In  some  parts  of  the  country  they  are  termed  "common  law 
companies,"  to  distinguish  them  from  statutory  corporations 

«  By  Sears. 


538  CORPORATE  LAW  (Bk.  I- 

and  joint-stock  companies.  This,  though,  is  objectionable  be- 
cause the  common  law  has  never  recognized  "trusts,"  which 
have  been  and  are  entirely  the  creatures  of  the  courts  of  equity. 
The  description  of  them  as  "associations  under  deeds  of 
trust"  is  accurate  but  cumbrous.  It  is  incorrect  to  call  them 
partnerships,  for  they  have  no  legal  element  of  a  partnership. 

§  579.    Misuse  of  Trust  Form  by  Incompetent  Parties 

Another  thing  that  has  tended  to  bring  this  form  of  business 
organization  into  disrepute  is  the  fact  that  lawyers  and  others 
of  little  business  or  professional  standing  have  advertised  to 
organize  such  associations  for  small  fees,  and  with  little  trouble 
to  the  promoters.  Such  organizations  have  been  made  with 
little  concern  as  to  the  laws  01  the  state  in  which  they  were  to 
operate,  or  to  the  needs  of  the  enterprise  for  which  they  were 
to  be  used.  Such  careless  and  slovenly  organization  is  apt  to 
be  disappointing  and  in  some  cases  disastrous  to  the  members. 
A  recent  and  very  competent  writer  on  this  subject  says: 

The  trust  idea  herein  discussed  has,  in  a  few  instances,  been 
commercialized  by  so-called  organizing  companies  in  much  the 
same  way  as  the  corporation  laws  of  certain  liberal  charter  granting 
states  are  advertised  and  exploited.  Forms  are  furnished  with 
apparently  little  regard  to  the  particular  purposes  in  view  or  the 
laws  of  the  state  wherein  the  trust  is  either  established  or  will  carry 
on  its  operations — no  warning  whatsoever  is  given  as  to  the 
methods  to  be  followed  and  the  strict  rules  of  equity  to  which 
trustees  are  subjected  are  unnoticed.  Those  in  search  of  a  "form 
method,"  the  avoidance  of  attorneys'  fees,  or  "cheapness"  in  or- 
ganization, will  generally  be  disappointed  in  the  results  which  they 
secure.  The  author  here  ventures  the  prediction  that  this  class  of 
organizers  will  fare  better  under  a  corporate  charter  than  they  will 
as  a  trust.  Incorporation  at  least  has  the  check  of  state  officials, 
and,  proper  steps  once  having  been  taken,  corporate  existence  is 
presumed  to  continue;  but  a  trust  must  always  be  a  trust  in  fact  as 
well  as  in  name,  and  must  be  opera  ted  as  such ;  no  mere  ipse  dixit  of 
the  trust  instrument  will  create  this  result.  No  one  but  a  competent 
legal  advisor  skilled  in  the  laws  of  the  state  in  question,  and  supplied 


Ch.  63]  EXPRESS  TRUSTS  539 

with  full  knowledge  of  his  client's  affairs,  can  be  relied  upon  to  deter- 
mine that  a  trust  should  be  created,  to  draft  the  trust  instrument 
properly  to  effectuate  the  objects  of  its  creation,  and  to  advise  and 
instruct  the  trustees  in  safe  management  of  the  trust  estate.^ 

§  580.    Present  Status  of  the  Express  Trust 

The  arrangements  by  which  property  is  placed  in  the  pos- 
session of  trustees  is  termed  in  law,  as  already  stated,  "a  trust," 
and  because  in  these  organizations  this  trust  is  created  by  ex- 
plicit words,  it  is  called  an  "express  trust."  The  result  is  that 
a  new  and  peculiar  form  of  business  organization,  without  in- 
corporation, formed  by  mere  agreement  of  the  parties,  has 
come  into  use.  '  >inV-.v}\  1 

In  a  report  of  the  Massachusetts  Commissioner  of  Corpora- 
tions made  to  the  legislature  of  that  state,  he  says:<* 

The  transferable  nature  of  these  shares  gives  to  these  associa- 
tions a  continuity  of  duration  usually  limited  by  express  provisions 
to  the  lives  of  the  subscribers  and  20  years  thereafter.  This  pro- 
vision differentiates  the  form  of  association  from  an  ordinary 
partnership,  where  the  death  of  a  partner  dissolves  the  partnership 
and  makes  it,  to  a  limited  extent,  similar  to  a  corporation  which 
may  or  may  not  have  perpetual  duration. 

The  report  also  states  in  further  characterization  of  the 
voluntary  association,  that  a  shareholder  has  no  right  to  an 
accounting,  as  in  a  partnership,  nor  any  right  to  examine  the 
books  as  in  a  corporation;  that  a  shareholder  is  not  a  tenant  in 
common  and  has  no  interest  in  the  property  of  the  trust;  that 
a  shareholder  is  not  responsible  for  the  debts  of  the  association ; 
and  that  a  provision  is  frequently  inserted  to  be  made  part  of 
every  contract  that  neither  shareholders  nor  trustees  are  to  be 
liable. 

In  closing  his  report  the  Commissioner  of  Corporations  sum- 
marizes the  advantages  afforded  by  these  voluntary  associations, 

as  follows: 

rr".  .T     . 

*  Scars  on  Trust  Estates  as  Bus.  Cos.  (1931),  {  8. 

*  Report  of  Mass.  Tax  Com.  upon  Voluntary  Assn.,  Jan.  17,  191a. 


540  CORPORATE  LAW  [Bk.  I- 

1.  The  experience  of  25  years  shows  that  they  furnish  a  con- 
venient, safe,  and  unobjectionable  form  of  co-operation,  ownership, 
and  management. 

2.  Their  form  of  management  is  more  flexible,  more  economical, 
and  more  convenient  than  that  of  a  corporation.  Trustees  can  do 
business  with  more  ease  and  rapidity  than  a  board  of  directors. 

3.  In  particular  they  afford  a  convenient  form  for  combining 
capital  for  the  development  and  improvement  of  real  estate,  as  the 
form  of  organization  insures  a  continuity  of  management  and 
control  that  specially  appeals  to  investors  in  real  estate,  and  which 
cannot  be  secured  by  a  corporation  on  account  of  the  change  of 
oflScers  each  year.  Trustees  are  not  changed  as  frequently  as  are 
directors  of  a  corporation. 

The  Commissioner  stated  that  where  such  associations  sought 
capital  in  the  open  market  they  should  be  subjected  to  the  same 
publicity  requirements  as  corporations. 

§  581.    Common  Advantages  of  Express  Trusts  and  Corporations 

The  use  of  the  express  trust  as  a  form  of  business  organiza- 
tion gives  the  following  advantages  which  are  also  common  to 
the  corporate  form: 

1.  Neither  shareholders  nor  trustees  are  liable  in  excess  of 

their  personal  interest  in  the  trust  property. 

2.  The  shares  are  transferable  as  are  corporate  shares. 

3.  Trustees  can  do  business  and  manage  the  trust  property 

as  directors  do  with  the  corporate  business  and  prop- 
erty. 

4.  For  all  practical  purposes  an  express  trust  can  be  made 

as  permanent  as  a  business  corporation.  In  most 
states  a  trust  can  be  created  for  one  or  more  lives  and 
21  years  more. 

5.  It  is  dissolved  by  agreement  as  readily  as  a  corporation. 

6.  An  express  trust  can  sue  and  be  sued  as  readily  as  a 

corporation  can. 

7.  Shareholders  have  a  right  to  accountings  and  to  all  such 

information  as  is  proper. 


Ch.  63]  EXPRESS  TRUSTS  541 

§  582.    Advantages  of  the  Express  Trust  Over  the  Corporate  Form 

In  the  following  particulars,  it  is  claimed  that  the  transaction 
of  business  under  an  express  trust  has  advantages  over  the 
corporate  form: 

1.  It  can  do  business  in  ary  part  of  the  country  as  freely  as 

an  individual  or  a  partnership.  In  some  states,  how- 
ever, the  members  may  be  held  as  partners. 

2.  It  is  not  required  to  make  out  the  reports,  to  take  out 

licenses,  and  to  pay  taxes  to  the  extent  that  is  re- 
quired of  a  corporation. 

3.  Under  some  conditions  the  permanence  of  management 
-    secured  by  a  continued  board  of  trustees  is  better  than 

the  plan  of  annual  elections. 

4.  The  trustees  may  ask  for  court  guidance  in  cases  where 

the  rights  or  powers  of  the  trust  are  unadjudicated 
or  not  clear, 

§  583.     Statutory  Regulations 

The  only  legislation  concerning  express  trusts  is  at  this  time 
found  in  Massachusetts  and  Oklahoma.  The  Massachusetts 
legislation  is  in  substance  as  follows  i^ 

1.  "Association"  means  a  voluntary  association  under  a 

written  instrument  or  declaration  of  trust  with  the 
beneficial  interest  divided  into  shares. 

2.  The  trustees  of  a  voluntary  association  under  a  written 

instrument  shall  file  this  declaration  of  trust  wdth  the 
commissioner  of  corporations,  and  with  the  clerk  of 
every  city  or  town  where  the  association  has  a  place 
of  business.  Any  amendment  of  the  declaration  of 
trust  shall  likewise  be  filed  with  the  commissioner  and 
the  town  clerks. 

3.  The  commissioner  of  corporations  shall  each  year  send 

copies  of  all  instruments  so  filed  to  the  secretary  of 
state,  who  shall  print  the  same. 

'  Cons.  Laws  of  Mass.,  Ch.  182;  Voluntary  Assn. 


542  CORPORATE  LAW  [Bk.  I- 

4.  Such  associations  may  be  sued  and  service  of  process  on 
any  one  trustee  is  sufl5cient. 

The  laws  in  Oklahoma  are  in  substance  as  follows :» 

1.  Express  trusts  may  be  created  in  real  or  personal  prop- 

erty. The  trustees  have  power  to  carry  on  or  conduct 
any  lawful  business  and  to  do  anything  in  respect 
thereto  that  an  individual  might  do. 

2.  Such  an  express  trust  must  be  created  by  written  instru- 

ment subscribed  by  the  grantors  and  duly  acknowl- 
edged. It  must  then  be  recorded  with  the  county 
clerk  of  the  county  where  the  property  is  situated  or 
the  business  is  conducted. 

3.  A  successor  must  be  provided  for  any  trustee  of  an  ex- 

press trust,  to  take  his  place  in  case  of  his  death, 
resignation,  removal,  or  incapacity. 

4.  Liability  for  all  trust  obligations  extends  to  the  whole 

of  the  trust  property,  but  no  liability  affects  the  trus- 
tees or  beneficiaries  personally. 

§  584.    Liability  to  State  Taxation 

Whatever  property  is  held  by  the  trustees  of  a  business  is 
taxable  as  other  property  held  by  individuals,  firms,  and  cor- 
porations, neither  more  or  less.  An  attempt  in  Massachusetts 
to  tax  the  shares  of  voluntary  associations  was  held  unconsti- 
tutional. It  is  one  of  the  advantages  of  such  trusts  that  they 
are  as  yet  not  liable  to  the  reports  and  taxes  and  licenses  required 
of  corporations. 

Such  associations  are  subject  to  the  federal  income  tax  if 
the  trustees  are  elected  annually  by  the  beneficiaries,  but  in 
Massachusetts  under  the  income  tax  law  enacted  in  19 16,  the 
legislature  has  tried  to  equalize  the  taxation  somewhat.  Under 
this  law,  dividends  or  shares  in  associations  and  trusts  having 
transferable  shares  are  taxable,  except  in  certain  cases  where 

*  Session  Laws  of  Oklahoma,  1921,  Ch.  16. 


Ch.  63]  EXPRESS  TRUSTS  543 

the  income  of  the  association  in  trust  would  be  exempt  if  re- 
ceived by  an  individual,  or  where  the  trustees  or  managers  agiee 
to  pay  the  tax.  Where  the  dividends  on  transferable  shares  are 
not  taxable,  the  income  of  associations  or  trusts  is  taxable  if 
derived  from  annuities,  professions,  employments,  trade,  or  busi- 
ness. 

Where  there  is  a  state  income  tax  law,  its  terms  and  its 
construction  by  the  state  courts  must  be  consulted,  to  ascertain 
whether  the  tax  imposed  is  to  be  paid  by  the  beneficiaries  or  by 
the  trustees.  ^rfJ  up'jvj)  enoii 

§  581^1 '  The  Federal  Income  Tax 

When  the  federal  income  tax  was  first  enacted  it  was  held 
that  such  associations  were  not  subject  to  its  provisions.  This 
has  been  changed,  and  the  present  ruling  is  as  follows: 

Where  beneficiaries  holding  certificates  evidencing  their  interest 
under  a  so-called  "Massachusetts  trust"  agreement  annually  elect 
persons  delegated  to  conduct  the  affairs  of  the  trusts,  thus  retain- 
ing a  voice  in  the  business,  the  trust  is  an  association  and  is  subject 
to  the  normal  tax  upon  its  income  under  the  Acts  of  1913,  191 6, 
and  191 8;  the  excess  profits  tax  under  the  Acts  of  191 7  and  1918; 
the  capital  stock  tax  under  the  Acts  of  1916  and  1918;  and  the  cer- 
tificates issued  by  the  trust  to  the  beneficiaries  are  subject  to  the 
stamp  tax  under  the  acts  of  191 7  and  1918. 

Where  the  trustees  originally  appointed  were  to  hold  office 
during  the  entire  period  of  the  trust,  the  right  of  the  shareholders 
being  limited  to  filling  vacancies,  the  beneficiaries  not  retaining  any 
substantial  control  over  the  affairs  of  the  trust,  such  a  trust  is  not 
an  association  or  taxable  as  such  under  section  230  of  the  act  of 
1918,  but  under  section  219  relating  to  trusts.  They  are  not 
subject  to  the  excess  profits  tax  nor  the  capital  stock  tax,  nor  are 
the  certificates  issued  by  the  trustees  subject  to  stamp  tax.» 

The  distinction  is  between  an  ordinary  tiust,  which  is  sub- 
ject to  the  rules  governing  trusts  and  trust  estates,  and  an  asso- 
ciation, wherein  trustees  are  elected  and  where  the  beneficiaries 


•  Montgomery  on  Income  Tax  Proc.  (1923),  p.  94. 


544  CORPORATE  LAW  [Bk.  I- 

thus  retain  a  certain  control  of  and  voice  in,  the  management 
of  the  business.  Where  such  management  is  exercised  by  the 
beneficiaries,  the  organization  is  held  to  be  a  business  associa- 
tion, and  is  subject  both  to  income  tax  and  capital  stock  tax. 

In  his  edition  of  1922,  Mr.  Montgomery  sets  forth  the  situa- 
tion as  follows: 

In  practice,  there  are  all  kinds  of  Massachusetts  trusts.  In 
some  the  beneficiaries  have  little  or  no  control  over  the  manage- 
ment of  the  trust;  others  have  practically  aU  the  characteristics 
of  corporations  (except  the  actual  corporate  existence  and  the 
limited  liability  of  a  stockholder  in  a  corporation),  and  are  governed 
by  elaborate  by-laws  providing  for  annual  meetings  of  certificate 
holders,  and  for  the  election  of  trustees  for  relatively  short  periods 
of  time,  thus  vesting  a  large  measure  of  control  in  certificate 
holders. 

From  a  tax  standpoint  the  question  is:  Is  a  Massachusetts 
trust  an  ordinary  trust  or  an  association?  If  the  latter,  it  is 
taxable  as  a  corporation.  If  the  former,  the  income,  if  distributa- 
ble, is  taxable  to  the  beneficiaries.'" 


>•  Montgomery  on  Inc.  Tax  Proc.  (1922),  p.  93. 


CHAPTER  LXIV 

HOW  AN  EXPRESS  TRUST  IS  ORGANIZED 

§  586.    Essential  Provisions  of  a  Trust  for  Business  Purposes 

The  essential  provisions  of  any  express  trust  organized  for 
business  purposes  are  as  follows : 

1.  A  deed  or  declaration  of  trust,  drawn  up  to  define  the 

rights  and  powers  of  trustees  and  shareholders. 

2.  Two  or  more  trustees  who  are  authorized  to  take  over 

and  manage  the  capital,  business,  or  other  property 
supplied  by  the  shareholders. 

3.  Shareholders   who   are   beneficiaries   and   who   receive 

transferable  certificates  representing  their  respective 
interests  in  the  profits  and  in  the  property  on  dissolu- 
tion. 

4.  Provisions  for  division  of  profits,  appointment  of  trustees 

to  fill  vacancies,  and  for  dissolution  at  termination  of 
the  trust. 

5.  Provisions  that  no  liability  is  to  attach  to  either  trustees 

or  shareholders,  but  only  to  the  trust  estate. ^ 

§  587.    The  Declaration  of  Trust 

When  an  express  trust  is  to  be  formed,  if  the  object  of  the 
trust  were  only  to  hold  real  property  and  pay  the  rentals  to  the 
beneficiaries,  it  might  be  attained  by  simply  turning  over  the 
property  to  the  trustees  by  a  simple  deed  of  trust.  If  cash, 
or  cash  and  property,  as  is  usually  the  case,  is  to  be  transferred 
to  the  trustees  for  the  establishment  and  conduct  of  some  busi- 


>  Hussey  v.  Arnold,  185  Mass.  203  (1904);  Bank  of  Topeka  v.  Eaton,  100  Fed.  Rep.  8 
(1900). 

545 


546  CORPORATE  LAW  [Bk.  I- 

ness  enterprise,  the  purposes  of  the  organization,  the  assets  it  is 
to  operate  with,  the  duties  of  the  trustees,  the  rights  of  the  bene- 
ficiaries, and  many  other  details  of  the  trust  are  set  forth  in 
appropriate  legal  phraseology  in  a  formal  instrument,  termed  a 
"declaration  of  trust,"  or  sometimes  a  "trust  agreement." 

In  such  case  the  declaration  of  trust  must  include  all  the  de- 
tails that  are  usually  set  out  in  the  charter  and  by-laws  of  a 
corporation.  The  shareholders  of  the  trust  as  beneficiaries  have 
no  voice  in  the  management,  they  can  pass  no  by-laws,  there  is 
no  annual  election,  they  cannot  remove  or  recall  any  of  the 
trustees;  hence  the  great  importance  of  the  declaration  of  trust, 
and  the  reason  for  its  elaborate  form. 

The  deed  of  trust  should  plainly  set  out  the  following  essential 
information:  -'/jahiul 

1.  The  trustees  and  the  immediate  beneficiaries  must  be 

designated,  and  provision  must  be  made  so  that  others 
desiring  to  be  beneficiaries  can  come  in  and  assist  in 
-;.i( '-  M     making  up  the  required  amount  of  capital. 

2.  If  any  property  is  to  be  transferred  to  the  trustees,  or  if 

they  are  to  purchase  any  particular  business  or  prop 
erty,  it  must  be  designated  and  described. 

3.  The  capital,  if  any,  that  is  to  be  raised  and  paid  over  to 

the  trustees  must  be  specified,  and  its  division  into 
shares  and  the  value  thereof  must  be  set  forth.  Both 
preferred  and  common  shares  may  be  prescribed. 

4.  The  declaration  must  also  state  that  the  property  ac- 

quired by  the  trustees  is  held  in  trust,  and  subject  to 
the  powers,  limitations,  and  liabilities  set  forth  in  the 
instrument  by  which  the  trust  is  created. 

§  588.    Detailed  Provisions  of  Declaration  of  Trust 

The  declaration  of  trust  or  trust  agreement,  in  addition  to 
these  more  general  matters,  must  specifically  prescribe  and  set 
forth  the  following  details :  .;  ., 


Ch.  64]  EXPRESS  TRUSTS— HOW  ORGANIZED  547 

1.  The  duties  of  the  trustees. 

2.  The  powers  of  the  trustees. 

3.  What  consent  on  the  part  of  the  shareholders  is  required 

for  the  exercise  of  any  special  powers  by  the  trustees. 

4.  Any  special  limitations  or  authorizations  of  the  trustees. 

5.  The  remuneration  of  the  trustees  for  their  services. 

6.  Any  directions  for  the  financial  management  of  the  trust. 

7.  How  and  under  what  circumstances  payments  of  profits 

or  of  the  trust  funds  are  to  be  made  to  the  holders  of 
'  common  and  preferred  shares. 

8.  Directions,  if  any,  as  to  the  sale  or  transfer  of  any  of  the 

trusteed  property. 

9.  The  continuance  of  the  trust  for  such  term  as  may  be 

allowed  by  law. 

10.  Provisions  as  to  registry  of  shareholders,  the  issuance  of 

certificates,  and  the  transfer  of  shares. 

11.  That  the  trustees  shall  have  no  authority  to  bind  any 

shareholder  by  contract  or  to  call  for  any  assessment 
from  them. 

12.  That  all  persons  dealing  with   the  trustees  shall  look 

only  to  the  trust  funds  and  not  to  either  trustees  or 
shareholders  for  payment,  and  that  every  order,  con- 
tract, or  obligation  entered  into  shall  stipulate  that 
neither  trustees  nor  shareholders  are  liable  thereunder. 

13.  Provisions  for  annual  meetings,  reports  and  audits,  and 

for  filling  vacancies  among  the  trustees,  with  rules  for 
voting. 

14.  How  special  meetings  may  be  called  and  how  notice 

of  them  is  to  be  given. 

15.  The  name  of  the  trust  and  how  the  trustees  shall  be 

known. 

16.  Provisions  for  any  other  details  of  the  trust  business  and 

organization  not  already  prescribed. 

The  declaration  of  trust  must  be  signed  by  the  parties  inter- 


548  '      CORPORATE  LAW  [Bk.  I- 

ested,  and  in  most  cases  will  be  acknowledged  before  a  notary 
or  other  official.  Care  must  be  taken  in  preparing  a  trust  that 
the  power  of  alienation  is  not  suspended,  especially  if  any  part 
of  the  trust  estate  consists  of  real  property .2 

§  589.    The  Creators  of  the  Trust 

Those  who  create  the  trust,  who  take  the  place  of  incorpo- 
rators in  an  ordinary  company,  must  be  competent  to  contract. 
No  specific  number  is  required.  Many  members  or  beneficiaries 
are  not  needed  as  original  parties  to  the  instrument  of  trust;  in 
fact,  a  single  person  could  create  a  trust.  The  trust  being  once 
created,  anyone  who  came  within  the  description  of  a  beneficiary, 
or  who  subscribed  according  to  the  terms  of  the  agreement,  would 
have  his  money  added  to  the  trust  fund,  and  would  thereafter 
share  in  the  rights  and  profits  of  the  trust  on  the  same  basis  as 
the  other  beneficiaries. 

§  590.    The  Trustees 

The  trustees  are  the  permanent  managers  of  the  enterprise. 
They  should  be  selected  with  care,  for  they  are  not,  as  directors 
are,  elected  annually.  It  is  possible  to  remove  a  trustee  for 
negligence  or  for  malfeasance,  but  it  is  not  usual,  nor  is  it  an 
easy  thing  to  do.  A  trustee  may  also  be  a  beneficiary  in  the 
trust  and  own  shares  as  do  other  beneficiaries — usually  they  do. 
None  of  the  trustees  need  be  signers  of  the  declaration  of  trust. 
They  may  join  in  its  execution,  or  they  may  formally  accept  the 
appointment  by  letter,  but  if  they  act  as  trustees  under  the 
declaration,  that  in  itself  would  be  a  practical  and  sufficient 
acceptance  of  the  trust.  The  original  trust  instrument  should 
provide  that  as  vacancies  occur. in  the  board  of  trustees  by  death, 
resignation,  removal,  or  incapacity,  the  beneficiaries  shall  fill 
them.  Or,  if  desired,  the  trustees  themselves  might  be  em- 
powered to  fill  vacancies  on  the  board. 


'Howe  V.  Morse,  174  Mass.  491  (1899);  Hart  v.  Seymour,  147  111.  598  (1893);  Mallory 
V.  Russell,  71  Iowa  63  (1887). 


Ch.  64]  '     EXPRESS  TRUSTS— HOW  ORGANIZED  549 

Because  of  the  continuance  of  the  trustees  in  office,  and  of  the 
stability  of  management  that  this  gives,  the  express  trust  is  an 
excellent  substitute  for  the  ordinary  "close"  corporation.  It 
would  be  satisfactory  also  in  many  cases  where  an  agreed  manage- 
ment is  desired,  as  often  happens  when  a  partnership  is  incor- 
porated or  a  minority  interest  demands  protection.  In  such 
cases  the  trustees  would  hold  the  stock  of  the  corporation  and 
vote  it  as  a  block.' 

§  591.    How  the  Board  of  Trustees  Acts 

The  board  of  trustees  of  a  trust  has  abundant  precedent  for 
its  operation  in  the  usual  procedure  of  a  corporate  board  of 
directors,  and  in  those  directors  of  educational  and  charitable 
foundations  that  have  existed  for  so  many  years  as  trusts.  A 
business  trust  has  no  by-laws.  All  that  ordinarily  goes  into  a> 
set  of  corporate  by-laws  is  supposed  to  be  set  out  in  the  declara- 
tion of  trust,  which  can  be  made  as  compendious  as  may  be 
required.  In  addition,  such  a  board  would  have  power  to 
arrange  its  own  details  of  procedure  and  methods  of  operation. 

That  which  usually  is  done  by  any  corporate  board  of  di- 
rectors is  followed  in  most  cases.  A  presiding  officer,  a  recording 
officer,  and  a  treasurer  are  chosen,  and  these  officers  are  given 
authority  to  perform  the  duties  of  their  particular  offices.  The 
trustees,  or  officers,  if  so  provided,  could  appoint  managers, 
superintendents,  auditors,  salesmen,  and  such  other  employees  as 
might  be  necessary  in  the  carrying  on  of  the  trust.  In  all  of  this 
they  would  be  merely  following  the  precedents  laid  down  for 
them  by  an  ordinary  corporate  board  of  directors. 

§  592.    Individual  Liability  under  Trust  Associations 

The  most  important  question  in  relation  to  this  form  of 
business  association  is  whether  the  individuals  concerned,  both 
the  trustees  and  the  beneficiaries,  are  likely  to  be  held  to  in- 
dividual liability  as  in  the  partnership.     It  is  a  general  condition 

» See  Ch.  LVI,  "Voting  Trusts." 


S50  CORPORATE  LAW  [Bk.  I- 

of  the  law  that  those  who  are  associated  in  business  with  others 
are  personally  liable  for  all  obligations  incurred  in  the  operations 
of  the  business. 

The  corporation  as  sanctioned  by  the  laws  of  most  civilized 
countries  is  an  exception  to  this  rule.  The  vital  question  as  to 
the  trust  associations  is  whether  business  can  also  be  done  by 
trustees  under  a  declaration  of  trust  with  equal  freedom  from 
individual  liability. 

Under  the  common  law  a  trustee  was  held  to  be  a  principal, 
not  an  agent,  and  when  he, contracted  as  trustee,  he  bound  him- 
self personally.  He  had  a  right  to  be  indemnified  from  the 
estate  if  he  became  liable  without  negligence  on  his  part.  If  he 
wished  to  avoid  all  this,  he  could  do  so  only  by  expressly  stipulat- 
ing that  only  the  estate  and  not  himself  was  to  be  bound. 

The  Supreme  Court  long  ago  laid  down  the  general  rule  that, 
"If  a  trustee  wants  to  protect  himself  from  liability  on  a  contract, 
he  must  stipulate  that  he  is  not  to  be  personally  responsible,  but 
that  the  other  party  is  to  look  solely  to  the  estate,"* 

In  later  Maryland  cases  the  courts  have  explicitly  stated  the 
rule  that  the  trustee  must  stipulate  that  he  is  not  to  be  personally 
liable,  or  he  will  be  so  held.s 

In  Massachusetts  it  has  been  held  that  where  trustees  signed 
a  note  "We  as  trustees,  but  not  individually,  promise  to  pay," 
they  were  not  personally  liable. ^ 

As  a  matter  of  precaution,  most  of  the  well-conducted  trusts 
that  are  in  active  business  are  particular  to  have  printed  on  all 
of  their  stationery  and  in  particular  on  all  bills,  orders,  invoices, 
and  any  other  instrument  that  may  involve  or  partake  of  a  con- 
tract liability,  a  full  disclaimer  of  all  individual  liability.  The 
following  disclaimer  is  of  this  nature : 

|.  .       The  Hampton  Company  is  the  designation  of  a  Board  of 
Trustees  acting  under  a  declaration  of  trust  dated  December  30, 


«  Taylor  v.  Davis,  no  U.  S.  331  {1884). 

•  Knapp  V.  Bagby,  126  Md.  461  (191s);  Boyle  v.  Rider,  136  Md.  285  (1920). 
•Shoe  Leather  Nat.  Bank  v.  Dix,  120  Mass.  148  {1877);  Adam  v.  Swig,  334  Mass.  584 
(1920);  Rand  v.  Farquhar,  226  Mass.  91  (1917). 


Ch.  64]  EXPRESS  TRUSTS— HOW  ORGANIZED  551 

1909,  and  filed  with  the  Northampton  National  Bank  of  Northamp- 
ton, Massachusetts.  Any  contract  made  or  liability  incurred  by 
them  binds  only  the  trust  property  in  their  hands,  and  neither 
themselves  nor  the  shareholders,  beneficiaries  of  the  trust,  shall  be 
held  to  any  personal  liability  under  or  by  reason  thereof. 

Where  this  has  been  done,  neither  trustees  nor  shareholders 
have  been  held  liable  for  anything  beyond  the  money  already 
invested  in  the  trust.  It  is  to  be  remembered,  however,  that 
trustees  cannot  avoid  personal  liability  for  torts  or  negligence. 

The  declaration  must  not  prescribe  any  control  of  the  trustees 
by  the  shareholders.  If  the  shareholders  are  in  any  way  to 
manage  the  business,  they  will  make  themselves  liable  as  part- 
ners. On  this  account  the  beneficiaries  must  not  by  means  of 
annual  elections  appoint  the  trustees.  This  would  be  manage- 
ment by  the  beneficiaries  and  they  would  be  held  personally 
liable  as  in  a  joint-stock  company. 


BOOK  II 
CORPORATE   FINANCE 


11  AiX)H 
1   HTA>i04>10:j 


■  li&iiUijU'il 


Part  I — The  Corporation 


-^uo.i-n  CHAPTER! 

PRINCIPLES  OF  FINANCE 

§  I.    Problems  of  Financing 

The  subject  of  this  part  of  the  present  volume  is  the 
securing  and  handling  of  money  and  credit  for  incorporated 
business  enterprises.  If  the  terms  money  and  credit  were  used 
with  strict  accuracy,  the  statement  might  be  shortened  by  leav- 
ing out  the  reference  to  money;  for,  after  all,  credit  in  one  form 
or  another  is  almost  the  only  element  involved.  But  it  is  not 
necessary  to  enlarge  upon  limitations  such  as  these  which  are 
purely  technical. 

Corporate  financing  deals,  first,  with  the  methods  of  raising 
the  initial  capital  needed  for  the  enterprise,  considering  what 
securities  to  issue,  how  and  to  whom  they  should  be  sold,  how 
best  to  utilize  the  funds  thus  secured,  together  with  their  proper 
apportionment  for  plant,  equipment,  and  working  capital;  and 
eecond,  with  the  accurate  determination  of  any  losses  and  profits 
and  their  allocation  to  dividends,  surplus,  sinking  fund,  and 
special  reserves,  and  the  enlargement  of  capital  permanently 
invested. 

Financing  is  also  concerned  with  the  forecasting  of  business 
development  and  resulting  financial  needs  and  with  provision  for 
the  business  equivalent  of  a  "rainy  day,"  and  in  addition  must 
take  thought  for  the  difficult  problems  that  arise  when  a  business 
enterprise  becomes  embarrassed  or  involved  and  is  threatened 
with  or  overtaken  by  insolvency. 

555 


556  CORPORATE  FINANCE  [Bk.  II- 

§  2.    Results  of  Unskilful  Financing 

Financing  is  perhaps  the  least  understood  subject  in  the  whole 
field  of  business.  A  great  many  men  have  proved  themselves 
able  and  successful  as  producers,  organizers,  and  sellers,  but  have 
failed  utterly  in  handling  their  financial  problems.  A  conspicu- 
ous example  of  this  was  George  Westinghouse,  the  brilliant  in- 
ventor, organizer,  and  salesman,  who  founded  the  Westinghouse 
Electric  and  Manufacturing  Company,  the  Westinghouse  Air 
Brake  Company,  and  other  enterprises.  Westinghouse  made  a 
success  of  every  business  enterprise  he  touched  except  in  so  far  as 
its  financing  was  concerned.  He  was  too  eager  to  grasp  the 
brilliant  future  he  saw  ahead  of  him  to  give  the  present  the  care 
and  attention  it  required.  More  specifically,  he  did  not  possess 
the  foresight  to  keep  his  enterprises  properly  provided  with  cash 
as  they  progressed.  Consequently,  the  Westinghouse  Electric 
and  Manufacturing  Company,  of  which  he  was  the  largest  single 
stockholder  and  the  active  head,  was  twice  faced  with  serious 
embarrassment,  and  in  the  end  its  too  ambitious  founder  was 
compelled  to  relinquish  its  management. 

This  case  is  not  an  uncommon  one.  In  fact,  it  is  generally 
true  that  men  of  an  optimistic,  emotional  turn  of  mind  who  make 
good  as  promoters,  producers,  and  salesmen,  are  just  the  ones 
who  are  prone  to  deceive  therpselves  as  to  their  own  affairs  and 
too  often  wreck  a  promising  business  on  some  financial  reef  that 
should  have  been  easily  avoided. 

It  is  surprising  to  find  how  often  directors  of  important  cor- 
porations give  insufficient  attention  to  the  basic  financial  prob- 
lems of  corporate  business.  Frequently,  embarrassment  or  in- 
solvency which  should  have  been  clearly  foreseen  comes  upon 
a  board  of  directors  when — as  in  the  case  of  the  Westinghouse 
Electric  and  Manufacturing  Company — the  members  fancy 
themselves  at  the  height  of  prosperity. 

Among  smaller  concerns  the  amount  of  ignorance  regarding 
financial  management  is  even  greater.  Every  experienced  busi- 
ness man  has  observed  instances  where  enterprises  that  should 


Ch.  i]  PRINCIPLES  OF  FINANCE  557 

have  been  profitable  were  half  developed  and  then  abandoned 
for  lack  of  funds,  when  in  nine  cases  out  of  ten  the  whole  financial 
process  might  have  been  figured  out  in  advance  and  the  necessary- 
funds  raised  with  little  difficulty.  Instead,  the  enterprise  too 
often  drags  out  a  painful  existence  for  a  few  months  or  a  few 
years,  eats  up  the  owner's  capital,  and  at  the  end  leaves  him  a 
poorer,  but  not  always  a  wiser  man. 

§  3.    Financing  and  Accounting 

Poor  financing  is  apt  to  be  combined  with  poor  accounting; 
and  in  that  case  the  unfortunate  owner  cannot  enjoy  even  the 
empty  satisfaction  of  a  post-mortem  diagnosis. 

This  brings  up  a  question  on  which  there  has  been  much  con- 
fusion of  thought — the  question  as  to  the  dividing  line  between 
the  subject  of  financing  and  the  subject  of  accounting.  It  is  not 
purely  an  academic  question,  for  in  many  business  concerns  the 
head  of  the  accounting  department  and  the  head  of  the  financial 
department  are  continually  treading  on  each  other's  toes. 

There  is  undoubtedly  a  "No  man's  land"  between  the  two 
subjects.  When  rates  of  depreciation,  sinking  fund  requirements, 
valuation  of  good-will,  budgets,  quotas,  and  the  like,  are  under 
discussion,  there  is  constant  danger  of  trespassing  into  account- 
ing territory;  while,  on  the  other  hand,  the  accountants,  espe- 
cially public  accountants,  have  not  hesitated  to  make  many  bold 
forays  into  financial  fields.  Frequently  they  are  called  upon  to 
advise  their  clients  as  to  the  securing  of  bank  loans,  the  proper 
types  of  bonds  and  shares  to  issue,  the  investment  of  capital 
funds,  the  declaration  of  dividends,  and  so  on. 

We  need  not  enter  into  the  technicalities  of  the  friendly  con- 
troversy. A  broad  distinction,  however,  between  the  two  fields 
of  work  and  study  may  be  easily  made.  Accounting,  properly 
speaking,  deals  with  recording  and  analyzing  results  that  have 
been  achieved;  and  the  high  and  increasing  esteem  in  which  it 
is  now  held  is  due  to  the  general  recognition  that  the  conclusions 
drawn  by  skilled  accountants  afford  a  safe,  and  indeed  an  essen- 


558  CORPORATE  FINANCE  [Bk.  II- 

tial  basis,  on  which  to  predicate  the  financing  and  other  impor- 
tant actions  upon  which  the  success  of  the  business  will 
largely  depend. 

Financing,  on  the  other  hand,  deals  not  with  recording  and 
analyzing,  but  with  securing  positive  results;  the  best  methods 
of  raising  money;  what  securities  to  issue;  to  whom  they 
should  be  sold;  and  how  the  proceeds  may  be  used  to  best  ad- 
vantage for  the  promotion  of  the  business.  These  are  some  of 
the  typical  problems  which  are  clearly  outside  the  scope  of 
accounting. 

§  4.    Analogy  between  Business  and  Individual  Financing 

A  condition  that  has  deterred  many  from  the  study  of  busi- 
ness finance  is  the  popular  supposition  that  many  difficulties  are 
to  be  encountered  in  solving  its  problems.  One  writer  has  even 
defined  the  science  of  business  finance  as  "the  modern  black 
art,"  as  if  it  were  something  mysterious  and  uncanny.  Yet, 
whatever  may  be  said  of  the  difficulties  pertaining  to  actual  prac- 
tice, the  essential  principles  of  business  finance  are  simple 
and  readily  understood  by  any  one.  There  is,  in  fact,  a  close 
analogy  between  the  financial  problems  of  the  business  enterprise 
and  the  financial  problems  encountered  by  the  ordinary  indi- 
vidual in  his  daily  life. 

The  individual  possesses  both  tangible  and  intangible  assets. 
He  has  money,  tools,  land,  and  other  tangible  things.  Also,  he 
possesses  health,  skill,  knowledge,  and  other  assets  that  are  in- 
tangible. Business  divides  its  assets  into  things  tangible  and  in- 
tangible in  the  same  way;  its  plant,  equipment,  stock,  and  cash 
being  tangible  assets;  while  its  good-will,  trade-name,  patents, 
and  copyrights  are  intangible  assets. 

The  individual  has  his  capital  and  his  income,  and  from  these 
he  must  make  the  necessary  expenditures ;  first,  to  niaintain  him- 
self in  condition  to  do  business;  second,  to  increase  his  produc- 
tive and  consequently  his  earning  power.  He  must  also  reserve 
a  portion  of  his  income  against  the  coming  of  old  age  or  some 


Ch.  i]  PRINCIPLES  OF  FINANCE  559 

prior  time  of  need.    He  knows  the  laws  of  thrift  and  prudence, 
and  knows  that  if  he  will  obey  them  he  will  prosper. 

It  will  be  shown  that  precisely  the  same  kind  of  wisdom  and 
foresight  is  required  to  invest  properly  the  capital  and  income  of 
a  great  business  so  that  it  shall  continue  to  grow  and  prosper 
and  shall  not  be  short  of  funds  and  credit  should  an  evil  day  un- 
fortunately come.  The  business,  great  or  small,  that  does  not 
keep  its  expenditures  within  its  income  is  as  certain  to  come  to 
grief  as  the  individual  who  spends  more  than  he  earns. 

An  individual  should,  from  time  to  time,  take  an  inventory 
of  his  resources  and  liabilities,  physical,  intellectual,  and  spirit- 
ual, as  well  as  material,  and  thus  determine  whether  he  is  be- 
coming richer  or  poorer.  In  like  manner  every  business  should 
at  regular  intervals  take  an  inventory,  balance  all  accounts,  sub- 
tract losses  and  add  gains,  and  thus  ascertain  whether  it  is  gain- 
ing ground  or  falling  behind. 

§  5.    The  Use  of  Credit 

All  our  greater  businesses  are  conducted  largely  with  bor- 
rowed money,  and  in  this  matter  we  may  carry  our  analogy  with 
the  individual  yet  further.  It  is  well  to  remember,  however,  that 
in  such  borrowing  we  are  not  engaged  in  that  shiftless  borrowing 
so  severely  and  properly  condemned  by  sages  and  moralists. 
Their  strictures  had  no  reference  to  borrowing  or  lending  money 
for  proper  business  purposes. 

For  instance,  when  a  young  man  makes  a  long-term  loan  and 
pays  interest  on  it  in  order  that  he  may  take  a  college  course  or 
prepare  for  a  profession,  he  is  not  acting  foolishly  but  with  the 
greatest  wisdom;  for  the  money  so  expended  will  bring  him  a 
wealth  of  skill  and  knowledge  that  will  enable  him  to  repay  both 
loan  and  interest,  and  during  his  whole  life  the  transaction  will 
increase  both  his  usefulness  to  society  and  his  earning  power.  In 
the  same  way,  when  a  business  concern  can  borrow  money  to 
enlarge  or  improve  its  plant,  to  develop  the  enterprise,  and  gen- 
erally to  increase  its  profits,  such  borrowing  is  not  only  permis- 
sible but  commendable. 


s6o  CORPORATE  FINANCE  [Bk.  II- 

There  are,  however,  some  obvious  limitations  which  will  at 
once  be  recognized.  No  individual  or  business  should  borrow 
money  unless  it  can  be  used  to  advantage  and  be  properly  cared 
for  when  it  falls  due.  For  this  reason  short-term  borrowing  is 
usually  poor  policy  for  either  an  individual  or  a  business,  unless 
it  is  to  tide  over  a  brief  stringency  or  to  "swing"  some  profitable 
transaction  that  can  be  completed  quickly. 

§  6.    Fixed  and  Working  Assets 

We  can  carry  our  analogy  still  further.  All  business  invest- 
ments belong  in  one  or  the  other  of  two  classes:  those  that  are 
fixed  and  permanent,  and  those  that  are  temporary  and  designed 
to  be  converted  into  cash  in  a  short  time ;  the  first  class  is  known 
as  "fixed  assets,"  and  the  second  as  "working  assets."  In  every 
business  there  should  be  a  proper  proportion  between  the  amount 
invested  in  fixed  assets  and  the  amount  reserved  for  working 
capital. 

Both  the  individual  and  the  business  concern  often  fail  to 
observe  the  necessary  proportions.  Not  infrequently  an  agri- 
culturist buys  more  land  than  he  can  work  profitably  and  we 
have  a  "land  poor"  farmer.  Many  country  merchants  buy  more 
stock  than  they  can  sell  immediately,  and  thus  become  "over- 
stocked." The  less  salable  portion  becomes  shopworn  and,  as  a 
consequence  of  this  injudicious  tying  up  of  money,  the  merchant 
is  without  funds  to  replace  the  more  salable  articles.  Many  busi- 
nesses, both  great  and  small,  have  met  disaster  because  the  neces- 
sary amount  of  working  capital  was  not  correctly  estimated,  too 
much  being  invested  in  plant  and  equipment  or  tied  up  in  stock, 
while  an  insufficient  amount  was  left  to  conduct  the  operations 
of  the  business.  Sometimes  a  shortage  of  working  capital  is  the 
result  of  changing  conditions,  as  when  at  the  close  of  the  Great 
War  many  concerns  found  themselves,  in  the  face  of  a  falling  de- 
mand, heavily  overstocked  with  high-priced  goods  and  materials. 
Usually,  though,  a  shortage  of  working  capital  is  the  result  of 
bad  or  mistaken  judgment. 


Ch.  i]  PRINCIPLES  OF  FINANCE  561 

It  is  always  advisable  for  both  the  individual  and  the  business 
to  possess  an  emergency  fund — something  in  the  nature  of  quickly 
convertible  assets.  From  time  to  time,  opportunities  offer  which 
can  be  taken  advantage  of  only  by  the  possessor  of  ready  cash, 
and  then  the  forehanded  man  or  business,  with  cash  or  readily 
salable  securities  in  hand,  can  act  quickly  and  profitably. 

§  7.    The  Budget  Plan 

Both  the  individual  and  the  business  concern  possess  a  certain 
income  from  which  living  or  maintenance  expenses  must  be 
drawn.  If  the  income  exceeds  the  amount  required  for  support 
and  the  establishment  of  a  prudent  reserve  or  surplus,  the  balance 
is  available  for  non-paying  purposes;  therefore,  to  both  the  indi- 
vidual and  the  business  concern  comes  the  question  of  how  much 
of  the  income  is  required  for  operating  and  prudential  purposes 
and  how  much,  if  any,  may  be  properly  utilized  for  the  less  essen- 
tial purposes,  such  as  pleasure  in  the  case  of  the  individual,  and 
dividends  in  the  case  of  the  business  concern. 

To  answer  this  question,  the  individual  should,  at  the  begin- 
ning of  each  year,  estimate  his  income  and  his  expenditures,  as 
nearly  as  he  can,  so  that  the  proper  relations  may  be  preserved 
between  that  which  comes  in  and  that  which  goes  out.  The 
business  establishment  should  in  like  manner  determine  whether 
an  increase,  a  maintenance,  or  a  curtailment  of  income  may  be 
expected,  and  in  the  light  of  this  information  arrange  its  budget 
deciding  what  amount  of  earnings  shall  be  set  aside  for  a  reserve, 
what  shall  be  appHed  to  each  department  for  up-keep,  how  much 
is  needed  for  depreciation,  what  shall  be  expended  for  general 
operation,  expansion,  etc.  Item  by  item  this  estimate  should 
be  scrutinized  to  learn  where  an  outlay  may  be  curtailed  to  ad- 
vantage, or  where  an  outlay  may  be  profitably  increased,  or 
where  some  new  outlay  may  be  made  for  the  ultimate  benefit  of 
the  business.  Such  a  proceeding  is  a  practical  method  of  planning 
a  financial  policy;  the  plan  as  laid  down  can  be,  and  should  be, 
consistently  followed. 


562  CORPORATE  FINANCE  [Bk.  II- 

§  8.    Fundamental  Rules  of  Finance 

The  following  elementary  rules  of  business  finance  apply  alike 
to  individuals  and  to  the  largest  enterprises;  the  present  work 
consists  practically  of  the  application  of  these  general  rules  to 
various  business  problems. 

1.  Study  and  utilize  all  sources  of  capital,  including  earning 

power  and  credit.  rr  *J--- -<t  ^,r*x     -  '■• 

2.  Do  not  hesitate  to  borrow  for  legitimate  business  pur- 

poses when  profits  can  be  earned  or  losses  avoided 
thereby,  provided  the  loans  can  be  repaid  when  due. 

3.  Do  not  dissipate  capital  on  side  lines  and  outside  invest- 

ments. 

4.  Systematically  accumulate  assets,  both  tangible  and  in- 
'^■"^  '^*=  tangible. 

5.  Always  keep  available  sufficient  cash  and  readily  con- 

vertible assets  to  meet  emergencies  and  to  seize  special 
opportunities. 

6.  Use  income  sparingly  for  living  expenses  and  pleasure, 

but  freely  for  business  maintenance  and  development. 

7.  Use  foresight — which  is  the  cardinal  virtue  in  all  financial 
'    '  operations;  make  budgets  to  govern  all  expenditures. 


These  are  the  prudent,  homely,  indisputable  rules  for  sensible 
financing.  They  have  been  preached  and  proven  over  and  over 
again  for  many  centuries  past.  The  wisdom  which  they  embody 
applies  just  as  truly  to  the  business  of  the  United  States  Steel 
Corporation  or  to  that  conducted  by  Henry  Ford,  as  to  the  affairs 
of  John  Smith,  A  man  who  can  grasp  these  principles,  hold  them 
continually  before  his  eyes,  and  apply  them  intelligently,  is 
bound  to  handle  his  finances  wisely  both  in  his  business  and  in 
his  private  life. 

However,  simple  as  they  are,  to  apply  these  fundamental 
principles  to  all  the  complex  situations  which  arise  in  modern 
business  is  no  easy  task.  Sound  financing  calls  for  clear  thinking 
and  a  wide  range  of  knowledge. 


CHAPTER  II 
ORGANIZATION  FOR  BUSINESS 

§  9.    Forms  of  Business  Organization  1 

Wherever  business  is  carried  on,  there  are  to  be  found  three 
basic  forms  of  business  organization : 

1.  The  sole  proprietorship,  i.e.,  an  individual  owning  out- 

right his  own  business  and  usually  managing  it  himself 
without  much  co-operation  or  assistance. 

2.  The  partnership,  in  which  a  group  of  owners  work  to- 

gether under  some  form  of  partnership  agreement. 

3.  The  corporation,  the  impersonal  owner,  standing  between 

the  business  and  the  individuals  composing  the  cor- 
poration who  have  various  kinds  and  degrees  of  claims 
upon  the  business. 

The  first  two  of  these  basic  forms-^sole  proprietorship  and 
partnership — involve  the  personal  relationship  of  a  man  or  a 
group  of  men  to  the  business;  but  the  third  form,  which  is  a  com- 
paratively modern  invention,  separates  the  owner  or  owners 
from  the  business  and  brings  into  being  an  impersonal,  intangible 
thing — a  corporation — in  which  the  nominal  or  legal  ownership 
is  vested. 

The  three  basic  forms  of  business  organization  are  combined 
and  recombined  in  many  different  ways  under  the  laws  and  cus- 
toms of  the  various  commercial  countries,  but  analysis  always 
reveals  one  or  the  other  of  the  three  forms  predominating. 

This  is  shown  by  the  short  description,  found  later  in  the 
chapter,  of  three  other  forms  of  business  organization  not  often 
used,  but  of  interest  here,  as  showing  how  difficult  it  is  to  get 

1  See  Book  I,  Ch.  II,  "Business  Organization." 

563 


564  CORPORATE  FINANCE  [Bk.  H- 

away  from  the  basic  types.     These  are  the  limited  partnership, 
the  joint-stock  company,  and  the  association  under  deed  of  trust. 

§  ID.    Capital,  Management,  and  Income 

It  has  been  pointed  out  by  writers  on  economics  that,  no 
matter  what  the  business  or  the  form  of  organization  under  which 
it  is  conducted,  capital  is  required  for  its  operation  and  this 
involves  more  or  less  risk;  also  that  management  must  be  pro- 
vided, and  that,  arising  from  the  operation  of  the  business,  there 
should  be  income.  Capital  may  be  contributed  directly  or  it 
may  be  secured  by  means  of  credit. 

In  an  individual  proprietorship,  one  man  supplies  the  capital, 
assumes  all  the  risk,  undertakes  the  management,  and  receives 
all  the  income. 

Under  the  partnership  form,  the  partners  as  a  body  supply 
the  capital,  undertake  the  risk  and  the  management,  and  receive 
the  income;  but  among  themselves  there  may  be  an  infinite 
number  of  combinations.  One  partner,  for  instance,  may  supply 
all  of  the  capital  and  assume  the  risk;  another  may  supply  the 
management;  and  they  divide  the  income  as  may  be  agreed. 

Under  the  corporate  form  the  risk  is  taken  by  the  share- 
holders who  supply  capital  under  conditions  that  have  been 
agreed  upon.  These  shareholders  divide  the  income,  if  there 
are  different  classes  of  stock,  in  rough  proportion  to  their 
risk.  The  management,  however,  is  not  usually  retained  in  the 
hands  of  the  people  who  contribute  the  capital,  but  is  turned  over 
to  directors  and  officers  who  may  not  personally  be  large 
shareholders.  The  tendency  plainly  has  been  to  separate  the 
supplying  of  capital  for  the  business  and  the  management  of 
this  capital  so  that  these  two  need  not  be  joined  in  one  man  or 
even  in  a  small  group  of  men, 

§  II.    Sole  Proprietorship 

The  first  of  the  three  basic  forms  of  business  organization — 
the  sole  proprietorship — is  the  simplest  and  is  even  yet  the  most 


Ch.  2]  ORGANIZATION  FOR  BUSINESS  565 

numerous.  Small  shops,  farms,  professional  activities,  and  the 
like,  are  usually  conducted  as  sole  proprietorships.  The. owner 
does  not  separate  his  ownership  of  the  business  from  his  manage- 
ment of  it;  frequently  he  does  not  even  separate  the  ordinary 
management  of  his  business  affairs  and  the  management  of  his 
personal  affairs.  He  himself  is  the  business  and  the  business  is 
a  part  of  him. 

The  simplicity  of  this  form  does  not  necessarily  imply,  how- 
ever, that  it  is  applicable  only  to  a  small  business.  Many  men 
of  great  wealth  could  properly  regard  the  investment  and  man- 
agement of  their  funds  as  in  itself  a  business,  for  this  work  some- 
times requires  the  services  of  a  force  of  assistants,  bookkeepers, 
and  clerks.  Then,  again,  an  individual  may  embark  upon  a  busi- 
ness enterprise  which  grows  rapidly  from  year  to  year  and 
becomes  very  extensive;  yet  the  original  proprietor  may  con- 
tinue to  own  and  direct  it  all.  This  was  the  case,  for  instance, 
until  a  comparatively  recent  period,  with  the  great  department 
stores  in  Philadelphia  and  New  York  which  were  personally 
owned  and  managed  by  John  Wanamaker.  However,  it  usually 
happens,  for  reasons  given  below,  that  a  business  which  is 
becoming  large  and  prosperous  finds  the  single  proprietorship 
undesirable. 

§  12.    Disadvantages  of  the  Sole  Proprietorship 

On  the  other  hand,  advantageous  as  the  sole  proprietorship 
frequently  is  for  the  first  years  of  business  activity,  it  is  not 
desirable  for  the  permanent  conduct  of  a  business  that  is  capable 
of  much  expansion.  The  more  serious  objections  to  the  sole 
proprietorship  for  such  a  business  are  three  in  number. 

First,  the  capital  of  the  business  is  limited  to  whatever  the 
owner  possesses,  earns,  or  can  borrow.  Some  kinds  of  businesses, 
if  they  grow  at  all,  finance  themselves,  so  that  there  is  never  need 
of  any  more  capital  than  the  amount  with  which  the  business  was 
started;  but  the  great  majority  of  business  concerns  which  are 
expanding  inquire  additional  capital. 


S66  CORPORATE  FINANCE  [Bk.  II- 

A  second  and  even  more  serious,  disadvantage  is  the  strict 
limitation  on  the  management  of  the  business.  The  owner 
must  depend  upon  employees  for  all  executive  work  outside  his 
own  efforts,  and  it  is  difficult  to  retain  men  of  real  executive 
ability  upon  a  salary.  Ordinarily  they  prefer  to  go  with  con- 
cerns in  which  they  themselves  have  or  can  secure  an  interest. 
If  the  individual  owner  wishes  the  services  of  such  men,  he  must 
pay  them  exceptionally  high  salaries.  To  refer  again  to  the  case 
of  John  Wanamaker,  it  is  stated  that  in  the  early  history  of  the 
Philadelphia  store  there  were  at  least  a  dozen  employees  who 
were  drawing  much  larger  incomes  from  the  business  than  was 
Wanamaker  himself. 

The  third  disadvantage  is  the  ever  present  liability  of  the 
owner  for  all  the  debts  of  his  business.  He  cannot  legally  dis- 
criminate between  the  property  he  has  reserved  for  other  pur- 
poses and  that  invested  in  his  business.  Everything  he  has  is 
liable  for  the  indebtedness  of  his  business. 

§  13.    The  Partnership 

Fundamentally  there  is  no  essential  difference  between  the 
sole  proprietorship  and  the  partnership,  except  that  in  the 
partnership  a  group  of  oyrners  take  the  place  of  the  individual 
owner.  There  may  be  any  number  of  partners  and  there  are 
many  different  forms  of  partnership  agreement.  Partners  are 
not  necessarily  equal,  by  any  means,  in  respect  to  their  invest- 
ments of  capital  and  ability,  or  as  to  their  division  of  the  income. 
Sometimes  one  partner  receives  a  larger  proportion  of  the  income 
than  corresponds  to  his  investment  of  capital  in  order  to  compen- 
sate him  for  a  special  contribution  to  the  business,  such  as  valu- 
able experience  or  connections,  or  unusual  business  ability.  A 
partner  coming  in  may  not  desire  to  be  known  as  being  in  any  way 
interested  in  the  business,  in  which  case  he  may  by  agreement 
become  a  "dormant"  or  "sleeping"  partner.  Again,  he  may 
desire  to  limit  his  own  liability  to  the  amount  which  he  invests, 
in  which  case  he  may  become  a  "limited"  partner.    ' 


Ch.  2]  ORGANIZATION  FOR  BUSINESS  567 

§  14.    Advantages  of  the  Partn.ership 

There  are  some  lines  of  business  in  which  it  is  desired  to  avoid 
the  legal  regulation  or  the  taxation  to  which  the  corporation  is 
liable,  and  for  this  reason  the  partnership  form  is  preferred. 
Mso,  because  of  the  personal  element  involved,  the  partnership 
IS  regarded  as  the  proper  form  in  which  to  organize  such  pro- 
fessional activities  as  those  of  lawyers,  accountants,  and  engi- 
neers when  two  or  more  are  to  be  associated  in  the  business.  In 
cases  such  as  these  it  may  be  necessary  to  bring  together  in  one 
organization  considerable  capital  and  the  talents  of  many  differ- 
ent men.  The  product  of  this  form  of  organization,  however,  is 
not  some  material  thing,  but  a  direct  personal  service;  hence 
the  personal  liability  and  the  personal  relationship,  which  are 
characteristic  of  the  partnership  form,  are  desirable  and  should 
be  retained. 

For  this  same  reason  most  concerns  engaged  in  private  bank- 
ing, in  buying  and  selling  securities,  in  underwriting,  and  the  like, 
are  not  incorporated,  but  are  organized  as  partnerships.  Among 
the  better  known  of  these  are  the  great  international  banking 
houses  of  J.  P.  Morgan  and  Company,  Kuhn,  Loeb  and  Com- 
pany, and  Brown  Brothers  and  Company.  There  are  now  but 
few,  if  any,  of  the  large  trading  and  manufacturing  enterprises 
still  in  the  partnership  form.  Arbuckle  Brothers,  the  Baldwin 
Locomotive  Works,  and  the  Endicott- Johnson  Company  were 
among  the  last,  having  been  conducted  as  partnerships  until 
comparatively  recent  years. 

§  15.    Partnership  Handicaps  in  Securing  New  Capital  , 

Of  the  three  serious  disadvantages  of  the  individual  pro- 
prietorship for  general  business  purposes,  only  one  is  not  found 
in  the  partnership.  There  is  but  little  difficulty  under  the  part- 
nership form  in  attracting  high-priced  business  talent;  in  this 
one  respect  the  partriership  is  probably  superior  to  both  the  sole 
proprietorship  and  the  corporation.  The  two  other  disadvan- 
tages of  individual  proprietorship— the  limitation  on  command  of 


568  CORPORATE  FINANCE  [Bk.  II- 

capital  and  the  personal  liability-  for  all  business  obligations — 
are,  however,  shared  by  the  partnership. 

This  is  so  as  to  the  command  of  capital  for  several  reasons. 
First,  because  of  the  personal  character  of  the  relationship 
between  each  of  the  owners  and  the  business.  This  renders  it 
highly  undesirable  that  anyone  should  be  included  in  a  partner- 
ship unless  he  is  personally  acceptable  to  the  other  partners. 
Then,  as  all  of  the  partners,  except  dormant  or  limited  partners, 
have  equal  rights  in  the  control  of  the  business,  and  as  any  one 
of  them  may  bind  the  entire  firm  by  his  acts  or  contracts,  the 
consequences  of  bringing  in  an  incompetent  or  unreliable  partner 
may  be  disastrous.  As  compared  with  a  corporation,  all  this 
introduces  a  serious  handicap  in  searching  for  fresh  capital  with 
which  to  develop  the  business.  It  is  necessary  not  merely  to 
find  a  man  with  capital,  but  to  find  a  man  who  has  the  integrity 
and  the  business  ability  to  make  him  a  safe  associate,  and  beyond 
this  a  personality  that  will  make  him  acceptable  and  insure  har- 
monious relations  with  the  existing  partners.  The  quest  is 
usually  a  difficult  one. 

§  1 6.    Partnership  Liability 

The  other  disadvantage,  namely,  the  complete  personal 
liability  of  each  part  owner,  is  even  more  serious  in  the  partner- 
ship than  in  the  sole  proprietorship.  The  individual  proprietor 
can  suffer  only  through  his  own  misfortunes  or  errors;  the 
partner,  however,  may  suddenly  find  himself  face  to  face  with 
heavy  loss  due  to  the  bad  fortune  or  errors  of  any  of  his  partners. 
His  own  personal  property — except  under  one  of  the  special 
forms  of  agreement  above  referred  to — is  pledged  to  the  creditors 
of  the  business  until  the  last  debt  has  been  paid.  If  one  of  his 
partners  proves  dishonest  or  treacherous,  he  may  be  called  upon 
to  pay  the  bill — not  merely  to  the  extent  of  his  previous  invest- 
ment in  the  business,  but  to  the  extent  of  all  his  personal  holdings. 
It  is  this  reason  above  all  others  that  makes  the  formation  of  a 
partnership  so  weighty  a  matter,  and  one  calling  for  such  careful 


Ch.  2]  ORGANIZATION  FOR  BUSINESS  569 

consideration.  Beyond  this,  however,  on  the  death  or  the  with- 
drawal of  any  of  the  partners,  if  an  agreement  cannot  be  reached 
with  the  retiring  partner  or  with  the  estate,  it  may  be  necessary 
to  wind  up  the  business  and  possibly  to  go  through  all  the 
trouble  of  a  suit  in  equity  for  an  accounting. 

In  the  face  of  all  these  disadvantages,  it  is  not  surprising  that 
very  few  business  concerns  have  retained  the  partnership  form. 
Outside  of  the  special  classes  of  business  mentioned,  it  is  becom- 
ing every  year  relatively  of  less  and  less  consequence. 

§  17.    The  Corporation  ^ — Capital  Stock 

The  corporation  is  quite  distinct  from  the  sole  proprietorship 
and  the  partnership.  The  capital  is  supplied  by  a  group  of  per- 
sons called  shareholders,  or  stockholders.  The  business  is  man- 
aged by  officers  and  directors  elected  by  the  shareholders.  In 
most  states  the  shareholders  have  no  liability  for  the  debts  of  the 
corporation  beyond  the  amount  which  they  have  contributed  as 
capital. 

One  of  the  distinctive  features  of  the  corporate  form  is  the 
division  of  the  capital  into  parts  or  shares,  usually  of  compara- 
tively small  amount.  Because  of  this  and  because  of  the  man- 
agement by  officers  and  directors  and  the  freedom  from  liability 
of  the  shareholders  for  the  debts  of  the  business,  funds  may  be 
raised  from  the  general  public  by  putting  these  shares  on  the 
market;  and  it  is  much  easier  to  finance  a  business  of  great  mag- 
nitude in  this  way  than  through  either  individual  ownership  or 
the  partnership. 

§  18.    The  Corporation — Management 

Under  the  corporate  form  the  business  is  usually  managed  by 
only  a  part  of  the  persons  who  supply  the  capital.  Indeed,  the 
active  management  may  be  in  the  hands  of  people  who  are  not 
shareholders  and  who  have  supplied  no  capital.     The  corporation 


'  For  extended  discussion  of  the  corporate  form,  see  Book  I,  "Corporate  Law." 


570  CORPORATE  FINANCE  [Bk.  II- 

itself  is  regarded  as  having  a  distinct  and  separate  entity  from 
its  stockholders.  It  is,  from  the  legal  standpoint,  an  individual- 
capable  of  doing  business  by  itself.  It  may  sue,  may  be  sued 
by,  and  may  contract  with  its  own  members,  as  well  as  with 
outsiders.  The  officers  and  directors  conduct  its  operations  in 
the  corporate  name. 

§  19.    Limited  Partnerships 

A  limited  partnership  may  be  formed  only  under  special  laws. 
It  differs  from  an  ordinary  partnership  in  that  one  or  more  of 
its  partners  are  inactive,  sharing  the  profits  but  taking  no  part 
in  the  management  of  the  business.  The  liability  of  these  part- 
ners is  limited  to  the  amount  actually  invested  by  them  in  the 
business,  and  they  are  called  "special"  partners  in  contradistinc- 
tion to  the  others,  who  are  called  "general"  partners. 

To  secure  the  restricted  liability  of  the  limited  partnership 
it  is  necessary  to  comply  closely  with  the  statutory  requirements 
of  the  state  in  which  the  partnership  is  formed.  In  fact,  the 
procedure  necessary  to  form  a  limited  partnership  is  almost  as 
formal  as  the  incorporation  of  a  stock  company,  and  failure  to 
observe  the  required  formalities  may  result  in  making  the  special 
partners  liable  as  general  partners. 

§  20.     Joint-Stock  Companies  ' 

A  joint-stock  company  is  a  partnership  with  its  capital 
divided  into  transferable  shares.  Except  in  the  state  of  New 
York,  such  a  company  may  be  formed  simply  by  agreement.  In 
New  York  special  statutes  provide  for  an  organization  known  as 
a  joint-stock  company,  which  is  similar  to  a  corporation,  and  the 
formation  of  such  associations  is  prohibited  except  as  provided 
by  the  statutes.  The  courts  in  New  York  define  these  organi- 
zations as  being  partnerships  with  some  of  the  powers  of  a  cor- 
poration.    In  New  York  these  joint-stock  companies  may  sue 


•  See  Book  I,  Ch.  LXII,  "Joint-Stock  Compames  and  Partnership  Associations." 


Ch.  2]  ORGANIZATION  FOR  BUSINESS  571 

or  be  sued  in  the  name  of  the  president  or  the  treasurer,  and  the 
individiial  members  may  not  be  sued  until  it  is  shown  that  the 
claim  cannot  be  collected  from  the  company.  Several  of  the 
leading  express  companies  were  organized  under  the  New  York 
Joint-Stock  Company  Law;  also  some  industrial  and  commercial 
businesses,  as  Robert  H.  IngersoU  and  Brother.  In  all  these 
cases  the  arrangement  seemed  to  work  very  satisfactorily.  In 
other  states  the  joint-stock  company  is  not  considered  a  desirable 
form  of  business  organization  and  is  rarely  used. 

§  21.    Associations  under  Deeds  of  Trust  * 

,  Various  experiments  have  "been  tried  at  different  times  in  the 
way  of  carrying  on  business  through  trustees.  It  was  long  ago 
decided  in  England  that  the  actual  owners  of  a  business  could 
not  be  held  liable  as  partners  if  it  was  held  in  trust  and  was  carried 
on  by  the  trustees.  The  main  object  of  utilizing  the  trust  as  a 
form  of  business  organization  was  to  secure  this  limited  liability — 
to  enable  a  number  of  individuals  to  unite  in  a  business  enter- 
prise without  the  personal  liability  of  the  partnership.  This 
could,  of  course,  be  secured  in  the  corporation,  but  the  trust  was 
not  subject  to  strict  limitations  of  statutory  law  as  was  the 
corporation  and  it  did  not  have  to  observe  the  many  formalities 
required  of  corporations ;  also,  owing  to  its  freedom  from  statu- 
tory limitation,  the  trust  could  be  used  for  purposes  for  which 
the  corporation  could  not  be  used. 

This  latter  fact  was  indeed  what  brought  the  trust  into  its 
present  position  as  a  form  of  business  organization.  Up  to  191 2 
the  law  in  Massachusetts  made  no  provision  for  corporations  to 
deal  in  real  estate.  It  was  found  that  the  trust  could  be  used 
for  the  purpose  and  consequently  a  large  number  of  real  estate 
trusts  under  the  name  of  "voluntary  associations"  came  into 
existence.  They  were  found  convenient  and  effective  and,  as 
stated,  not  subject  to  the  limitations  and  requirements  imposed 


« See  Book  I,  Ch.  LXIII,  "Express  Trusts  as  a  Form  of  Business  Organization." 


572  CORPORATE  FINANCE  [Bk.  II- 

upon  corporations.  Accordingly  they  have  increased  greatly 
in  number,  and  have  been  extended  to  many  other  lines  of 
business. 

The  use  of  the  voluntary  association  under  deed  of  trust  has 
also  spread  widely  in  other  states.  At  the  present  time  many  of 
the  Texas  and  Oklahoma  oil  companies  are  operating  under  deeds 
of  trust.  The  states  are,  however,  one  by  one,  imposing  re- 
strictions on  these  voluntary  associations,  and  it  is  probable 
that  eventually  they  will  be  subject  to  the  same  requirements 
and  limitations  as  are  corporations. 


CHAPTER  III 
THE  CORPORATE  ORGANIZATION 

§  22.    Origin  of  the  Corporate  Form 

The  modern  corporation  did  not  suddenly  spring  into  being 
as  a  device  for  overcoming  the  obstacles  of  previous  forms  of 
business  enterprises.  It  has  been  slowly  and  painfully  develop- 
ing for  centuries,  and  in  its  present  form  is  a  composite  of  the 
ideas  and  the  experience  of  many  different  races  and  generations 
of  men.  It  is  distinctly  an  evolution  and  the  process  is  still  far 
from  completion.! 

On  one  side,  the  business  corporation  is  closely  related  to  the 
municipal  and  religious  corporation.  The  jurists  of  the  early 
middle  ages  conceived — or  rather  adapted  from  Roman  law — 
the  idea  of  the  church  as  a  legal  entity,  distinct  from  any  of  its 
officers  or  ministers.  It  was  clear  that  the  endowments,  for  in- 
stance, which  were  given  to  bishops  and  abbots  were  not  intended 
for  their  personal  enjoyment  nor  to  be  disposed  of  as  they  saw  fit. 
It  was  desirable  that  the  custody  of  these  funds  should  be  en- 
trusted to  an  owner  that  would,  if  anything  of  the  kind  could  be 
devised,  exist  year  after  year  and  generation  after  generation, 
irrespective  of  human  frailties  or  vicissitudes.  Out  of  this  need 
for  permanence  in  holding  religious  property  grew  the  idea  of  the 
permanent,  continuing  church,  and  of  other  religious  and  char- 
itable organizations  existing  as  entities  or  "corporations,"  dis- 
tinct from  the  individuals  who  composed  them.  It  was  an  easy 
step,  when  a  similar  need  arose  in  business  undertakings,  to  trans- 
fer this  conception  from  religious  organizations  to  business  or- 
ganizations. 


•  For  detailed  discussion  of  the  corporate  organization,  see  Book  I,  Part  I,  "The  Corporate 
Form." 

573 


574  CORPORATE  FINANCE  [Bk.  II- 

During  the  last  three  centuries  the  corporation  has  grown, 
both  in  Europe  and  in  the  United  States,  along  parallel  lines  of 
development.  The  result  attained  is  not  exactly  the  same,  for 
there  are  many  technical  points  of  difference  between  the  Ger- 
man Gesellschaft  mit  beschrankter  Haftung,  the  French  soci'ete 
anonyme,  the  English  "joint-stock  company"  and  the  American 
"corporation,"  but  these  points  of  difference  are  of  no  great  im- 
portance compared  with  the  central  fact  that  in  all  these,  and  in 
all  other  commercial  countries  as  well,  there  has  come  to  exist  a 
certain  type  of  business  association,  the  essential  features  of 
which  are: 

1.  Little  or  no  direct  personal  relation  among  proprietors  or 

between  the  proprietors  and  the  business;  such  rela- 
tions as  do  exist  being  on  the  impersonal  basis  of  capi- 
tal invested. 

2.  Control  and  management  by  elected  representatives,  vir- 

tually acting  as  trustees  for  the  proprietors. 

3.  Liability  of  proprietors  limited  to  their  investment  or  to 

some  fixed  amount  proportioned  to  their  investment. 

§  23.     Corporate  Entity  ^ 

Both  the  Continental  courts  and  the  English  courts  have 
tended  always  to  regard  the  corporation  or  company  as  if  it  were 
a  group  of  individuals,  while  in  this  country  the  tendency  has 
been  to  follow  strictly  Chief  Justice  Marshall's  famous  definition 
in  the  Dartmouth  College  case,  wherein  he  spoke  of  the  corpora- 
tion as  "an  artificial  being,  invisible,  intangible,  and  existing  only 
in  contemplation  of  the  law."  The  logical  simplicity  of  this  view 
appeals  strongly  to  the  legal  mind.  Li  practice,  however,  we  all 
know  that  the  corporation  has  no  existence  and  no  interests  apart 
from  the  existence  and  interests  of  its  shareholders,  creditors,  and 
officers. 

The  fiction  is,  though,  a  convenient  one;   in  some  cases  too 


»  See  Book  I,  {  20. 


Ch.  3]  THE  CORPORATE"  ORGANIZATION  575 

much  so,  for  by  its  means  the  corporation  becomes  an  effective 
shield  to  protect  the  men  back  of  it  who  are  intent  upon  actions 
and  policies  for  which  they  would  not  care  to  accept,  as  individ- 
uals, the  full  responsibility. 

Recognizing  this  abuse  of  the  corporate  form,  the  courts  of 
this  country  have  become  more  and  more  inclined  in  recent  years 
to  tear  aside  the  corporate  mask  and  look  for  the  men  and  the 
motives  behind  corporate  actions.  Nevertheless,  they  are  still 
tangled  and  blocked  at  every  step  by  the  thousands  of  precedents 
consisting  of  decisions  based  upon  the  fundamental  idea  of  the 
corporation  as  a  thing  distinct  from  the  men  of  whom  it  is  com- 
posed, and  progress  is  slow. 

§  24.     Stockholders 

The  men  who  took  part  in  the  early  English  joint-stock  enter- 
prises— such  as  trading  expeditions  to  the  Indies  or  Americas — 
were  appropriately  known  as  "adventurers."  The  title  would 
not  be  inappropriate  in  many  cases  if  it  were  applied  to  present- 
day  stockholders,  or  shareholders,  in  corporations.  The  average 
shareholder  in  a  large  corporation  pays  for  his  holdings  of  stock, 
and  in  return  has  the  right  to  his  proportionate  share  of  whatever 
profits  are  distributed.  He  has  also  the  right — which  the  small 
shareholder  seldom  exercises — of  voting  for  directors  who  are 
supposed  to  represent  him.  That  duty  having  once  been  per- 
formed, he  ceases  to  be  a  factor  of  any  importance  in  the  man- 
agement of  the  company  until  the  next  annual  election;  in  fact, 
as  a  shareholder  he  probably  does  nothing  except  hopefully  wait 
for  and  gratefully  receive  whatever  dividends  the  board  of  direc- 
tors sees  fit  to  allot  to  him. 3 

§  25.    Stockholders'  Relation  to  Corporate  Business 

In  American  practice  the  average  shareholder,  even  of  smaller 
corporation's,  unless  he  happens  to  be  also  a  director  or  officer,  is 
not  only  helpless,  but  uninformed.    He  may  be  furnished,  if  it  so 


'  See  Book  I.  Ch.  XVII,  "Stockholders.' 


57$  CORPORATE  FINANCE  [Bk.  II- 

pleases  the  directors,  with  a  fairly  complete  annual  report;  the 
more  enlightened  corporations  even  send  out  monthly  or  quar- 
terly statements  of  earnings.  He  does  not,  however,  meet  his 
directors  and  officers  face  to  face  unless  as  a  purely  personal  or 
exceptional  event.  He  does  not  ask  questions;  he  has  no  repre- 
sentative to  dig  up  information  for  him ;  he  is  conipletely  in  the 
dark  as  to  the  plans  formulated  by  the  directors  and  even  as  to 
the  real  results  and  prospects  of  his  corporation.  There  are  of 
course  some  exceptional  cases.  A  few  stockholders  occasionally 
drift  into  the  annual  meetings  of  large  corporations,  but  these 
meetings  are  of  so  formal  a  character  that  the  stockholders  who 
attend  are  not  likely  to  be  men  of  much  weight  and  influence. 
Partly  because  of  these  conditions,  many  able  business  men  de- 
cline to  invest  in  any  corporation  in  which  they  cannot  protect 
their  interests  by  a  controlling  voice  or  at  least  a  seat  in  the 
directorate. 

§  26.     Stockholders'  Meeting  * 

The  larger  corporations  in  the  United  States  make  it  their 
custom  to  send  out  notices  of  annual  meetings  to  all  stockholders, 
and  to  forward  with  these  notices  a  printed  pro.xy,  which  author- 
izes the  secretary  or  some  other  officer  of  the  corporation  to  repre- 
sent the  shareholder  at  the  annual  meeting.  Most  of  the  cor- 
porations supply  stamped  envelopes  and,  if  they  do  not  hear 
from  the  shareholder,  forward  a  second  request  for  his  proxy. 
All  that  the  shareholder  is  asked  to  do  is  to  sign  his  name,  enclose 
the  proxy  in  the  Envelope  and  mail  it.  Nevertheless  the  interest 
on  the  part  of  the  average  shareholder  is  so  slight  that  only  a 
small  proportion  of  these  proxies  are  ordinarily  returned.  It  is 
easy  enough  to  return  the  proxy,  but  it  is  just  a  trifle  easier  to 
drop  it  into  the  waste  basket.  Probably  the  average  shareholder 
sees  no  reason  why  he  should  take  action  one  way  or  the  other. 
He  does  not  know  whether  the  corporation  is  being  well-managed 
or  whether  the  officers  and  directors  deserve  his  support  or  not. 

*  See  Book  I,  Ch.  XLII,  "Annual  Meeting  of  Stockholders,"  and  Ch.  XLIII,  "Special 
Meetings  of  Stockholders." 


Ch.  3]  THE  CORPORATE  ORGANIZATION  577 

Except  in  very  unusual  cases,  when  there  is  an  opposition  and 
when  a  campaign  to  get  his  support  is  carried  on,  he  knows  that 
his  vote  will  not  have  the  slightest  influence  either  for  or  against 
any  man  or  measure. 

Usually  the  secretary  and  one  or  two  other  officials  of  the 
corporation  take  th^  proxies  to  the  annual  meeting,  go  through 
all  the  formalities  of  electing  a  chairman  and.  a  secretary,  pre- 
senting reports,  casting  votes,  and  carrying  out  whatever  pro- 
gram has  been  agreed  upon  by  the  officers  of  the  corporation. 
Every  year,  for  instance,  an  officer  of  the  Union  Pacific  Railroad 
Company  takes  a^atchel  full  of  proxies,  makes  the  trip  from  New 
York  to  Salt  Lake  City  (the  Union  Pacific  Railroad  Company 
being  incorporated  in  Utah)  and  holds  the  annual  meeting.  Even 
when  action  out  of  the  ordinary  is  proposed,  very  few  share- 
holders ever  take  the  trouble  to  attend  these  meetings. 

§  27.    Helplessness  of  Minority  Stockholders 

The  minority  stockholder  is  able  to  do  Httle  or  nothing  to  pro- 
tect his  interests  even  though  he  suspects  impropriety  on  the 
part  of  his  directors. s  W.  Bourke  Cockran,  an  eminent  attorney, 
representing  a  stockholder  of  the  International  Steam  Pump 
Company,  appeared  before  the  Supreme  Court  of  the  State  of 
New  York  in  an  effort  to  compel  the  directors  of  the  company  to 
furnish  more  complete  data  than  his  chent  had  previously  been 
able  to  secure.  "Doesn't  the  existing  law  on  corporations  give 
you  sufficient  power  to  go  in  and  inspect  the  books?"  asked  the 
Justice.  "Why,  your  Honor,"  replied  Mr.  Cockran,  "they  would 
only  laugh  at  anyone  who  really  tried  to  get  at  the  books.  It 
would  take  until  doomsday." 

Under  recent  decisions  the  New  York  courts  have  made  it 
possible  for  shareholders  to  inspect  the  stock  ledger  and  transfer 
books  of  their  corporations  for  the  purpose  of  procuring  a  list  of 
the  stockholders,  but  they  cannot  inspect  the  books  of  account. 


« See  Book  I,  Ch.  LVIII,  "Protection  of  Minority," 


578  CORPORATE  FINANCE  [Bk.  II- 

§  28.    Status  of  Stockholders  in  Other  Countries 

In  other  countries,  the  tendency  of  the  management  to  ignore 
the  stockholders  has  not  yet  gone  so  far.  Corporations  in  these 
countries  are  not  of  such  enormous  size  as  those  in  America. 
The  custom  of  meeting  the  directors  and  officers  at  least  once  a 
year  and  of  persistently  seeking  information  as  to  the  internal 
affairs  of  the  company  has  not  fallen  so  completely  into  disuse. 

Also  the  English  statutes  provide  for  the  auditing  of  eyery 
company's  accounts  by  an  independent  accountant  elected  by 
the  shareholders.  The  auditor  is  responsible  to  the  shareholders 
and  not  to  the  directors,  and  he  is  legally  liable  to  the  company 
for  any  loss  occasioned  by  neglect  or  carelessness  on  his  part. 
The  courts  have  said  that  it  is  the  duty  of  an  auditor  not  to  con- 
fine himself  to  verifying  the  arithmetical  accuracy  of  the  balance 
sheet,  but  to  inquire  into  its  substantial  accuracy.  The  report 
of  the  auditor  must  be  sent  to  the  shareholders.  The  courts  have 
further  said  that  an  auditor  does  not  discharge  his  duty  by  sim- 
ply putting  the  shareholders  in  the  way  of  obtaining  information; 
he  must  go  beyond  this  and  state  his  conclusions  in  unmistakable 
terms. 

In  addition  to  this  effective  auditing  of  the  company's  ac- 
counts, the  annual  meeting  is  a  real  and  vital  feature  of  the 
corporate  system.  The  shareholders  attend,  hear  reports,  ask 
questions,  and  hear  explanations.  This  "heckling,"  as  it  is  called, 
is  expected,  and  public  opinion  makes  it  an  effective  discipline  of 
the  corporate  managers.  To  explain  mismanagement  to  a  crowd 
of  angry  and  disappointed  investors  is  not  a  pleasant  thing  to 
anticipate,  and  it  makes  the  managers  much  more  cautious  in 
their  administration  of  the  corporate  business. 

§  29.    The  Board  of  Directors 

The  board  of  directors  has  the  final  authority  within  a  cor- 
poration. The  board  elects  officers,  determines  policies,  author- 
izes contracts,  passes  on  methods  of  financing,  declares  or  with- 
holds dividends,  and  in  general  manages  all  the  affairs  of  the 


Ch.  3]  THE  CORPORATE  ORGANIZATION  579 

corporation.  This  describes  their  legal  status  and  responsi- 
bilities." 

In  practice,  however,  boards  of  directors  are  likely  to  become 
mere  appendages  or  echoes  of  some  one  or  two  individuals  who 
actually  direct  the  corporation.  The  real,  final  authority  is  fre- 
quently lodged  in  the  president,  if  he  is  an  active  man  and  per- 
forms all  the  duties  of  his  office,  and  the  board  of  directors  simply 
ratifies  his  decisions.  This  is  frequently  the  case  even  though 
the  directorates  may  be  made  up  of  able  and  forceful  men. 
Under  the  American  system  they  have  no  direct  interest,  except 
as  shareholders,  in  the  profits  of  the  corporation,  and  cannot 
afford  to  devote  a  great  deal  of  time  and  thought  to  its  activities. 
They  have  confidence,  presumably,  in  the  president  or  in  the 
chief  officer  or  officers,  whoever  they  may  be,  and  they  prefer  for 
their  own  convenience  and  comfort  to  leave  the  whole  corpora- 
tion in  the  care  of  its  actual  head. 

Under  such  conditions  the  thing  that  frequently  happens  is 
that  the  shareholders  elect  directors;  the  directors  elect  a  presi- 
dent or  other  chief  officer;  and  this  man  designates  the  other 
officers,  fixes  the  policy  of  the  concern,  and  carries  on  all  its 
affairs  subject  only  to  the  formal  ratification  of  his  board.  So 
long  as  the  president  and  other  officials  are  well  chosen,  the  sys- 
tem works  well.  Its  weakness  lies  in  the  fact  that  the  directors 
themselves  are  poorly  informed  and  are  left  in  a  helpless  or  ignor- 
ant condition  as  compared  with  the  officers;  hence  they  are  quite 
unable  to  protect  themselves  or  the  corporation  against  practices 
on  the  part  of  the  officers  that  are  perhaps  detrimental.  In  place 
of  a  representative  democracy,  which  is  the  ideal  form  of  govern- 
ment for  a  corporation,  they  substitute  a  small  despotism. 

§  30.    Inefficiency  among  Directors 

This  failure  of  the  board  to  function  is  due,  in  the  United 
States,  partly  at  least  to  the  custom  of  choosing  directors  of  im- 
portant corporations  from  a  very  small  circle  of  well-known  busi- 

«  See  Book  I,  Ch.  XVIII.  "Directors." 


580  CORPORATE  FINANCE  /Bk.  11^ 

ness  men.  The  result  is  that  one  man  may,  nominally,  serve  on 
10,  20,  50,  or  even  100  different  boards.  Even  though  some  of 
these  boards  may  be  those  of  subsidiary  corporations  which 
transact  nothing  but  the  most  formal  business,  nevertheless  the 
men  who  are  members  of  so  many  boards  cannot  be  thoroughly 
informed  as  to  the  affairs  of  any  of  them.  Within  recent  years 
there  has  been  a  significant  tendency  to  reduce  the  number  of 
directorates  of  which  one  man  is  a  member,  but  the  number  is 
still  too  large.  Henry  L.  Doherty,  who  is  largely  interested  in 
public  utility  properties,  is  a  director  in  83  corporations ;  Alfred 
H.  Smith,  president  of  the  New  York  Central  Railroad,  is  a  direc- 
tor in  88  corporations;  Albert  J.  County,  vice-president  of  the 
Pennsylvania  Railroad,  is  a  director  in  no  corporations. 

The  report  of  the  Interstate  Commerce  Commission  on  the 
financial  history  and  status  of  the  New  York,  New  Haven  and 
Hartford  Railroad,  strongly  condemns  inactivity  and  ignorance 
on  the  part  of  the  directors.  To  quote  the  plain  language  of  the 
Commission : 

There  are  too  many  ornamental  directors  who  have  such 
childlike  faith  in  the  man  at  the  head,  that  they  are  ready  to 
endorse  or  approve  anything  he  may  do.  .  .  .  The  minutes  of  the 
New  Haven's  meetings  reveal  that  the  Board  confined  itself  almost 
wholly  to  ratifying  and  authorizing  action;  there  was  little  real  in- 
formation or  discussion.  None  of  the  directors  would  have  been  so 
careless  in  the  handling  of  his  own  money  as  the  evidence  demon- 
strated they  were  in  dealing  with  the  money  of  other  people. 

§  31.    Real  Function  of  the  Board 

On  the  other  hand,  there  is  sometimes  a  mistaken  idea  that 
the  board  of  directors  ought  to  manage  all  the  details  of  a  busi- 
ness. Its  real  function  is  in  selecting  the  right  officials,  outlining 
policies,  and  passing  well-informed  judgment  from  time  to  time 
as  to  the  efficiency  and  honesty  of  the  management.  One  of  the 
most  successful  publishers  in  the  United  States,  the  late  Henry 
Watterson,  gave  a  very  forceful  opinion  of  directorates  which 
run  too  much  to  details.    Referring  to  the  management  of  the 


Ch.  3]  THE  CORPORATE  ORGANIZATION  58 1 

New  York  World  after  the  death  of  the  organizer  and  former  pro- 
prietor, Joseph  Pulitzer,  Colonel  Watterson  said : 

I  understand  that  the  paper  is  edited  by  a  board  of  directors. 
You  might  as  well  try  to  run  a  locomotive  by  a  board  of  directors. 
The  moment  the  wisdom  of  one  man  or  two  men  is  superseded  by 
the  foUy  of  one  man  or  two  men,  the  efforts  of  a  lifetime  may  then 
and  there  be  wrecked.    It  has  been  done  repeatedly. 

In  other  words,  the  quick  and  usually  correct  decisions  of  one  or 
two  men  familiar  with  the  conditions  are  preferable  to  the  com- 
promise decisions  of  a  body  of  men,  even  though  these  1?  tter  may 
be,  as  to  individuals,  quite  as  capable. 

§  32.    Compensation  of  Directors 

It  has  been  suggested  that  the  reason  for  the  inefficiency  and 
tiie  light  ethical  standards  characteristic  of  so  many  directorates, 
is  to  be  found  not  only  in  wrong  practice  in  selecting  these  men, 
but  also  in  wrong  practice  in  compensating  them.  In  many  for- 
eign countries,  notably  in  Continental  Europe,  it  is  the  custom 
to  distribute  among  the  directors  at  the  end  of  each  year  a  fixed 
percentage  of  the  net  profits ;  thus  each  director,  even  though  he 
may  not  be  a  heavy  shareholder,  has  a  direct  and  personal  inter- 
est in  building  up  the  profits.  He  is  less  likely  to  wink  at  incom- 
petence or  to  avoid  criticism  that  would  be  for  the  good  of  the 
corporation,  if  he  realizes  that  he  must  himself  pay  a  portion  of 
the  penalty  in  the  form  of  reduced  compensation.  Paul  War- 
burg, formerly  of  the  firm  of  Kuhn,  Loeb  and  Company,  has  ex- 
pressed his  belief  that  in  this  country  we  should  follow  the  Euro- 
pean plan  of  paying  directors  in  proportion  to  the  profits  the 
corporation  earns  under  the  management.  One  important  gain 
in  this  plan  is  that  it  becomes  easier  to  secure  as  directors  men 
who  may  themselves  have  only  a  small  shareholding  interest  in 
the  corporation;  the  range  of  choice  is  widened. 

As  matters  stand  now,  a  man  who  becomes  a  director  of  an 
important  corporation  usually  takes  the  position  for  one  of  three 
reasons:   because  he  has  a  large  share-interest  that  he  feels  he 


582  CORPORATE  FINANCE  [Bk.  II- 

should  protect,  because  it  adds  to  his  prestige,  or  because  it  gives 
him  a  connection  or  "inside"  information  that  has  a  cashable 
value.  The  second  motive  has  a  strong  influence  in  making  up 
the  directorates  of  banking  institutions.  ''Membership  on  the 
boards  of  good  banks,"  someone  has  said,  "is  largely  a  social 
function."  This  is  not  the  way  to  get  efficient,  hard-working 
directors.  Under  the  American  system  it  is  a  common  practice 
to  pay  nominal  fees  for  attendance  at  board  meetings,  but  these 
seldom  amount  to  more  than  $20  a  meeting,  and  are  not  a  factor 
of  any  real  weight. 


CHAPTER  IV 

THE  CORPORATION  IN  MODERN  BUSINESS; 
HOLDING  COMPANIES 

§  33.    Widespread  Use  of  the  Corporation 

The  great  commercial  agencies  of  the  United  States  list  some 
2,180,000  individuals,  firms,  and  corporations  as  being  in  busi- 
ness. Over  320,000  corporations  in  the  United  States  filed 
income  tax  returns  for  the  calendar  year  ended  December  31, 
1919.  This  would  seem  to  indicate  that  about  15%  of  all  busi- 
ness enterprises  are  organized  in  the  corporate  form.  However 
these  figures  do  not  in  themselves  give  any  adequate  idea  of  the 
relative  importance  of  the  corporate  form.  The  85%  of  business 
enterprises  owned  by  individuals  or  by  partnerships  include, 
with  comparatively  few  exceptions,  only  small  concerns.  The 
320,000  corporations  include  almost  every  important  business 
undertaking  of  the  country. 

It  is  interesting  to  note  the  distribution  of  the  corporations 
of  the  country  on  the  basis  of  their  capitalization  as  shown  by  the 
last  census: 

184,554  corporations  with  capital  of  less  than  $1,000,000 
3.569 
1,290  "  "  " 

639 

411 

78s     «      " 

660     «      «     « 

7S 
54 

In  other  countries,  also,  large  enterprises  are  almost  always 
organized  under  the  form  which  there  corresponds  to  our 
corporation. 

583 


1,000,000 

to$ 

2,000,000 

2.000,000 

" 

3,000,000 

3,000,000 

" 

4,000,000 

4,000,000 

u 

5,000,000 

5,000,000 

u 

10,000,000 

10,000,000 

u 

50,000,000 

50,000,000 

u 

100,000,000 

00,000,000 

and 

over 

S84  CORPORATE  FINANCE  [Bk.  II- 

§  34.    The  Small  Corporation 

Yet,  as  shown  by  the  foregoing  table,  the  corporation  is  by 
no  means  confined  in  its  usefulness  to  concerns  doing  an  enor- 
mous business.  On  the  contrary,  it  is  becoming  every  year  more 
and  more  frequent  to  organize  even  small  enterprises  in  this 
form.  The  "one-man"  or  "close"  corporation  is  no  longer  an 
isolated  phenomenon.  Thousands  of  men  who  prefer  to  have 
themselves  and  their  estates  relieved  from  possible  liabilities 
due  to  misfortunes  of  business,  or  who  wish  to  organize  in  such  a 
way  that  it  will  be  easy  to  sell  interests  or  gradually  to  transfer 
the  control,  have  decided  to  adopt  the  corporate  form. 

Also  it  is  becoming  more  and  more  common  to  incorporate 
the  estates  of  deceased  persons  and  to  distribute  shares  in  the 
corporation  among  the  heirs  of  the  estate  so  that  a  proper 
division  of  interest  may  be  secured  without  a  physical  division 
or  forced  sale  of  the  property.  Small  corporations  for  temporary 
purposes,  also,  are  not  uncommon.  An  individual  may  get  up 
a  corporation  to  publish  a  book  or  to  carry  through  a  speculation 
in  real  estate. 

Indeed,  the  question  is  often  raised  whether  this  tendency 
is  not  carried  too  far;  whether  enterprises  that  would  be  better 
off  as  temporary  syndicates  or  as  special  partnerships,  are  not 
unthinkingly  organized  as  corporations.  As  regards  many  in- 
dividual cases,  the  suspicion  is  no  doubt  well  justified.  On  the 
whole,  however,  there  can  be  little  question  but  that  the  corpora- 
tion has  proved  itself  useful,  sound,  and  economical,  not  only  for 
nation-wide  and  world-wide  concerns,  but  for  small  and  local 
enterprises  as  well. 

§  35.    The  Army  of  Stockholders 

Another  point  to  consider  here  is  the  great  number  of  persons 
interested  in  corporations  as  holders  of  their  stocks  and  bonds. 
A  single  corporation — United  States  Steel — has  over  189,000 
stockholders.  This  is  of  course  exceptional,  but  when  we  con- 
sider that  over  320,000  corporations  make  annual  income  tax 


Ch.  4]  THE  CORPORATION  IN  MODERN  BUSINESS  585 

reports  it  is  obvious  that  the  total  number  of  stockholders  is 
far  up  in  the  millions.  On  a  smaller  scale,  the  same  thing  is  true 
in  other  countries.  It  constitutes  one  sound  reason  for  saying 
that  the  corporate  form  of  organizing  enterprises  is  becoming 
one  of  the  far-reaching  factors  in  modem  business  life. 

§  36.    Is  the  Corporate  Organization  Efficient? 

Adam  Smith,  the  first  and  perhaps  the  greatest  of  economists, 
was  extremely  skeptical  as  to  the  usefulness  of  the  large  "joint- 
stock"  companies  which  in  his  day  were  just  beginning  to  play  a 
prominent  part  in  business  Hfe.  "Without  a  monopoly,"  he 
says,  "a  'joint-stock'  company,  it  would  appear  from  experience, 
cannot  long  carry  on  any  branch  of  foreign  trade,  for  it  is  a 
species  of  warfare  in  which  the  operations  are  continually 
changing,  and  which  can  scarcely  ever  be  conducted  successfully 
without  such  an  unremitting  exertion  of  vigilance  and  attention 
as  cannot  long  be  expected  from  the  directors  of  a  joint-stock 
company."  Elsewhere  he  asserts  that  "negligence  and  pro- 
fusion must  always  prevail  more  or  less  in  the  affairs  of  a  'joint- 
stock'  company." 

In  view  of  the  rapid  spread  of  the  joint-stock  or  corporate 
form  of  organization  and  the  immense  number  now  in  existence, 
it  may  seem  at  first  glance  that  wise  old  Adam  Smith  for  once 
was  entirely  wrong.  Yet,  if  he  were  to  step  into  twentieth  cen- 
tury life  and  read  all  the  details  of  the  various  corporate  failures, 
some  of  them  verging  on  the  scandalous,  that  are  from  time  to 
time  brought  to  light,  he  would  perhaps  not  be  easily  convinced. 

§  37.    Reason  for  Adoption  of  Corporate  Form 

As  a  matter  of  fact,  it  is  probably  true  that  the  many  advan- 
tages ofifered  by  the  corporate  form,  such  as  the  freedom  it  offers 
from  individual  liability,  its  convenient  stock  system,  its  per- 
petuity, etc.,  are  more  responsible  for  its  widespread  adoption, 
than  any  claim  it  can  reasonably  offer  to  superior  efficiency. 

There  are  some  features  of  corporate  organization  which  are 


586  CORPORATE  FINANCE  [Bk.  li- 

no doubt  an  improvement  in  respect  to  efficiency,  over  any  other 
forms  of  organization.  The  people  who  supply  the  money  are 
not  necessarily  the  ones  who  personally  manage  the  enterprise; 
and  this  leaves,  or  should  leave,  an  opportunity  to  engage  men 
of  special  talent  as  managers.  The  custom  at  one  time  was  to 
select  one  of  the  largest  stockholders  as  the  nominal  president 
of  an  important  bank,  railroad,  or  manufacturing  corporation, 
but  this  has  now  been  largely  abandoned  in  favor  of  making  the 
responsible  manager  of  the  institution  also  its  president,  although 
he  may  hold  but  a  few  shares  of  stock.  On  the  other  hand,  the 
most  important  or  influential  stockholder,  instead  of  becoming 
president,  is  now  more  frequently  made  chairman  of  the  board — 
a  position  which  usually  pays  no  salary.  Furthermore,  it  is 
at  least  theoretically  true  that  the  creation  of  a  board  of  directors 
who  can  oversee  and  direct  its  officers,  is  a  striking  gain. 

§  38.    Causes  of  Corporate  Inefficiency 

While  the  corporate  form  of  organization  has  many  ad- 
vantageous features  some  of  which  should  contribute  directly 
to  its  efficiency,  as  suggested  in  the  preceding  chapter,  these  ad- 
vantages are  too  often  nullified  by  the  selection  of  incompetent 
or  overoccupied  directors.  As  Adam  Smith  foresaw,  these  men 
are  not  so  zealous  in  protecting  the  shareholders  as  they  are  in 
advancing  themselves.  Sometimes  responsibility  is  so  divided 
that  it  rests  too  lightly  on  the  shoulders  of  each  individual 
director.  Hartley  Withers  makes  the  interesting  comment  that 
"the  real  business  of  most  boards  is  done  by  a  small  minority 
who  save  the  rest  from  the  consequences  of  their  inexperience." 
He  continues: 

In  actual  practice  the  notion  that  the  board  is  chosen  by  the 
shareholders  or  is  really  representative  of  the  shareholders,  is 
generally  a  delusion.  The  board  either  forms  itself  or  is  formed  by 
the  promoter  and  fills  its  own  vacancies,  subject  only  to  the  purely 
formal  confirmation  of  the  shareholders.  The  officers  are  chosen  ' 
by  the  board  or  by  one  another,  and  joint-stock  companies  are  thus 
governed  in  practical  fact  by  a  self-elected  oligarchy. 


Ch.  4]  THE  CORPORATION  IN  MODERN  BUSINESS  587 

This  is  true  not  only  in  London,  which  Mr.  Withers  has  in  mind, 
but  in  New  York,  Montreal,  Paris,  Berlin,  and  every  other  part 
of  the  world.  How  do  these  self-chosen  oligarchies  work,  and 
what  do  they  accomplish? 

§  39.    Insolvency  of  the  Northern  Pacific 

During  a  period  of  almost  ten  years,  Henry  Villard  was  not 
only  a  director  of  the  Northern  Pacific  Railroad  Company,  but 
was  president  of  the  company,  and  was  generally  regarded  as 
its  active  and  responsible  head.  In  his  "Memoirs,"  no  doubt 
wishing  to  relieve  himself  in  part  at  least  from  responsibility  for 
the  insolvency  of  the  company  under  his  management,  he  says: 

in  1 89 1  Mr.  Villard  .  .  .  made  ...  his  last  official  tour  of 
inspection  of  the  main  line  and  principal  branches  of  the  Northern 
Pacific  .  .  .  The  most  alarming  impression  of  all  made  upon  him 
was  the  revelation  of  the  weight  of  the  load  that  had  been  put  upon 
the  company  by  the  purchase  and  construction  of  the  longer  branch 
lines  in  Montana  and  Washington,  which  he  then  discovered  for 
the  first  time  ....  They  represented  a  total  investment  in  cash 
and  bonds  of  not  far  from  $30,000,000,  which  together  hardly 
earned  operating  expenses.  The  acquisition  and  building  of  these 
disappointing  lines  had  in  a  few  years  absorbed  the  large  amount 
of  consolidated  bonds  set  aside  for  construction  purposes,  which 
had  been  assumed  to  be  sufi&cient  for  all  needs  in  that  direction  for  a 
long  time. 

It  is  clear  that  Mr.  Villard,  whatever  may  have  been  his 
abiUties  and  good  intentions,  had  not  been  devoting  sufficient 
attention  to  the  business  of  this  corporation  to  intelligently 
direct  its  affairs. 

§  40.    Management  of  the  Colorado  Fuel  and  Iron  Company 

Some  interesting  testimony  along  somewhat  the  same  line  was 
given  by  John  D.  Rockefeller,  Jr.,  when  called  before  a  subcom- 
mittee of  Congress  and  questioned  as  to  his  control  over  the 
Colorado  Fuel  and  Iron  Company.  Mr.  Rockefeller  testified 
that  his  father  held  40%  of  the  common  and  40%  of  the  preferred 
shares  in  this  company.     He  stated  that  he  personally  was  a 


588  CORPORATE  FINANCE  [Bk.  II- 

member  of  the  board  of  directors,  but  did  not  attend  meetings, 
and  explained  that  he  had  every  confidence  in  the  officers  of  the 
company  and  kept  in  touch  with  them  by  correspondence.  The 
chairman  of  the  committee  intimated  that  Mr.  Rockefeller 
should  have  attended  an  important  meeting  in  October.  "If 
you  mean  that  I  should  have  gone  to  Denver  to  attend  a  meeting 
of  the  board  of  directors,"  was  the  reply,  "I  will  say  that  it  is 
not  by  attending  the  board  meetings  that  we  keep  in  touch  with 
the  officers.  If  the  time  comes  when  we  cannot  rely  on  the 
officers  then  we  will  get  somebody  else,  for  it  is  impossible  for 
us  to  attend  to  all  of  these  things  ourselves,  and  we  have  got  to 
get  the  ablest  men  obtainable  to  act  for  us." 

§  41.    Present  Status  of  the  Corporation 

In  spite  of  the  defects  that  develop  in  the  corporate  mechan- 
ism and  the  abuses  that  sometimes  creep  in  when  businesses  are 
conducted  under  the  corporate  form,  it  does  not  follow  by  any 
means  that  the  corporate  form  is  to  be  condemned.  The  perfect 
system  of  business  organization  has  not  yet  been  devised,  and 
abuses  will  creep  in  under  any  existing  form  of  business  organi- 
zation. Furthermore,  the  defects  of  the  other  existing  forms  of 
business  organization  are  greater  than  those  of  the  corporation 
and,  on  the  other  hand,  the  corporation  possesses  advantages 
which  are  found  in  none  of  these  others.  It  is,  in  short,  the  most 
useful  form  of  business  organization  that  has  yet  been  devised. 

To  sum  the  matter  up,  it  may  be  said  that  without  the  use 
of  the  corporation — or  some  effective  substitute — the  vast 
extension  of  modem  business  could  not  have  been  effected. 

Although  merely  an  immaterial  form,  it  has  nevertheless 
wielded  an  economic  and  social  influence  greater  than  any  other 
purely  conceptual  entity  of  the  last  century.  The  contribution 
of  the  corporation  to  the  evolution  of  the  form  of  modern  in- 
dustry has  been  no  less  potent  than  that  of  machinery  to  its 
technique. 


'  Dewing  on  Finan.  Pol.  of  Corp. 


Ch.  4]  THE  CORPORATION  IN  MODERN  BUSINESS  589 

§  42.    Holding  Companies 

A  striking  development  of  recent  years  has  been  the  growing 
use  and  importance  of  companies  which  hold  the  stock  of  other 
corporations.  There  was  originally  no  thought  that  corpora- 
tions might  be  organized  for  any  other  purpose  than  to  conduct 
directly  the  business  operations  specified  in  their  articles  of  in- 
corporation. It  was  in  time  discovered,  however,  that  among 
the  possible  activities  of  a  corporation  might  be  the  holding  of 
the  securities  of  other  corporations. 

At  the  beginning,  the  only  use  made  of  this  power  was  to 
purchase  interests  that  could  be  regarded  as  useful  to  the  corpora- 
tion or  as  subserving  the  main  purpose  for  which  it  was  created. 
This  remains  today  the  most  common  and  important  purpose  for 
which  corporations  acquire  the  shares  of  other  corporations. 

But  the  holding  company  device  has  proved  extremely  useful 
also  for  another  purpose  on  which  public  attention  has  been 
largely  centered.  This  purpose  is  to  achieve  a  combination  of 
competing  concerns  which  will  restrain  competition  and  be 
within  the  requirements  of  the  law.  This  subject  has  been  so 
fully  discussed  in  various  books  and  articles  that  it  needs  but 
brief  reference.2 

§  43.    Development  of  the  Holding  Company 

Before  the  adoption  of  the  "holding"  company  device,  com- 
binations of  competing  concerns  had  been  effected  in  several 
different  ways.  The  first  attempt  to  achieve  such  combinations 
in  the  United  States  was  made  by  competing  railroads  which 
worked  out  various  "gentlemen's  agreements"  for  the  regulation 
of  rates  and  competitive  methods.  These  agreements  never 
stood  the  strain  of  every-day  use  for  any  long  period.  They 
always  broke  down  because  they  were  not  hard  and  fast  con- 
tracts; they  were  differently  interpreted  by  the  various  indi- 
viduals who  entered  into  them  and  they  had  no  legal  sanction. 


*See  Book  I,  Ch.  LVII,  "Holding  Companies."  a  f;ifij   rl;-lI<irftO'>'>i;  {ti 


590  CORPORATE  FINANCE  [Bk.  II- 

Another  form  of  combination  that  has  proved  unsuccessful 
in  this  country — though  it  has  worked  to  some  extent  abroad— 
is  the  "pool"  or  selling  agency,  which  is  an  agreement  to  restrict 
production  and  sales,  and  which  frequently  accomplishes  this 
purpose  by  having  all  the  sales  of  the  competing  companies 
handled  by  one  selling  organization.  This  arrangement  was 
found  to  be  illegal  in  this  country  and  was  given  up  more  than  a 
generation  ago. 

§  44.    The  Export  Association 

In  1918  the  pool  or  selling  agency  was  legalized  for  export 
purposes  by  the  passage  of  the  so-called  "Webb-Pomerene  Law," 
which  expressly  authorizes  the  formation  of  export  associations 
of  "any  corporation  or  combination,  by  contract  or  otherwise, 
in  the  form  of  two  or  more  persons,  partnerships,  or  corpora- 
tions." Perhaps  the  best-known  organization  under  this  law 
is  the  Copper  Export  Association,  Inc.,  in  the  formation  of  which 
seventeen  companies  participated,  all  of  them  prominent  in 
copper  production,  refining,  or  export.  In  the  early  part  of  192 1 
this  association  held  some  400,000,000  pounds  of  refined  copper 
for  resale  in  foreign  markets.  Against  this,  to  finance  its  con- 
stituent companies,  it  issued  $40,000,000  of  gold  notes  to  be 
paid  from  the  proceeds  of  its  stock  of  copper  as  this  was  sold. 

§  45.    The  Trust  and  Its  Successors 

The  successor  of  the  pool  or  selling  agency  for  domestic 
activity  was  the  monopoHstic  "trust."  Under  this  form  of  com- 
bination, controlling  shares  in  competing  corporations  were 
turned  over  to  a  group  of  trustees  who  issued  in  exchange 
trustees'  certificates.  The  trustees  were  able  in  this  way  to  direct 
all  the  corporations  and  to  restrain  their  competition  with  each 
other.  In  the  late  eighties  this  arrangement  also  was  found  to 
be  illegal  and  the  trusts  already  formed  were  dissolved. 

Shortly  afterward  began  the  use  of  the  "holding"  company 
to  accomplish  this  same  purpose.     One  corporation  was  formed 


Ch.  4]  THE  CORPORATION  IN  MODERN  BUSINESS  591 

which  purchased  the  controlling  shares  of  competing  corporations 
and  was  thus  able  to  direct  them  in  the  same  way  that  the  trusts 
had  previously  done. 

A  variation  of  this  was  the  formation  of  a  large  corporation 
that  bought  up  the  entire  plants,  patents,  and  properties  of  com- 
peting companies.  Pa3mient  was  usually  made  in  securities  of 
the  large  corporation,  which  the  absorbed  corporations  distri- 
buted among  their  stockholders  before  they  were  dissolved. 
The  same  large  corporation  would  also,  where  it  seemed  advan- 
tageous, merely  buy  up  stock  enough  to  control  and  would  in  that 
case  act  as  the  usual  holding  corporation. 

Both  of  these  plans  are  in  use  today,  and  both  may  be  dis- 
solved by  the  courts,  if  evidence  is  brought  forward  showing  that 
the  arrangement  is  being  used  to  stifle  competition,  to  enhance 
prices,  or  to  restrain  trade. 

§  46.    Present  Status  of  Holding  Companies 

Out  of  the  discussion  and  the  various  legal  measures  that 
have  been  taken  to  restrain  them,  there  has  arisen  a  popular 
feeling  that  all  holding  companies  are  questionable,  and  it  has 
even  been  seriously  proposed  that  corporations  should  be  for- 
bidden to  hold  stock  in  any  other  corporation.  Yet  as  a  matter 
of  fact,  no  real  legal  objection  to  a  holding  company  in  itself 
has  ever  been  raised.  The  only  question  that  has  arisen  is 
whether  the  particular  holding  company  or  companies  have  been 
used  for  purposes  of  restraining  trade  and  competition,  and  it  is 
that  use  which  is  forbidden.  For  any  purpose  that  is  legal  for 
a  corporation,  a  holding  company  may  be  used  as  effectively  and 
with  as  little  legal  objection  as  ever. 

There  are  two  purposes  for  which  the  holding  corporation 
may  be  legitimately  used : 

j^j^jgi.  To  bring  about  a  grouping  or  combination  of  concerns 
that  are  non-competitive.  This  occurs  most  fre- 
quently in  the  public  utility  field.  ,nrwi>n  *  ai  boiM<v « 


59»  CORPORATE  FINANCE  [Bk.  H- 

rfiDtijf;  (To  control  subsidiary  corporations  in  such  a  way  as  to 

?J:imi  ;    advance  the  main  interests  of  the  holding  company, 

but  not  with  intent  to  prevent  or  restrain  competition. 

\M,*  The  holding  corporation  in  such  case  is  designated  as 

-r;  ''the  parent  company." 

I'.  >')iJ;  -q 

§  47.    Holding  Companies  in  the  Public  Utility  Field  (j 

The  best  illustration  of  the  use  of  the  holding  corporation  for 
the  first  purpose  is  to  be  found  in  the  public  utility  field.  There, 
as  stated  in  a  brief  filed  with  the  Interstate  Commerce  Commit- 
tee of  the  United  States  Senate  :3 

, ,. ,  The  total  capital  employed  in  electric,  gas,  street  and  interurban 
railway  companies,  commonly  called  "public  utility  corporations," 
in  this  country  today  is  estimated  to  exceed  eight  billion  dollars.  "^ 
Of  this  capital,  nearly  five  and  a  half  billion  dollars  are  controlled 
by  holding  companies  and  their  subsidiary  companies.  Of  the 
approximately  eighty-nine  millions  of  people  served  by  electric 
light  and  power  and  gas  companies  over  sixty-two  millions  (approx- 
imately 70  per  cent)  are  served  by  holding  company  systems. 


I '48.''  Advantages  of  the  Holding  Company 

The  chief  advantages  of  the  holding  company  as  used  in  con- 
nection with  public  utilities  are: 

'  ;ix»!  The  able  management  and  expert  assistance  supplied  by 
the  holding  company.  Most  of  the  local  companies  are  in 
small  cities  and  do  not  have  the  resources  which  would  enable 
them  to  employ  high-priced  talent.  The  holding  companies, 
through  their  superior  resources  and  organization,  are  able  to 
supply  this  and  thus  to  increase  the  ef&ciency  of  the  local 
companies. 

2.  The  more  adequate  financing  made  possible  by  the 
standing  and  superior  marketing  facilities  of  the  holding  com- 
pany.   The  securities  of  the  local  public  utilities  can  be  sold 


•Quoted  in  4  Dewing  on  Finan.  Pol.  of  Corp.,  p.  130  (footnote).    /IJLL 


Ch.  4l  THE  CORPORATION  IN  MODERN  BUSINESS  593 

only  in  or  near  the  place  of  their  operations;  the  securities  of 
great  holding  companies,  though  largely  based  upon  these  same 
local  securities,  enjoy  a  national  and  even  international  market 
and  consequently  can  be  sold  more  widely  and  on  a  much' 
better  basis.  ■       —    ,         •- 

!ij«  lol  oiul'uuu}  vino 
§  49.    Parent  and  Subsidiary  Corporations   o  oimLqaa  n  gfiirmol 

A  subsidiary  corporation  may  come  into  existence  through 
the  creation  of  a  separate  corporation  to  handle  a  distinct  phase 
of  a  company's  business,  or  through  the  purchase  of  interests  in 
companies  previously  existing,  the  main  corporation  being  in 
this  case  the  holding  company.*  The  use  of  subsidiary  corpora- 
tions is  becoming  more  and  more  extensive.  A  certain  manu- 
facturing corporation,  for  instance,  has  no  less  than  six  sub- 
sidiary corporations,  i.e.,  one  operating  company,  one  selling 
company,  one  purchasing  company,  one  company  owning  a 
short  railroad,  one  real  estate  company  to  buy  lands  and  to 
erect  buildings,  and  another  company  to  operate  these  buildings. 

The  advantage  of  forming  a  distinct  corporation  in  such  a 
case,  rather  than  to  simply  establish  another  department  of  the 
business,  is  not  always  clear  to  the  outsider.  Various  reasons 
may  lead  to  its  formation.  Frequently  a  subsidiary  corporation 
is  organized  to  meet  personal  requirements.  A  first-class  real 
estate  man,  for  example,  may  not  desire  to  come  to  a  corporation 
as  a  paid  employee,  but  would  be  willing  to  assume  the  nianage- 
ment  of  a  distinct  corporation,  even  though  this  be  subsidiary  to 
the  other  corporation,  under  conditions  that  would  enable  him 
to  secure  adequate  profit. 

Another  condition  frequently  arising  is  where  it  is  desired  to 
give  the  manager  of  a  plant,  or  of  a  branch  office,  an  opportunity 
to  acquire  a  personal  stock  interest  in  the  operations  directly 
under  his  control,  and  this  can  be  most  easily  done  through  the 
formation  of  a  separate  corporation.     Other  motives  may  come 


*  See  Book  I,  i  527. 


594  CORPORATE  FINANCE       i>a  5nn^         [Bk.  11- 

into  play,  as  for  instance  in  the  case  of  a  furniture  business  which 
included  among  its  activities  the  sale  of  papers  for  wrapping  and 
packing  furniture.  This  company  found  that  difficulty  was 
being  experienced  by  its  sales  force  in  selling  people  interested 
in  suh  pcapers,  because  of  the  impression  that  the  salesman  had 
only  furniture  for  sale.  The  difficulty  was  easily  overcome  by 
forming  a  separate  company  to  handle  the  sale  of  paper,  with  a 
separate  name,  stationery,  and  sales  manager,  but  otherwise 
conducted  as  a  part  of  the  parent  business.  j  ^ 

It  may  be  thought  strange  that  a  corporation  holding  a 
charter  and  grant  of  powers  from  the  state,  could  be  organized  so 
lightly  and  for  so  minor  a  purpose,  yet  such  incorporations  are 
not  at  all  uncommon.  It  has  become  so  easy  and  so  customary 
to  organize  a  corporation  for  some  specific  purpose,  that  it  is 
frequently  done  with  Httle  thought  and  often  when  little  or 
nothing  is  gained.  The  arrangement  is  in  many  instances  of  the 
greatest  advantage,  and  we  should  not  be  misled  by  any  popular 
outcry  against  corporations  and  holding  companies  into  con- 
demning or  endeavoring  to  prevent  practices  that  on  the  whole 
make  for  business  efficiency.  i?^  oj  ajsrfj  •i^A3s>i 


■  iJBi  lari' 


Part  II — Corporate  Securities 


CHAPTER  V 

COMMON  STOCK  1 

§  50.    Owned  and  Borrowed  Capital 

The  capital  funds  used  in  any  business  enterprise  fall  into  two 
classes:  "owned  funds"  and  "borrowed  funds."  In  an  in- 
dividual proprietorship  or  in  a  partnership  the  distinction  is 
clear  and  easily  made.  The  capital  funds  of  such  a  business  are 
represented  on  the  liability  side  of  the  balance  sheet,  first  by 
obligations,  or  "borrowed  funds,"  and  secondly  by  proprietor- 
ship, including  whatever  surplus  has  accumulated. 

In  a  corporation  the  distinction  between  "owned"  and  "bor- 
rowed" capital  is  not  always  so  clear.  As  in  the  partnership  or 
sole  proprietorship,  the  capital  funds  are  represented  on  the 
liability  side  of  the  balance  sheet  by : 

1.  Its  obligations  or  "borrowed  funds." 

2.  Its  capital  stock,  surplus,  and  reserves — which  take  the 
,  ,    J       place  of  the  proprietorship  accounts  of  the  other  forms 

of  business  organization,  and  represent  the  "owned 
funds"  of  the  corporation. 

But  any  outstanding  bonds  are  entered  among  the  borrowed 
funds  as  a  matter  of  course,  and  equally  as  a  matter  of  course  any 
outstanding  preferred  stock,  as  part  of  its  capital  stock,  is 
entered  among  its  owned  funds.  Yet  the  distinction  between 
bonds  and  preferred  stock  is  not  always  clear.  Many  modem 
■■n'.-yr,  'y\ii  'yii  -^Jnjl^  iKjfii  arh '^a  lob/i.-.n 

« See  Book  I,  Ch.  X,  "Stock."  ...^        r,    .i,,,j^i 

59S 


596  CORPORATE  FINANCE  [Bk.  II- 

issues  of  preferred  stock  are  not  only  redeemable,  but  carry  as 
one  of  the  conditions  of  issue  a  sinking  fund  provision  to  insure 
this  redemption.  On  the  other  hand,  participating  bonds  which 
share  in  the  profits  of  the  corporate  business  beyond  their  fixed 
interest  are  occasionally  issued,  and  income  bonds  the  interest 
on  which  is  payable  only  when  earned,  are  a  not  uncommon 
feature  of  corporate  financing.  Indeed,  it  would  be  difficult  to 
fix  on  any  dividing  line  which  clearly  separates  the  shareholders 
of  a  corporation  from  the  holders  of  its  bonds. 

Nevertheless,  we  may  in  general  follow  the  customary  line  of 
distinction  and  say  that  the  bonds,  notes,'  accounts  payable, 
and  other  obligations  of  a  corporation  may  be  regarded  as  repre- 
sentative of  borrowed  capital,  and  that  its  outstanding  shares  of 
capital  stock,  both  common  and  preferred,  may  be  regarded  as 
representative  of  owned  capital. 

Some  companies  have  practically  nothing  but  owned  capital ; 
that  is  to  say,  their  borrowings  are  almost  nil.  Ordinarily  the 
only  corporations  in  this  condition  are  those  which  have  just 
started,  or  those  which  are  small  and  struggling  and  have  not  the 
credit  which  would  enable  them  to  borrow  even  on  short  time. 
Once  in  a  while,  however,  we  find  a  large  corporation  which 
follows  the  same  policy.  JFor  instance,  the  W.  L.  Douglas  Shoe 
Company,  with  a  capitalization  of  common  and  preferred  stock 
of  over  $5,000,000,  carries  on  the  liability  side  of  its  balance  sheet 
only  common  stock,  preferred  stock,  and  current  accounts  pay- 
able." The  same  thing  is  true  of  the  Singer  Manufacturing  Com- 
pany, which  has  $90,000,000  of  common  stock  but  no  funded 
debt  of  any  kind. 

b  >•/.,(  ,..Ki  ■>rf J  Tiiu,rn;5  bai  ^l>flud.5flJbn 

§  51.    Stocks  and  Shares 

The  title  of  this  section  is  that  of  a  very  readable  English 
publication  to  which  reference  is  made  below.  At  first  glance 
the  combination  of  words  in  the  title  seems  to  the  American 
reader  so  much  nonsense,  for  in  the  United  States  we  are  accus- 
tomed to  apply  the  two  words  "stocks"  and  "shares"  almost 


Ch.  s]  COMMON  STOCK  597 

indiscriminately,  both  meaning  the  units  of  a  corporation's 
owned  capital.  We  derive  our  meaning  of  the  word  "stock"  in 
its  financial  sense  from  its  original  meaning  of  something  heaped 
up  like  a  stack ;  this  is  the  sense  in  which  it  is  used  in  the  phrase 
"stock-in-trade."  Adam  Smith  uses  the  word  to  mean  the 
capital  of  a  firm  or  company,  and  this  meaning  has  survived  in 
the  United  States,  but  not  in  Europe.  In  England,  stock  is 
distinguished  from  shares  by  the  fact  that  it  is  divisible  into,  and 
transferable  in,  odd  and  varying  amounts,  ranging  from  tens  of 
thousands  down  to  a  penny.  At  the  original  subscription  any- 
one may  take  any  odd  amount  of  the  stock  that  he  cares  for. 
The  Stock  Exchange  calls  the  amount  that  is  not  divisible  by  one 
hundred,  a  "broken  lot."  Stock  is  quoted  on  the  London  Stock 
Exchange  at  so  much  per  £100.  Shares  are  distinguished  from 
stock  by  the  fact  that  they  are  expressed  in  terms  of  definite 
amounts  and  are  indivisible.  There  are,  however,  some  few 
English  companies  that  will  transfer  tractions  of  shares.2 

§  52.    United  States  vs.  English  Practice 

In  the  United  States  there  is  no  security  which  corresponds 
to  what  the  English  call  "stock."  The  owned  capital  of  any 
corporation  is  always  represented  by  an  issue  of  shares,  each  share 
being  of  a  uniform  amount  with  the  other  shares  in  the  same 
series,  and  of  like  standing  and  rights.  In  both  countries  the 
capital  stock  of  the  corporation  may  be  of  two  or  more  classes, 
which  in  this  country  are  usually  called  "common"  and  "pre- 
ferred." In  England  the  more  usual  titles  are  "ordinary"  and 
"preference,"  and  in  that  country  there  is  a  much  larger  variety 
of  shares  than  we  have  here.  There  are  "deferred  shares," 
"founders'  shares,"  "deferred  ordinary  shares,"  "preferred  ordi- 
nary shares,"  and  so  on  almost  indefinitely.  In  this  country, 
after  we  have  used  the  terms  "common"  and  "preferred"  we 
usually  fall  back  on  such  matter-of-fact  titles  as  "Class  A," 
"Class  B,"  "first  preferred,"  "second  preferred,"  and  the  like. 

'  Hartley  Withers  on  Stocks  and  Shares,  pp.  33-38. 


59^  CORPORATE  FINANCE  [Bk.  II- 

§  53.     "Common  Stock"  or  "Ordinary  Shares"  ^ 

In  the  United  States  we  speak  of  ''common  stock";  in 
England  they  use  the  term  "ordinary  shares."  The  two  ex- 
pressions are  practically  identical  in  meaning;  both  refer  to 
shares  which  have  no  special  privileges  or  rights  but  which  are 
entitled  to  whatever  capital  or  income  remains  after  prior  claims 
have  been  satisfied.  One  verbal  exception  to  this  general  state- 
ment may  be  noted.  In  English  usage  there  are  sometimes 
"deferred"  or  "deferred  ordinary"  shares,  which  are  inferior  in 
claims  to  the  so-called  ordinary  shares.  In  this  case  the  shares 
that  are  called  ordinary  are  really  "preferred." 

Occasionally  this  same  practice  is  found  in  the  United  States. 
For  instance,  the  Nassau  Gummed  and  Coated  Paper  Company 
has  two  classes  of  common  stock,  which  are  known  respectively 
as  '  Common  Class  A'  "  and  "Common  Class  'B'."  Voting 
power  is  vested  only  in  Class  "A,"  which  accordingly  is  given 
preference  in  this  respect  over  Class  "B."  Class  "A"  also  has 
a  dividend  preference  over  Class  "B,"  which  is  sold  only  to 
employees  of  the  company.  Customarily,  however,  common,  or 
ordinary  shares  are  all  of  the  same  class  and  represent  the  final 
equity  in  the  enterprise  after  prior  claims  have  been  made. 

The  simplest  case  of  capitalization  arises  when  a  corporation 
has  outstanding  only  one  class  of  stock  and  no  notes  or  bonds. 
The  laws  of  some  of  the  states  specifically  provide  that  in  the 
absence  of  any  special  preference  for  certain  classes  of  stock,  all 
stock  shall  be  of  one  class  and  shall  be  known  as  common  stock. 
Any  stock  that  is  set  aside  and  given  special  privileges  has  still 
all  the  rights  of  common  stock,  except  so  far  as  these  are  taken 
away  or  limited  by  statute  or  charter  provision. 

§  54.    Special  Forms  of  Shares 

There  are  many  peculiar  varieties  of  capital  shares  which  do 
not  come  definitely  within  the  two  main  classes,  common  and 
preferred,  or  which  have  notable  features.     In  Great  Britain  it 

»  See  Book  I,  {  loi;  for  discussion  of  shares  without  par  value,  see  Book  I,  Chs.  XIV-XVI. 


Ch.  5]  COMMON  STOCK  599 

is  a  common  practice  to  compensate  the  organizer  of  a  corpora- 
tion by  giving  him  a  final  claim  on  earnings  which  is  valid  only- 
after  all  the  claims  of  those  who  have  furnished  capital  have  been 
fully  met.  The  shares  which  represent  this  claim  are  variously 
known  as  "founders'  shares,"  "management  shares,"  and  "de- 
ferred shares."  Although  this  practice  is  frequently  con- 
demned, it  seems  at  least  as  defensible  as  the  custom  in  the 
United  States  in  accordance  with  which  the  promoter  of  a  cor- 
poration retains  by  way  of  compensation  as  much  as  he  can  of 
the  common  stock. 

§  55.    Founders'  Shares* 

Deferred,  management,  or  'founders'  shares  in  England  are 
usually  of  very  small  par  value — most  commonly,  one  shilling 
per  share.  In  case  the  corporation  succeeds  in  fulfilling  the 
expectations  of  its  organizer,  the  founders'  shares  may  come  to 
receive  large  dividends  and  to  possess  a  high  market  value  alto- 
gether out  of  proportion  to  their  nominal  value.  Indeed,  there 
are  instances  in  which  separate  companies  have  been  formed  in 
order  to  hold  the  founders'  shares  and  distribute  interest  in  them 
in  a  more  convenient  manner.  A  slightly  different  plan  was  fol- 
lowed by  the  holders  of  the  founders'  shares  in  the  original  Suez 
Canal  Company.  There  were  100  of  these  shares  which  were  of 
no  par  value  but  which  were  entitled  to  10%  of  the  surplus 
profits.  These  100  shares  were  divided  into  100,000  and  were 
sold  on  the  open  market.  The  customary  arrangement  is  that 
founders',  management,  or  deferred  shares  shall  take  one-half 
the  profits  remaining  after  the  ordinary  shares  have  received  a 
given  rate  of  dividend. 

Occasionally  founders'  shares  are  employed  in  this  country, 
as  was  the  case  in  the  organization  of  the  United  Retail  Stores 
Corporation,  which  issued  160,000  founders'  shares  without  par 
value,  which  were  sold  at  $5  a  share  to  those  identified  with  the 
management.     Class  "A"  common  shares  were  also  issued  and 

♦See  Book  I,  {{  116,  117. 


6oo  CORPORATE  FINANCE  [Bk.  II- 

sold  at  $70  a  share.     The  founders'  shares  ranked  equally  with 
Class  "A"  shares  in  dividend  distributions. 

§  56.    Restrictions  on  Sale  of  Stock 

Sometimes  voting  shares  are  subjected  to  peculiar  restrictions 
for  the  sake  of  forestalling  any  danger  of  losing  control  or  of, 
bringing  into  the  management  people  who  are  not  desired.  For 
instance,  one  of  the  English  tobacco  companies  had  but  three  or 
four  hundred  holders  of  its  voting  shares  and  was  controlled  by 
a  much  smaller  number.  In  order  to  maintain  its  character  as  a 
close  corporation,  it  stipulated  in  the  articles  of  incorporation 
that  no  shareholder  might  dispose  of  his  shares  except  by  offering 
them,  through  the  company,  to  other  shareholders  at  a  price  to 
be  fixed  by  the  shareholders  from  time  to  time.  An  exception 
was  made  with  respect  to  the  transfer  of  shares  to  members  of 
the  immediate  family  of  a  shareholder.  The  price  fixed  for  trans- 
fers was  always  considerably  less  than  the  probable  market  value. 

In  the  United  States  small,  close  corporations  sometimes 
attempt  to  accomplish  the  same  result  by  means  of  by-laws 
prohibiting  the  sale  of  stock  to  anyone  not  already  a  stockholder, 
or  prohibiting  the  sale  of  stock  without  the  consent  of  the  direc- 
tors, or  unless  it  has  first  been  offered  to  the  directors  at  a  price 
not  greater  than  that  at  which  it  is  subsequently  to  be  offered 
or  sold  to  outsiders.  These  provisions,  however,  are  illegal  and 
unenforcible.  Nevertheless  they  are  sometimes  adopted,  and 
printed  on  the  face  of  stock  certificates  to  give  notice  that  out- 
side purchasers  are  not  welcome,  and  that  whatever  rights  they 
may  obtain  they  will  be  able  to  enforce  only  through  legal  process. 
Sometimes  stockholders  agree  among  themselves  to  withhold 
their  stock  from  outsiders.  Such  a  contract  would  be  legal  as  be- 
tween the  stockholders,  but  would  not  affect  the  rights  of  any  out- 
sider who  might  purchase  stock  without  notice  and  in  good  faith,  s 


•  See  Book  I,  VS20. 


CHAPTER  VI 
PREFERRED  STOCKi 

§  57.    Nature  of  Preferred  Stock 

Preferred  stock  is  that  which  has  some  right  or  privilege  not 
enjoyed  by  the  ordinary  or  common  stock.  This  preference  us- 
ually takes  the  form  of  a  prior  dividend  received  by  the  preferred 
stock  before  any  dividends  may  be  paid  upon  the  common  stock. 
After  payment  of  its  preferred  dividend,  the  preferred  stock  may 
participate  further  in  dividends  on  prescribed  terms,  or  it  may 
be  a  non-participating  stock  which  receives  its  preferred  dividend 
and  no  more. 

Preferred  stock  may  also  have  restrictions.  The  most  com- 
mon of  these  is  the  deprivation  of  the  voting  right.  Preferred 
stock  may  also  have  other  features  which  are,  or  are  not  privileges 
according  to  the  conditions  and  the  point  of  view.  For  instance, 
preferred  stock  is  commonly  made  redeemable  at  any  time  at 
the  option  of  the  company,  or  at  some  specified  time.  In  either 
case,  if  the  stock  is  a  safe,  dividend-paying  stock  and  especially 
if  it  is  a  participating  stock,  this  redemption  feature  detracts 
materially  from  its  value.  To  offset  this  and  make  the  stock 
attractive,  the  redemption  figure  is  usually  placed  above  par,  as 
105  or  no,  in  some  instances  the  redemption  figure  running  up 
as  high  as  125.  ,  , 

§  58.    Origin  and  Uses  of  Preferred  Shares 

Preferred  shares  came  into  popularity  in  the  United  States 
chiefly  on  account  of  their  utihty  in  railroad  reorganizations.  It 
was  and  is  still  customary  in  severe  reorganizations  to  cut  down 
the  fixed  obligations  of  the  corporation  by  compelling  some  of 


-tftfrSee  Book  I,  Ch.  XI,  "Preferred  Stock";   for  form  of  certificate  see  Book.IV,  Form  80. 

601 


6o2  CORPORATE  FINANCE  [Bk.  li- 

the junior  bondholders  to  accept  preferred  shares  in  exchange  for 
their  bonds.  By  making  this  exchange  the  former  bondholders 
retain  their  claims  upon  the  income  of  the  corporation,  but  the 
claim  is  made  simply  a  preference  instead  of  a  positive  obligation. 
Except  in  reorganizations,  preferred  shares  have  been  very  little 
used  in  the  United  States  by  railroad  corporations. 

The  smaller  corporations  have  also  found  preferred  stock  use- 
ful. One  of  the  striking  features  of  the  stock  market  up  to  the 
time  of  the  Great  War  was  the  successful  floating  of  a  large  num- 
ber of  preferred  share  issues  by  these  smaller  industrial  corpora- 
tions. Sometimes  the  shares  were  sound,  sometimes  unsound. 
In  either  case  it  seemed  to  be  fairly  easy  to  dispose  of  them ;  the 
buying  pubHc  had  evidently  been  educated  to  like  and  approve 
industrial  preferred  shares.  The  better  securities  at  high  rates 
issued  during  the  war  drove  these  low-grade  issues  from  the  gen- 
eral market.    They  are  now  gradually  reappearing. 

Preferred  shares  are  on  rare  occasions  used  to  distribute  vot- 
ing power  in  such  a  way  as  to  give  control  to  a  comparatively 
small  group.  The  preferred  stock  of  the  Allis- Chalmers  Com- 
pany referred  to  later  in  the  chapter  is  of  this  kind. 

In  the  incorporation  of  partnerships,  preferred  stocks  are 
often  used  to  make  the  necessary  adjustments.  If  it  is  desired 
to  give  equality  of  voting  right,  the  partner  having  an  excess  of 
capital  is  given  a  similar  excess  of  stock  in  non-voting  preferred 
stock.  Or  common  stock  may  be  given  to  those  who  have  the 
management  and  non-voting  preferred  stock  may  be  given  to 
those  who  are  outside.  By  means  of  the  two  kinds  of  stock  with 
the  different  powers,  privileges,  and  limitations  that  may  be 
attached  to  preferred  stock,  almost  any  desired  difference  of  in- 
vestment or  power  of  control  may  be  secured. 

§  59.    Preferred  Dividends 

The  preferred  dividend  may  be  either  cumulative  or  non- 
cumulative.  A  cumulative  dividend  is  one  which  carries  over 
from  year  to  year;  that  is  to  say,  in  case  the  profits  are  not  suffi- 


Ch.  6]  PREFERRED  STOCK  603 

cient  to  pay  the  full  preferred  rate  in  any  given  year,  the  unpaid 
dividends  will  remain  as  a  prior  claim  to  be  paid  in  some  succeed- 
ing year  before  dividends  are  declared  on  the  common  shares. 
Non-cumulative  dividends  give  the  preferred  shares  a  prior  claim 
for  dividends  each  year;  but  in  case  these  profits  are  not  suffi- 
cient to  meet  the  claims,  or  for  other  reasons  dividends  are  not 
declared,  no  obligation  rests  upon  the  corporation  to  make  up 
the  deficiency  in  later  years. 

§  60.    Non-Cumulative  Dividends 

At  one  time  most  preferred  shares  were  non-cumulative.  But 
the  non-cumulative  feature  has  been  found  unsatisfactory  be- 
cause of  the  conflict  of  interest  between  the  common  and  the 
preferred  shareholders  as  to  the  payment  of  preferred  dividends 
each  year.  It  is  entirely  in  the  discretion  of  the  directors  to  de- 
cide whether  or  not  the  preferred  dividend  shall  be  paid.  It  is 
obviously  to  the  advantage  of  the  common  shareholders — whom 
the  directors  more  directly  represent — to  defer  dividends  on 
such  preferred  shares  as  long  as  possible,  since  the  cumulating 
profits  are  usually  lost  forever  to  the  preferred  stock  and  inure 
directly  to  the  benefit  of  the  common  stock.  It  is  a  simple  mat- 
ter of  accounting  procedure  to  pass  the  profits  of  the  corporation 
to  increase  surplus  or  perhaps  to  expend  them  in  activities  not 
unmediately  productive,  as  the  establishment  of  a  new  magazine, 
or  the  introduction  of  a  new  product,  and  ignore  preferred  divi- 
dends entirely  until  sufficient  profits  have  accumulated  to  pay 
dividends  to  both  common  and  preferred  stock.  And  these  divi- 
dends may  be  large  for  the  common  stock  but  small  for  the  pre- 
ferred stock  considering  the  number  of  dividends  it  has  missed. 
Obviously,  there  is  plenty  of  opportunity  for  unfair  diversion  of 
funds  when  preferred  dividends  are  non-cumulative.  • 

§  61.    Effect  of  Non-Cumulative  Preferred  Stock 

Non-cumulative  preferred  stock  is,  in  fact,  a  standing  invita- 
tion to  the  directors,  unless  their  ethical  standards  are  high,  to 


,6o4  CORPORATE  FINANCE  [Bk.  II- 

administer  the  corporate  finances  to  the  advantage  of  the  com- 
mon stockholder.  As  stated,  profits  that  might  very  properly 
have  been  applied  to  the  preferred  dividends  are  diverted  into 
improvements  or  developments.  These  redound  to  the  ultimate 
advantage  of  the  company,  but  meanwhile  stand  in  the  way  of 
dividends  on  the  non-cumulative  preferred  stock  until  the  com- 
pany has  reached  a  point  where  common  and  preferred  stock 
dividends  are  both  possible.  The  preferred  stockholder's  divi- 
dends for  this  period  are  absolutely  lost  as  far  as  he  is  concerned. 
The  company  has  profited  at  his  expense.  The  directors  might 
properly  have  paid  them  if  they  would,  but  decided  in  favor  of 
the  common  stockholder. 

If  investors  were  wise  there  would  ordinarily  be  no  sale  for 
the  non-cumulative  stock,  for  there  is  no  legal  way  for  the  holder 
of  such  stock  to  prevent  the  directors  postponing  dividends  until 
the  common  stockholders  can  share  equally  or  even  receive  more 
than  do  the  holders  of  preferred  stock. 

On  the  other  hand,  it  must  be  admitted  that  when  issued  by 
a  strong  company  with  an  honest  administration,  a  non-cumula- 
tive preferred  stock  may  be  very  satisfactory.  Such  a  stock  is 
the  6%  non-cumulative  preferred  stock  of  the  International 
Nickel  Company  which  has  received  its  full  dividends  since  1906. 
Another  similarly  desirable  non-cumulative  preferred  stock  is 
that  of  the  American  Car  and  Foundry  Company,  which  has  re- 
ceived its  7%' preferential  dividend  regularly  since  the  organiza- 
tion of  the  company  in  1899.  Even  better  is  the  record  of  the 
American  Cotton  Oil  Company  which  has  paid  a  6%  dividend 
regularly  upon  its  non-cumulative  preferred  stock  since  1892. 
Unhappily  for  the  record  this  dividend  was  deferred  June  i,  1921, 
for  the  first  time  in  the  history  of  the  company. 

It  is  to  be  noted  that  if  the  preferential  dividend  is  to  be  non- 
cumulative,  this  fact  must  be  clearly  expressed  in  the  formal 
provisions  by  which  the  stock  is  authorized.  Where  not  so  ex- 
pressed the  courts  have  held  the  preferential  dividends  to  be 
cumulative  and  payable  in  full  out  of  the  first  profits  before  any- 


Ch.  6]  PREFERRED   STOCK  605 

thing  is  received  by  the  common  stock.  The  cumulative  feature 
of  preferred  stock  is,  however,  for  the  sake  of  security  and  defi- 
niteness  usually  covered  by  express  provision. 

§  62.    Cumulative  Dividends 

Cumulative  dividends,  on  the  other  hand,  have  an  uncom- 
fortable habit  of  piling  up,  and  may  become  in  the  course  of  a 
few  years  so  serious  a  burden  as  to  leave  no  reasonable  hope  for 
dividends  on  the  common  shares.  Such  a  situation  might  inter- 
fere with,  or  prevent  entirely,  additional  financing  were  it  needed. 
It  is  not  at  all  uncommon  in  corporate  experience  for  a  company 
to  go  through  several  years  of  depression  and  limited  income,  and 
then,  through  good  management  or  by  some  fortunate  circum- 
stance, suddenly  enter  upon  a  period  of  prosperity.  Naturally, 
the  common  shareholders,  having  received  no  dividends  through 
the  lean  years,  feel  that  they  are  entitled  to  some  recompense. 
If  a  large  amount  of  unpaid  dividends  on  cumulative  preferred 
shares  stands  in  the  way,  it  is  now  customary  to  try  to  find  some 
way,  under  the  conditions  stated,  of  "funding"  these  unpaid 
dividends,  thus  satisfying  both  the  common  and  the  preferred 
shareholders.  The  funding  of  the  unpaid  dividends  is  usually  ac- 
complished by  issuing  securities  of  some  kind  to  the  preferred 
shareholders  in  exchange  for  their  dividend  claims.  Thus  in  the 
readjustment  of  the  capitalization  of  the  Interborough-Metro- 
politan  Company  in  191 5,  the  holders  of  the  5%  cumulative  pre- 
ferred stock  on  which  a  considerable  amount  of  dividends  had 
cumulated,  were  given,  in  consideration  of  their  surrender  of 
these  cumulated  dividends,  a  new  6%  non-cumulative  preferred 
stock  of  the  Interborough  Consolidated  Corporation. 

§  63.    Rates  of  Preferred  Dividends 

Although  preferred  shares  are  entitled  only  to  what  is  spe- 
cifically granted  to  them,  some  customs  have  become  fairly  well 
established.  In  the  United  States  nearly  all  industrial  preferred 
shares  bear  cumulative  dividends.    Before  the  Great  War  these 


6o6  CORPORATE  FINANCE  [Bk.  II- 

rates  ranged  from  6%  to  8%,  the  great  majority  receiving  7%. 
During  the  time  of  the  war  the  prevaiUng  dividend  rate  rose  to 
8%  and  has  since  remained  there.  Just  why  these  percentages 
should  have  been  chosen  is  somewhat  difficult  to  say.  Probably 
the  best  answer  is  to  be  found  in  the  statement  that  high-grade 
preferred  shares  have  been  selling  for  several  years  on  about  an 
8%  basis ;  that  is  to  say,  if  they  are  7%  shares  they  sell  at  about 
$87.50  for  each  $100  share;  if  they  are  8%  shares  they  sell  at 
about  par.  Inasmuch  as  shares,  when  they  have  a  market  value 
of  or  near  par,  are  more  convenient  and  more  salable  than  would 
otherwise  be  the  case,  there  is  an  advantage  in  making  their 
preferential  dividend  8%,  or  whatever  the  rate  may  be  that  will 
sell  the  stock  at  par. 

§  64.    Participation  Rights  of  Preferred  Shares 

Unless  otherwise  expressly  provided,  preferred  stock  partici- 
pates equally  with  the  common  stock  in  all  dividends  after  both 
common  and  preferred  have  received  an  equal  dividend.  That 
is,  if  the  preferred  stock  has  received  its  preferential  dividend  of, 
say,  8%  togetlier  with  any  cumulated  arrearages,  it  participates 
no  further  in  dividends  until  8%  has  been  paid  upon  the  common 
stock  as  well,  but  thereafter  both  classes  of  stock  stand  upon 
exactly  the  same  basis  as  to  any  further  dividends  declared  dur- 
ing that  year.  If  such  further  participation  on  the  part  of  the 
preferred  stock  is  not  desired,  it  must  be  expressly  denied.  In 
such  case  the  charter  usually  contains  a  provision  prohibiting 
such  participation,  and  the  preferred  shares  then  receive  their 
fixed  dividends,  and  no  more. 

The  usual  preferred  stock  does  not  participate  in  profits  be- 
yond its  fixed  rate,  but  there  are  numerous  exceptions  to  this 
rule.  For  instance,  in  one  remarkable  case,  that  of  the  American 
Brake  Shoe  and  Foundry  Company,  until  recently  7%  was  paid 
on  the  preferred  shares,  7%  on  the  common  shares,  and  the  pre- 
ferred shares  were  then  entitled  to  all  additional  earnings.  The 
Westinghouse  Electric  and  Manufacturing  Company's  preferred 


Ch.  6]  PREFERRED  STOCK  607 

has  a  prior  claim  to  7%  and,  after  the  common  has  received  7%, 
shares  equally  with  the  common  in  any  further  distribution. 
The  Chicago  and  Northwestern  Railway's  preferred  stock  is 
entitled  to  7%,  to  be  followed  by  7%  on  the  common;  then  the 
preferred  is  entitled  to  an  additional  3%,  and  thereafter  if  profits 
permit  the  common  receives  a  similar  amount.  After  this,  both 
stocks  participate  equally  in  any  further  dividends.  In  1920  the 
preferred  stock  received  7%,  the  common  5%. 

American  International  Corporation  preferred  participates 
equally  with  the  common  stock  until  both  have  received  7%, 
thereafter  the  preferred  receives  one-fifth  of  any  additional 
amount  declared  in  dividends  that  year,  the  common  stock  re- 
ceiving the  remainder, 

§  65.    Preference  as  to  Assets 

Shares  may  be  preferred  not  only  as  to  dividends,  but  also  as 
to  assets;  that  is,  in  case  of  dissolution  or  insolvency,  the  full 
par  value  of  the  preferred  shares  is  to  be  paid  before  any  payment 
is  made  on  account  of  the  common  shares.  We  shall  see,  when 
we  come  to  consider  reorganization,  that  as  a  matter  of  fact  going 
cori^orations  are  seldom  sold  or  entirely  liquidated  and  the  assets 
distributed  among  the  various  security  holders.  It  is  usual  to 
bring  about  a  reorganization  in  which  the  claims  of  each  class  of 
securities  are  so  readjusted  that  they  may  all  be  met  by  the  cor- 
poration. Hence  the  prior  claim  of  preferred  shares  upon  assets 
is  not  to  be  taken  too  literally,  but  is  to  be  regarded  rather  as  a 
legal  point  of  advantage  in  securing  the  best  possible  terms  in 
case  reorganization  should  become  necessary.  From  this  point 
of  view,  the  preference  as  to  assets  is  of  considerable  importance. 

The  preferred  stock  of  industrial  corporations  is  almost  in- 
variably preferred  as  to  assets. 

§  66.    Voting  Rights  of  Preferred  Stock 

Preferred  stock  has  the  same  right  to  vote  as  has  the  common 
stock  unless  the  right  is  specifically  denied.    Usually  it  is  denied, 


6o8  CORPORATE  FINANCE  [Bk.  II- 

or  is  given  in  some  restricted  form.  Thus  a  protective  feature 
given  by  many  companies  is  the  proviso  that  the  preferred  share- 
holders shall  automatically  obtain  control,  or  partial  control, 
over  the  directorate  of  the  corporation  in  case  their  dividends  are 
not  paid.  It  is  also  customary  to  give  the  preferred  the  power  to 
veto  an  increase  of  bonds  or  of  preferred  stock.  The  Wisconsin 
Central  Railroad  Company  provides  that  in  case  of  failure  for 
two  successive  years  to  pay  4%  dividends  on  its  preferred,  the 
preferred  shareholders  shall  have  the  right  to  elect  a  majority 
of  the  directors.  In  the  American  Smelters  Securities  Company 
the  preferred  shareholders  are  permitted  to  vote  if  dividends  for 
one  year  remain  unpaid.  The  William  Carter  Company  gives 
both  the  preferred  and. the  common  shares  equal  voting  power, 
except  that  if  there  is  default  in  four  successive  quarterly  divi- 
dends on  the  preferred,  or  if  the  net  quick  assets  are  for  one  year 
less  than  the  par  value  of  the  preferred  shares  outstanding,  the 
preferred  becomes  the  sole  voting  stock.  The  American  Sumatra 
Tobacco  Company  provides  that  if  unpaid  dividends  accumulate 
above  14%,  the  preferred  shareholders  shall  have  the  right  to 
elect  a  majority  of  the  board  and  shall  continue  to  have  such 
right  until  all  accrued  dividends  have  been  paid.  The  American 
Rolling  Mill  Company  gives  its  6%  preferred  stock  the  right  to 
vote  only  when  four  successive  dividend  periods  have  been 
passed. 

All  of  these  provisions  appear  to  be  equitable,  although  the 
mere  grant  of  voting  power  to  preferred  shareholders,  if  the 
common  shares  still  retain  control  of  a  corporation,  may  prove 
to  be  a  concession  of  only  slight  importance.  If  it  is  expected 
and  seriously  intended  that  the  dividends  on  preferred  shares 
shall  be  paid  regularly  year  after  year,  then  it  would  seem  only 
fair  that  the  common  shareTiolders,  if  they  fail  to  live  up  to  this 
expectation,  should  forfeit  control  and  give  the  preferred  share- 
holders a  chance  to  see  what  they  can  accomplish. 

While  preferred  stock  has  every  right  of  common  stock  that 
is  not  expressly  denied;,  it  is  well  to  reiterate  that,  on  the  other 


Ch.  6]  PREFERRED  STOCK  609 

hand,  the  preferences  granted  to  preferred  shares  are  no  more 
than  are  distinctly  specified,  and  that  these  preferences  may  con- 
sist not  only  of  prior  claims  as  to  dividends  and  assets,  but  even 
of  prior  claims  as  to  voting.  For  instance,  the  preferred  shares 
of  the  old  Rock  Island  Company  of  New  Jersey  (the  former  hold- 
ing company  for  the  Chicago,  Rock  Island  and  Pacific  Railway) 
were  entitled  to  elect  a  majority  of  the  directors  of  that  company. 
At  the  present  time  the  preferred  stock  of  the  Allis- Chalmers 
Manufacturing  Company  has  the  voting  power  and  is  entitled 
to  elect  a  majority  of  the  board  of  directors. 

§  67.    Redemption  of  Preferred  Shares 

It  has  already  been  noted  that  in  modern  corporations  the 
distinction  between  owned  capital  and  borrowed  capital  is  some- 
times shadowy.  Preferred  shares,  for  instance,  are  sometimes 
protected  and  subject  to  redemption  in  such  a  way  as  to  bring 
them  almost,  if  not  wholly,  into  the  same  class  as  junior  bonds. 
It  is  very  common  practice  for  a  company  to  reserve  the  right 
to  redeem  preferred  shares,  usually  at  a  premium  varying  from 
5%  to  25%  or  more.  The  decision  of  the  matter,  however,  rests 
with  the  corporation.  Further  than  this,  many  companies  make 
redemption  obligatory  and  even  provide  for  the  building  up  of 
sinking  funds  for  this  purpose,  just  as  in  the  case  of  sinking  fund 
bonds.  The  California  Petroleum  Corporation,  for  example,  has 
set  aside  5  cents  on  each  barrel  of  petroleum  sold,  to  redeem  its 
preferred  shares,  which  are  subject  to  call  at  any  time  after  three 
years  from  date  of  issue,  at  120.  The  Studebaker  Corporation 
and  the  Underwood  Typewriter  Company  both  have  sinking 
funds  for  this  purpose. 

There  are  a  number  of  provisions  concerning  the  redemption 
of  preferred  shares,  that  are  worth  noting.  The  General  Asphalt 
Company  has  outstanding  $7,541,100  5%  cumulative  preferred 
which  is  convertible  into  common  at  any  time  on  even  terms,  in 
addition  to  wliich  the  preferred  shareholder  will,  for  each  share 
exchanged,  receive  a  bonus  or  premium  of  $50  of  common  stock; 


6lO  CORPORATE  FINANCE  [Bk.  II- 

that  is,  for  each  single  share  of  preferred  stock  he  turns  in,  he  will 
receive  a  share  and  a  half  of  common  stock — $150  of  common 
stock  for  each  $100  of  preferred. 

As  to  the  rate  of  redemption,  the  Fisk  Rubber  Company  has 
an  unusual  provision  to  the  effect  that  in  case  of  forced  liquida- 
tion the  preferred  stock  is  entitled  to  par  and  accrued  dividends, 
but  in  case  of  voluntary  Uquidation  it  is  entitled  to  110%  of  par 
and  accrued  dividends.  The  preferred  stock  of  the  Studebaker 
Corporation  may  be  called  at  125,  and  the  preferred  stock  of  the 
Underwood  Typewriter  Company  and  of  the  F.  W.  Woolworth 
Company  may  be  redeemed  at  the  same  figure. 

§  68.    General  Protection  of  Preferred  Stock 

It  is  also  becoming  a  more  and  more  prevalent  custom  to 
protect  preferred  stock  by  specific  provisions  as  to  ratio  of  cur- 
rent Habilities  to  current  assets,  of  net  surplus  to  capital,  of  divi- 
dends to  current  surplus,  and  the  like.  The  Stollwerck  Choco- 
late Company,  for  instance,  may  not  pay  any  dividend  on  its 
common  stock  until  the  net  quick  assets  are  equal  to  75%  of  the 
first  preferred  stock  outstanding,  and  may  not  pay  dividends  on 
the  common  stock  in  excess  of  5%  until  the  net  quick  assets 
equal  the  full  face  value  of  the  outstanding  first  preferred  stock. 
Montgomery  Ward  and  Company,  Inc.,  provide  that  no  addi- 
tional preferred  beyond  the  present  issue  can  be  put  out  unless, 
after  such  issue,  the  net  quick  assets  shall  equal  at  least  120% 
of  the  outstanding  preferred.  The  Griffin  Wheel  Company  has 
a  number  of  detailed  provisions.  Additional  issues  (after  the 
original  issue)  of  its  preferred  stock  cannot  be  put  out  up  to  more 
than  66^%  of  the  cost  of  improvements,  extensions,  or  increased 
working  capital.  Common  dividends  may  not  be  increased  to 
more  than  7%  unless  the  net  tangible  assets  are  at  least  150% 
and  net  quick  assets  50%,  of  the  preferred  shares;  even  then  the 
common  may  get  only  one-half  the  surplus  earnings  above  the 
preferred  and  previous  common  dividends.  When  the  tangible 
assets  rise  to  2cx)%,  the  net  quick  assets  being  50%  of  the  pre- 


Ch.  6]  PREFERRED  STOCK  6ll 

ferred,  the  directors  of  this  company  may  declare  such  dividends 
on  the  common  "as  may  be  deemed  prudent." 

§  69.    General  Characteristics  of  Preferred  Shares 

From  the  various  examples  that  have  just  been  cited,  the 
reader  may  construct  a  composite  picture  of  preferred  share 
issues.  He  will  find  that  they  range  in  their  fixed  dividend  rate 
from  as  low  as  6%  to  as  high  as  10%,  with  a  marked  preference 
among  industrials  for  8%.  He  will  find  that  of  the  older  pre- 
ferred stocks,  a  great  majority  either  are  irredeemable  or  are 
redeemable  at  the  option  of  the  corporation,  so  that  they  are  not 
obligations  of  the  issuing  corporation;  and  that  a  small  but  in- 
creasing number  of  the  more  modern  preferred  stocks  are  pro- 
tected by  sinking  funds  and  by  other  provisions  which  make 
them,  for  all  practical  purposes,  definite  obligations  of  the 
corporation. 

In  every  case  in  which  preferred  shares  are  under  considera- 
tion, it  must  be  remembered  that  shares  may  be  preferred  in  a 
great  many  different  respects  and  forms,  and  that  it  is  therefore 
necessary  to  study  each  instance  of  preference  separately.  This 
is  well  illustrated  by  the  struggle  in  1901  between  the  Hill- 
Morgan  party  on  the  one  side  and  the  Harriman-Kuhn,  Loeb 
party  on  the  other,  for  control  of  the  Northern  Pacific  Railroad 
Company,  in  the  course  of  which  the  Hill-Morgan  party  secured 
a  majority  of  the  common  shares,  and  the  Harriman-Kuhn, 
Loeb  party  a  majority  of  the  preferred  shares  together  with 
enough  of  the  common  shares  to  give  them  a  majority  of  the  en- 
tire outstanding  stock.  Inasmuch  as  both  common  and  preferred 
shares  had  voting  rights,  it  seemed  clear  that  the  victory  remained 
with  the  Harriman-Kuhn,  Loeb  group.  Unfortunately  for  their 
calculations,  however,  the  charter  of  the  company  gave  the  com- 
mon shareholders  a  right — which  had  apparently  been  overlooked 
by  their  opponents — to  redeem  at  any  time  the  preferred  shares 
at  par.  This  right  the  Hill-Morgan  party  exercised  and,  through 
the  preponderance  thus  given  them,  obtained  control  of  the  road. 


CHAPTER  VII 

BONDS 

§  70.    Corporate  Borrowings^ 

There  is  no  distinction  between  the  method  of  a  private  loan 
made  by  an  individual,  by  a  partnership,  or  by  a  corporation. 
The  usual  evidence  of  the  debt  in  any  of  these  cases  is  a  note, 
and  the  general  form  of  the  note  given  by  a  corporation  is  the 
same  as  that  given  by  any  other  borrowing  concern  or  individual. 

When,  however,  we  come  to  the  public  loans  so  characteristic 
of  corporate  financing,  this  is  no  longer  true.  The  instruments 
by  which  the  debt  is  evidenced  are  still  notes  in  form,  but  of  a 
form  peculiar  to  the  corporation — the  short-term  note  and  bond. 
Both  these  are,  as  stated,  notes,  but  differ  from  the  ordinary 
"bankable"  notes  made  by  the  same  corporation  in  the  longer 
time  for  which  they  run ;  in  the  fact  that  while  the  total  amount 
is  large,  the  notes  making  up  this  total  are  of  comparatively 
small  face  value;  in  the  method  by  which  they  are  secured; 
and  generally  in  the  formality  of  their  issue. 

§  71.    Long-Term  Loans 

There  is  a  fundamental  difference  between  short-term  and 
long-term  borrowing.  While  they  tend  in  certain  isolated  cases 
to  merge  into  each  other,  the  distinction  is  for  practical  purposes 
clearly  marked. 

The  simplest  form  of  long-term  or  "funded"  borrowing  is  the 
ordinary  mortgage  on  real  estate,  or,  as  it  is  sometimes  called,  the 
bond  and  mortgage.  The  form  of  this  instrument  is  almost  as 
ancient  as  law  itself.  It  purports  to  be  a  transfer  of  the  title 
to  a  piece  of  real  estate  from  the  former  owner  to  a  new  owner, 

» See  Book  I,  Chs.  LIV,  LV,  "Bonds";  also  Book  IV,  Forms  250-253. 

6l2 


Ch.  7]  BONDS  613 

with  the  proviso,  however,  that  the  title  may  be  redeemed  by  the 
former  owner  on  repayment,  at  maturity,  of  an  acknowledged 
debt  which  he  obligates  or  "bonds"  himself  to  repay.  Although 
this  is  the  immemorial  form,  the  instrument  does  not,  as  a  matter 
of  practice  and  of  legal  interpretation,  actually  convey  ownership 
of  the  property  cited;  its  effect,  in  spite  of  the  wording  of  the 
mortgage,  is  merely  to  pledge  the  property  as  security  for  the 
repayment  of  the  loan.  There  are  varying  forms  of  the  bond 
and  mortgage  in  the  different  states  which  may  not  be  covered 
in  all  their  details  by  the  description  given  above,  but  the  essen- 
tial characteristics  of  these  bonds  and  mortgages  are  the  same 
in  all  cases. 

The  bond  and  mortgage  is  used  ordinarily  for  relatively  small 
amounts.  It  is  the  favorite  form  under  which  individuals  who 
own  farms,  city  real  estate,  and  other  property,  raise  long-term 
loans  secured  by  this  property.  It  is  frequently  used  also  by 
smaller  partnerships  and  corporations.  But  there  are,  of  course, 
some  obvious  drawbacks  to  this  form.  In  the  first  place,  it  is 
necessary  for  the  mortgagor  to  find  someone  who  is  willing  to 
invest  the  whole  amount  named  in  the  bond  in  a  lump  sum.  This 
may  not  be  difficult  so  long  as  the  sum  is  small.  Mortgages  are 
very  commonly  taken  by  savings  banks  and  other  institutions, 
as  well  as  by  individuals  who  reside  in  the  neighborhood  of  the 
property  mortgaged  and  therefore  are  acquainted  with  it  and 
at  the  same  time  are  able  and  willing  to  advance  the  sum  of 
money  that  is  required.  Within  recent  years  there  has  been  a 
concerted  and  successful  effort  to  extend  the  market  for  farm 
mortgages,  and  brokers  and  land  mortgage  companies  operating 
in  the  agricultural  states  of  the  West  have  built  up  successful 
businesses  in  selling  mortgages,  and  bonds  based  on  mortgages, 
direct  to  investors  in  the  eastern  states.  Also  the  federal  land 
banks  and  the  national  farm  loan  associations  together  with 
the  joint-stock  land  banks,  all  agencies  authorized  by  Con- 
gressional action  and  operating  under  federal  supervision,  have 
come  to  the  relief  of  the  farmers  and,  by  means  of  bonds  based 


6i4  CORPORATE  FINANCE  [Bk.  li- 

on farm  mortgages,  have  enabled  them  to  borrow  even  more 
advantageously  than  the  large  corporations, 

if:;.,  ■  -|M.  ,i!  !!M>ini(l  "ahnoii"  Hi  ^otiivji  'iriw  idah 

§  72.    The  Corporate  Bond  and  Mortgage 

The  difficulty  in  raising  money  on  the  ordinary  mortgage  is 
due  to  its  lack  of  flexibility.  For  instance,  the  mortgagor  of  a 
piece  of  property  may  wish  to  borrow,  let  us  say,  $20,000.  He 
finds  it  absolutely  impossible  to  secure  this  amount  in  a  lump  no 
matter  how  good  his  security.  He  can,  however,  find  three  men, 
one  of  whom  could  lend  $10,000,  one  $8,000,  and  the  third 
$2,000,  but  no  one  who  is  in  position  to  lend  $20,000.  Each  one 
objects  to  any  claim  taking  precedence  of  his  own — in  other 
words,  he  insists  on  a  first  mortgage.  How  is  the  difficulty  to 
be  solved?  The  answer  is  to  be  found  in  separating  the  bond  and 
the  mortgage.  Let  the  mortgage  be  drawn  in  favor  of  some  dis- 
interested party  who  will  hold  it,  as  trustee,  for  the  lenders  of  the 
money.  Let  a  bond,  or  promise  to  repay  the  sum  advanced,  be 
given  to  each  lender,  the  bond  to  be  secured  by  the  claim  on  the 
property  which  has  been  given  to  the  trustee.  By  separating 
the  bond  and  mortgage  we  have  made  it  possible  to  secure  the 
money  that  is  needed  from  a  number  of  different  sources  and  yet 
have  given  the  same  protection  to  each  lender  that  would  have 
been  obtained  by  an  individual  who  might  have  advanced  the 
whole  sum  in  a  lump.  b-jaxj^j' 

In  this  way,  under  suitable  conditions  it  is  a  comparatively 
simple  matter  to  secure  money  in  very  large  amounts.  For  in- 
stance, in  November  of  192 1,  the  New  York  Telephone  Com- 
pany wished  to  raise  $50,000,000  for  refunding  purposes.  It 
would  have  been  impossible  to  find  one  man,  and  difficult  to 
find  one  institution,  that  was  willing  to  lend  $50,000,000,  but  it 
was  not  especially  difficult  to  give  one  mortgage  for  this  sum,  to 
issue  bonds  for  varying  amounts — coupon  bonds,  $1,000,  $500, 
$100;  registered  bonds,  $1,000,  $5,000,  $10,000 — all  equally 
secured  by  the  mortgage,  and  to  sell  the  bonds  to  investors.  As 
a  matter  of  fact  the  entire  issue  was  oversold  in  a  single  day. 


Ch.  7]  BONDS  615 

§  73.    Corporate  Deeds  of  Trust  2 

The  mortgage,  separated  from  the  bond,  is  more  commonly 
known  as  a  "deed  of  trust."  In  ordinary  practice  the  trustee 
who  holds  title  to  the  property  mortgaged  and  is  supposed  to  act 
on  behalf  of  the  bondholders  is  a  trust  company.  This  trust 
company,  however,  is  actually  chosen,  not  by  the  bondholders, 
but  by  the  corporation  which  issues  the  bonds.  It  is  expected 
that  the  duties  of  the  trustee  will  be  of  a  purely  formal  character, 
but  at  the  same  time  the  bondholders  must  look  to  the  trustee 
for  the  protection  of  their  interests,  and  this  protection  is  not 
always  cheerfully  accorded —rarely  unless  he  is  requested  to  act 
by  a  majority  in  amount  of  the  bondholders,  and  not  then  until 
money  has  been  provided  to  defray  the  cost  of  litigation.  When 
this  is  done,  there  has  still  been  considerable  complaint  that  the 
trustee's  duties  were  not  performed  with  sufficient  vigor.  Some 
effective  remedy  for  this  condition  ought  to  be  found.  The 
investment  bankers  of  the  country,  who  have  a  moral  responsi- 
bility in  the  matter,  inasmuch  as  they  sell  corporate  bonds  in 
large  quantities  to  the  general  public,  might  well  consider  the 
advisability  of  using  their  powerful  influence  to  insure  closer 
vigilance  on  the  part  of  the  trustees  of  large  corporate  mortgages. 

The  deed  of  trust  for  important  bond  issues  is  apt  to  be  an 
extremely  complicated  and  detailed  document.  To  the  lay 
reader  its  phrasing— like  the  phrasing  of  many  other  legal 
documents —appears  cumbersome  and  unnecessarily  redundant; 
but  it  must  be  borne  in  mind  that  thousands  of  cases  have  been 
adjudicated,  each  one  of  which  has  helped  to  interpret  the  ex- 
act shade  of  meaning  of  certain  combinations  of  words.  After 
the  interpretation  has  once  been  made,  it  is  safer  by  far  to  use 
that  phraseology  in  the  future,  rather  than  to  experiment. 

§  74.    After-Acquired  Property  Clause 

The  deed  of  trust  specifies  the  property  upon  which  the  bond 
issue  it  covers  is  secured.     In  addition  to  the  security  of  the 

»  See  Book  I,  If  SO4-S06;  also  Book  IV,  Ch.  XXV,  "Bond  Issues— Deed  of  Trust.' 


6l6  CORPORATE  FINANCE  [Bk.  II- 

property  then  held  by  the  mortgagor,  many  corporate  mort- 
gages contain  what  is  known  as  the  "after-acquired  property" 
clause,  which  makes  the  mortgage  cover  all  other  property  that 
may  later  be  acquired.  The  object  is  to  furnish  the  fullest 
possible  protection  to  the  bondholders  and  to  make  it  difficult  for 
the  corporation  to  embark  upon  new  expenditures  without 
giving  them  full  protection.  When  this  clause  is  missing,  there, 
is  always  the  possible  danger  that  the  property  covered  by  the 
mortgage  may  deteriorate  or  at  least  become  of  secondary  im- 
portance as  compared  with  other  property  later  acquired.  Sup- 
pose, for  instance,  that  a  manufacturing  corporation  mortgages 
one  of  its  plants,  but  later  purchases  another  plant  which  is 
better  located,  or  in  better  condition,  or  better  equipped.  In  any 
such  case  the  first  plant  would  probably  be  neglected,  would 
rapidly  deteriorate,  and  become  inadequate  protection  for  the 
outstanding  mortgage. 

§  75.    Danger  of  After-Acquired  Property  Clause 

There  is  the  opposite  danger  to  the  corporation  in  case  the 
after-acquired  property  clause  is  included  in  the  mortgage.  The 
company  may  later  wish  to  purchase  property  essential  to  its 
business  and  which  will  tend  to  increase  the  value  of  the  property 
mortgaged.  In  order  to  purchase  the  new  property,  it  will  need 
to  borrow  more  funds.  But  the  after-acquired  property  clause 
automatically  covers  the  new  property  with  a  first  lien,  so  that  it 
is  impracticable  to  use  it  as  security  for  a  new  loan.  The  usual 
solution  of  this  particular  problem  is  either  specifically  to  permit 
purchase  money  mortgages,  or  to  evade  the  provisions  of  the 
mortgage  by  purchasing  the  desired  property  through  a  sub- 
sidiary corporation  which  is  then  able  to  give  a  first  mortgage 
and  borrow  as  necessary,  or  as  may  be  possible. 

The  question  as  to  whether  the  corporation  should  include 
the  after-acquired  property  clause  or  not,  is  clearly  a  choice 
between  evils.  There  is  no  universal  answer  that  will  cover 
all  cases.     The  circumstances  and  probabilities  in  each  must  be 


Ch.  7]  BONDS  617 

considered.  The  problem  is  one  that  would  be  more  easily 
solved  if  the  trustees  of  corporate  mortgages  were  willing  to 
assimie  a  greater  responsibility,  for  in  that  case  the  bondholders 
could  safely  leave  them  a  considerable  amount  of  discretion  and 
not  insist  on  such  rigid  and  far-reaching  provisions  to  the  deed 
of  trust. 

d 
§  76.    Open  and  Closed  Bond  Issues 

Another  question  in  connection  with  many  corporate  bond 
issues,  is  whether  they  shall  be  "closed"  or  "open."  They  are 
closed  when  no  more  bonds  may  be  issued  under  the  mortgage — 
i.e.,  that  transaction  is  closed.  The  open  mortgage,  which  is 
usually  confined  to  railroad  and  public  service  corporations, 
leaves  the  total  amount  of  bonds  that  may  be  issued  under  the 
mortgage  indefinite,  although  some  restrictions  are  usually 
imposed.  A  common  arrangement  among  public  service  cor- 
porations is  to  restrict  the  issue  of  new  bonds  to  70%  or  80%  of 
the  cost  of  the  improvements  for  which  funds  are  required. 
Among  railroads  it  is  customary  to  permit  the  issue  of  bonds  at 
a  fixed  rate  per  mile  of  track  or  up  to  the  actual  cost  of  con- 
struction, whatever  it  may  be.  r 

The  closed  mortgage,  like  the  after-acquired  property  clause, 
may  prove  a  serious  hindrance  to  the  financing  of  new  purchases 
which  may  be  in  every  respect  desirable.  The  open  mortgage 
is  subject  to  obvious  abuses.  In  the  practice  of  railroad  cor- 
porations, a  compromise  has  been  found  through  the  creation  of 
what  is  known  as  "limited  open-end"  mortgages,  which  au- 
thorize the  ultimate  issue  of  a  much  larger  amount  of  bonds  than 
it  is  intended  to  issue  immediately.  In  this  way  the  future  is 
provided  for  to  a  reasonable  extent  and  yet  the  bondholders  are 
protected  from  a  reckless  overissue  which  would  dangerously 
reduce  the  margin  of  safety  back  of  their  holdings. 

These  limited  open-end  mortgages  may  even  cover  bonds 
which,  while  all  of  one  issue,  bear  different  rates  of  interest.  This 
has  been  the  case  with  a  number  of  railroad  mortgage  issiues. 


6l8  CORPORATE  FINANCE  [Bk.  II- 

Both  the  Chicago  and  Northwestern  Railroad,  and  the  Chicago, 
Milwaukee  and  St.  Paul  Railroad  have  general  mortgages  pro- 
tecting two  classes  of  bonds,  the  one  bearing  3>^%  interest  and 
the  other  4%  interest.  The  latter  road  also  has  general  and 
refunding  bonds  in  two  series,  both  under  the  same  mortgage, 
but  Series  "A"  calls  for  4^%  interest,  while  Series  "B"  calls 
for  5%. 

§  77.    Nature  of  the  Bond 

The  bondholder's  interest  in  the  corporation  which  issues  his 
bond  is  entirely  different  from  that  of  the  stockholder.  The 
ownership  of  his  bond  does  not  usually  carry  with  it  any  rights  of 
participation  in  the  corporate  control  or  in  the  corporate  profits 
beyond  the  specified  bond  interest.  The  money  paid  the  cor- 
poration for  its  bond  is  nothing  more  nor  less  than  a  loan.  Pay- 
ment of  principal  at  a  specified  time  is  promised  and  its  interest, 
payable  at  a  fixed  date  and  at  a  specified  time,  must  be  paid 
whether  earned  or  not.  Dividends  on  stock  may  never  be  paid 
from  capital,  but  bond  interest  may,  if  necessary. 

Exceptions  to  almost  every  one  of  the  foregoing  statements 
in  regard  to  bonds  can  be  found,  and  many  of  these  exceptions 
are  noted  in  the  discussion  which  follows.  Most  issues  of  bonds, 
however,  possess  these  general  characteristics. 

§  78.    Size  of  Bond  Issue 

The  larger  an  issue  of  corporate  bonds — assuming,  of  course, 
that  it  is  well  secured — the  greater  will  be  its  marketabihty,  and 
consequently  the  value  of  each  bond.  It  is  clear  that  a  local 
corporation  which  puts  out,  let  us  say,  fifty  $1,000  bonds,  will 
be  able  to  sell  them  only  in  its  local  market.  The  issue  is  too 
small  to  become  known  and  hence  is  not  readily  salable  else- 
where. The  big  bond  issues,  on  the  other  hand,  are  readily 
salable  because  widely  known,  and  are  traded  in  on  the  exchanges 
and  can  be  easily  sold  at  any  time.  It  is  for  this  reason  that  the 
tendency  has  been  strong  in  the  United  States  toward  consoli- 


Ch.7]  BONDS  619 

dating  the  various  bond  issues  of  the  larger  railways,  and  even 
of  industrial  corporations,  into  one  issue,  under  a  so-called 
"blanket"  mortgage,  thus  securing  the  important  advantages  of 
simplicity  and  of  ready  salability.  Bond  issues  to  the  amount 
of  $100,000,000  which  ten  years  ago  were  rare,  are  no  longer  un- 
common. There  are  a  number  of  much  larger  issues.  The 
biggest  of  all  contemplated  issues  in  the  realm  of  sane  finance 
is  that  of  the  Northern  Pacific  Railroad  Company.  In  this 
case  the  open-end  mortgage  of  19 14,  under  which  the  com- 
pany's Refunding  and  Improvement  Gold  4^'s,  Series  "A," 
are  secured,  permits  the  issue  of  bonds  up  to  three  times  the  out- 
standing capital  stock  of  the  road,  or  up  to  nearly  $750,000,000. 
However,  but  $20,000,000  of  bonds  issued  under  this  mortgage 
are  now  outstanding. 

In  England  this  tendency  toward  large  single  issues  is  not 
nearly  so  apparent.  On  the  contrary,  English  practice  seems 
strongly  to  favor  "hand  to  mouth"  financing.  Whenever  money 
is  needed,  a  separate  security  is  planned  and  issued  without 
much  reference  either  to  previous  security  issues  or  to  the 
future.  The  result  is  that  many  of  the  English  companies  have 
a  complex  series  of  small  bond  issues,  the  relative  claims  and 
value  of  which  can  be  determined  only  after  competent  study. 
The  basic  reason  is  doubtless  to  be  found  in  the  fact  that  the 
English  investing  public  is  more  accustomed  to  real  investment, 
to  the  buying  and  holding  of  securities  until  their  maturity,  so 
that  there  is  relatively  less  trading  in  the  open  market  than  in 
this  country.  ,,/  >   ■.  1    .1  -m,,-   •>.  .    v.^w,.,  ■ 

§  79.    Face  Value  of  Bonds  ^  g^j., , „jj^,.j  ni?Dqoiu:'l 

Until  comparatively  recent  years,  private  bonds,  ias  dis- 
tinguished from  government  financings,  were  almost  uniformly 
of  the  face  value  or  denomination  of  $1,000.  At  the  present 
time  $500  and  $100  bonds  are  common,  and  bonds  of  smaller 
denominations  are  issued  on  occasion. 

Liberty  bonds  were  issued  in  denominations  as  low  as  $50, 


620  CORPORATE  FINANCE  [Bk.  II- 

and  the  original  Farm  Loan  Act  provided  for  bonds  of  the  de- 
nominations of  $25,  $50,  $100,  $500,  and  $1,000.  This  was 
changed  by  the  amendment  of  1920,  bonds  of  the  denominations 
of  $40  taking  the  place  of  the  $25  and  $50  bonds.  The  chief 
argimient  for  these  small  bonds— "baby"  bondsr-is  that  they 
make  it  possible  for  a  small  investor,  with  perhaps  only  $1,000 
to  $5,000  available,  to  diversify  his  investment  just  as  is  com- 
monly done  by  large  investors.  This  is  an  important  benefit  to 
the  investor  as  its  effect  obviously  is  to  reduce  the  risk  of  the 
heavy  loss  possible  where  all  the  "eggs"  are  in  one  basket. 

The  disadvantage  of  the  small  bond  lies  in  the  increased 
expense  of  selling.  It  costs  practically  as  much  for  a  banker  to 
sell  a  $100  bond  as  to  sell  a  $1,000  bond,  and  his  clerical  expenses 
in  connection  with  the  transaction  are  fully  as  great.  For  this 
reason,  unless  he  is  operating  on  a  larger  margin  of  profit  he  does 
not  find  the  small  bond  business  very  attractive.  On  the  other 
hand,  the  wide  distribution  that  the  issue  of  small  denomination 
bonds  makes  possible  is  very  desirable  for  the  issuing  corpora- 
tion, giving  the  issue  stability  and  a  ready  market. 

§  80.    Payment  of  Bonds  in  Foreign  Currency 

Bonds  are  frequently  payable  in  a  currency  different  from 
that  of  the  country  in  which  they  are  issued.  Many  Canadian 
bonds,  for  example,  were,  before  the  Great  War,  made  payable 
in  both  Canadian  dollars  and  pounds  sterling,  with  a  view  to 
facilitating  their  sale  in  the  London  market.  While  the  war 
was  in  progress,  or  since  its  termination,  external  bond  issues  of 
England,  Canada,  France,  Switzerland,  Belgium,  and  other 
European  countries  have  been  made  payable  both  as  to  principal 
and  interest,  in  the  currency  of  this  country.  The  Pennsylvania 
Railroad  Company,  the  New  York  Central  and  Hudson  River 
Railroad  Company,  and  others  have  issues  that  are  payable  in 
francs  as  well  as  in  sterling.  The  Brazil  Railway  Company,  an 
American  corporation  operating  in  South  America^  has  a  curious 
medley  of  issues,  payable  in  milreis  (Brazilian  currency),  francs, 


Ch.  7|  BONDS  621 

pounds  sterling,  and  dollars.  Before  the  Great  War,  a  stronger 
and  stronger  tendency  had  been  evident  toward  making  the 
larger  and  more  important  issues  international,  and  providing 
for  their  payment  at  fixed  rates  of  exchange  in  the  currency  of 
any  of  the  larger  commercial  countries,  at  the  option  of  the 
holder.  Temporarily  at  least,  this  tendency  has  been  checked 
by  the  financial  confusion  resulting  from  the  Great  War. 

§  81.    Gold  Bonds 

Many  bonds  are  specifically  payable  in  gold  coin.  This  is  a 
highly  important  provision  in  countries  in  which  there  is  fluc- 
tuation, or  any  considerable  danger  of  fluctuation,  in  the  value 
of  the  national  currency.  The  Great  War,  for  instance,  caused 
a  serious  depreciation  in  the  value  of  the  currencies  of  many 
countries,  and  in  this  way  inflicted  serious  loss  on  holders  of 
securities  payable  in  national  currency.  On  the  other  hand, 
corporations  whose  securities  were  payable  in  gold  suffered 
serious  loss  when  they  were  unable  proportionately  to  increase 
their  income,  which  was  necessarily  in  national  currency,  but  at 
the  same  time  had  to  pay  their  obligations  in  gold. 

The  gold  bond  came  into  prominence  during  the  period  of 
free  silver  agitation  in  the  United  States,  prior  to  1896,  when 
bonds  which  included  the  so-called  "gold"  clause,  sold  at  a  con- 
siderably better  rate  than  those  payable  in  American  currency, 
the  value  of  which  it  was  feared  might  depreciate.  At  the  pres- 
ent time  the  great  majority  of  the  bonds  and  short-term  notes 
issued  in  this  country  are  made  payable  in  gold  or  its  equivalent 
in  currency. 

§  82.    Maturity  of  Bonds 

The  life  of  bond  issues  naturally  varies  a  great  deal,  depend- 
ing upon  the  needs  of  the  corporate  business,  stability,  and  prom- 
inence of  the  corporation,  and  the  nature  of  the  assets  offered 
as  security.  Short-term  notes  sometimes  run  but  a  few  years. 
On  the  other  hand,  some  few  bond  issues  are  perpetual,  as  for 


622  CORPORATE  FINANCE  [Bk.  II- 

instance  the  Lehigh  Valley  Railroad's  Consolidated  "Annuity" 
bonds,  issued  in  1873.  Among  the  railroads,  100-year  bonds 
have  been  fairly  popular.  Some  of  these  now  outstanding  are 
Lake  Shore  and  Michigan  First  sK's,  issued  in  1896;  Norfolk 
and  Western  First  Consolidated  4's,  issued  in  1896;  Union 
Pacific  First  and  Refunding  4's,  issued  in  1908;  and  Reading 
Divisional  Mortgage,  issue  of  1897.  The  Northern  Pacific  has 
outstanding  two  issues  of  bonds  maturing  in  2047,  one  issued  in 
1896,  the  other  in  1914,  and  in  192 1  another  issue  maturing  in  the 
same  year  was  authorized.  For  a  still  longer  term  are  the  bonds 
of  the  West  Shore  Railroad  issued  in  1886  and  maturing  in  2361, 
a  term  of  473  years.  Among  industrial  corporations  bonds 
rarely  run  over  50  years,  and  the  great  majority  are  of  very  much 
shorter  life. 

§  83.    Bond  Interest  ' 

Interest  on  bonds  is  almost  always  paid  semiannually.  The 
favorite  payment  dates  are  probably  February  and  August, 
although  payments  are  scattered  through  the  year.  On  account 
of  the  tendency  which  exists  toward  reinvesting  interest  and 
dividend  disbursements  in  January  and  June,  and  the  conse- 
quent tendency  to  increase  stock-market  prices  at  this  time, 
there  is  theoretically  a  slight  advantage  to  the  bondholder  in 
getting  his  interest  payments  at  other  periods.  This  can  hardly 
be  called  a  consideration  of  much  practical  weight. 

§  84.    Registered  and  Coupon  Bonds  ' 

In  American  practice  some  bond  issues  are  registered  and 
some  are  in  "bearer"  or  coupon  form.  It  is  becoming  more  and 
more  the  custom,  when  the  issue  of  bonds  is  large,  to  give  a 
choice  between  the  two  forms.  The  registered  bond  has  the 
advantage  of  greater  safety  and  the  bearer  bond  the  advantage 
of  greater  convenience.  When  the  issuing  corporation  is  located 
at  a  considerable  distance  from  those  who  are  expected  to  pur- . 

'See  Book  I,  5  S03;   also  Book  IV,  Ch.  XXIV,  "Bond  Issues— The  Bond." 


Ch.  7]  BONDS  623 

chase  the  bonds,  as  is  the  case  when  an  international  market  is 
desired,  the  bearer  form  is  Hkely  to  be  preferred.  A  favorite 
plan  is  to  make  bonds  registered  as  to  principal  so  that  the 
transfer  of  the  bond  is  riot  fully  completed  until  it  is  made  on 
the  books  of  the  corporation,  but  to  attach  coupons  covering  the 
interest  payments  so  that  these  coupons — which  are  practically 
postdated  checks — may  be  clipped  and  deposited  as  they  fall  due. 
This  has  been  demonstrated  by  long  experience  to  be  the  simplest 
and  most  satisfactory  method  of  collecting  bond  interest. 


:iri;  iu> 


,rrn 


CHAPTER  VIII 

SECURED  BONDS 

§  85.    Security  for  Bond  Issues  ^ 

It  has  been  assumed  so  far  that  bonds  are  always  secured  by 
mortgages  covering  real  property.  This  is  not,  however,  the 
case.  There  are  other  important  types  of  security:  bonds, 
shares,  or  other  securities  may  be  posted  as  collateral;  or  a  lien 
on  chattel  property  such  as  locomotives,  rolling  stock,  and  the 
like  may  be  utilized  and  is  looked  upon  as  the  best  of  security. 
Beyond  these  bonds  secured  by  property  of  some  kind  comes 
the  unsecured  bond,  depending  for  its  payment  solely  on  the 
general  credit  of  the  corporation  by  which  it  is  issued. 

§  86.     Misleading  Terminology 

It  will  plainly  be  seen,  in  reviewing  these  various  types  of 
securities  and  their  variations,  that  it  is  unsafe  to  place  much 
dependence  upon  bond  names.  A  "first  mortgage"  or  a  "general 
mortgage"  bond  does  not  necessarily  have  a  first  lien  upon  any- 
thing; "first  and  refunding"  or  "first  and  unifying"  and  the 
like  may  indicate  a  first  mortgage  on  some  small  subdivision  of 
the  property,  and  a  second,  third,  or  fourth  mortgage  on  the  rest 
on  the  property.  On  the  other  hand,  a  bond,  second  or  third 
mortgage  in  name,  may  be  in  fact  a  first  mortgage  bond  by 
reason  of  the  payment  of  the  earlier  mortgage  or  mortgages. 
Every  bond  issue  stands  by  itself  and  has  its  own  peculiarities. 
It  is  unsafe  to  comment  upon  it — and  it  is  certainly  unsafe  in 
the  extreme  to  buy  it — without  having  first  studied  with  some 
care  the  exact  terms  and  extent  of  its  claim  upon  property,  if  any, 
and  of  the  nature  and  value  of  the  property  itself. 

1  See  Book  I,  {  502. 

624 


Ch.  8]  SECURED  BONDS  625 

§  87.    Mortgage  Bonds 

Bonds  that  are  backed  by  a  mortgage  on  real  property  are, 
in  this  country,  the  most  popular  type  of  bonds  and  will  probably 
always  remain  so.  In  the  United  Kingdom  it  is  customary  to 
issue  debenture  bonds  (having  no  specific  security  behind  them) 
in  many  cases  where  here  mortgage  bonds  would  be  issued.  The 
difference  is  in  name  more  than  in  fact,  for  the  English  debenture 
bonds  are  considered  by  the  investor  with  at  least  partial  refer- 
ence to  the  amount  and  the  nature  of  the  corporation's  holdings 
of  real  property. 

After  all,  the  great  bulk  of  the  wealth  of  this  country  is  in 
the  form  of  real  estate.  The  greater  the  increase  of  other  forms 
of  wealth,  the  greater  must  be,  necessarily,  the  increase  in  land 
values.  It  is  also  the  most  stable  form  of  wealth.  Hence,  a 
mortgage  on  land,  assuming  that  it  is  conservatively  placed,  is 
bound  to  remain  the  most  popular  and  perhaps  the  safest  form 
of  security.  This  is  not  to  say,  by  any  means,  that  every  bond 
secured  by  realty  is  safe,  but  only  to  state  the  general  principle 
that  land  and  other  real  property  constitute  the  most  acceptable 
form  of  security  for  bond  issues. 

Not  only  is  a  note  or  bond  secured  by  real  estate  the  most 
popular  type  of  secured  obligation,  but,  for  most  individually 
owned  businesses,  partnerships,  and  small  corporations,  it  is 
the  only  practical  form  of  long-term  obligation.  Other  for;ns 
of  security  are  utilized  in  the  main  only  by  large  concerns  which 
are  widely  and  favorably  known  and  therefore  enjoy  an  excep- 
tional measure  of  credit  apart  from  their  property  holdings. 

§  88.     Junior  Issues 

The  great  mass  of  obligations  on  real  property  are  secured 
by  first  mortgages.  There  is  a  considerable  amount,  also,  of 
second  mortgage  securities,  and  relatively  few  third,  fourth,  or 
later  mortgage  securities  Anything  beyond  a  second  mortgage 
is  seldom  found  except  among  the  obligations  of  large  railroad 
corporations,  and  seldom  there  under  any  title  really  descriptive. 


62l6  CORPORATE  FINANCE  [Bk.  II- 

The  old  New  York  and  Erie  Railroad's  first,  second,  third,  fourth, 
and  fifth  mortgage  bonds,  assumed  by  the  Erie  Railroad,  are  still 
outstanding,  but  modern  practice  favors  disguising  these  junior 
issues  by  some  more  confidence-inspiring  and  suggestive  title. 

This  is  illustrated  by  the  subsequent  financing  of  the  Erie 
Railroad.  When  another  mortgage  secured  on  practically  the 
same  property  as  the  five  preceding  mortgages  was  found  to  be 
desirable,  it  was  not  called  a  "sixth  mortgage"  but  "First  Con- 
solidated Gold  7's."  This  title  does  not  mean,  as  the  unsophis- 
ticated might  imagine,  that  the  issue  is  protected  by  a  first 
mortgage,  but  only  by  a  "consolidated  mortgage"  which  here 
covers  what  is  left  after  the  five  earlier  mortgages  have  been 
satisfied.  A  little  later  we  have  the  "First  Consolidated  Mort- 
gage Funded  Coupon  Gold  7's,"  which  received  the  title  of 
"first"  apparently  because,  though  not  the  first  consolidated  issue 
of  the  road,  they  are  the  first  consolidated  issue  to  be  secured  by 
the  coupons  of  the  preceding  issue.  Further  removed  than  this 
are  the  Erie's  "General  Mortgage  Convertible  4's,  1953," 
secured  partially  upon  this  same  much  mortgaged  property. 

The  Erie  is  a  shining  but  by  no  means  isolated  example.  It 
would  not  be  difficult  to  bring  to  light  many  another  fourth, 
fifth,  sixth,  or  even  later  mortgage  which  appears  perhaps  as  a 
"first  refunding,"  or  "prior  lien,"  or  masquerades  under  some 
other  high  sounding  but  very  delusive  title. 

A  second  mortgage  issue,  when  it  is  recognized  as  such,  will 
usually  have  to  pay  a  rate  of  interest  perhaps  }4  to  1%  higher 
than  a  first  mortgage  issue.  The  issues  which  are  protected  by 
subsequent  mortgages  may  be  expected  ordinarily  to  pay  still 
higher  interest  rates  in  rough  proportion  to  the  number  and 
amounts  of  the  claims  before  them.  However,  this  is  not  an 
invariable  rule,  for  the  property  pledged  may  be  ample  to  protect 
all  the  issues.  In  practice  junior  mortgage  issues  in  many  cases 
are  of  larger  size,  carry  no  higher  rate  of  interest,  and  enjoy  a 
wider  market  than  do  the  issues  which  precede  them.  ,    , 


Ch.  8]  SECURED  BONDS  627 

§  89.    Ratio  of  Mortgage  to  Value  of  Property 

The  question  as  to  the  correct  percentage  of  obligations 
secured  by  mortgage  to  the  appraised  value  of  the  mortgaged 
property  is  one  of  much  practical  interest.  There  are  many 
surprising  variations  in  practice.  Roughly  speaking,  it  may  be 
said  that  the  highest  grade  issues,  secured  by  a  mortgage  on  land, 
do  not  exceed  50%  to  60%  of  the  appraised  value  of  the  land. 
The  highly  regarded  "cedulas,"  for  example,  issued  by  the  Na- 
tional Mortgage  Bank  of  the  Argentine  Republic,,  never  exceed 
50%  of  the  appraised  value  of  the  mortgaged  land.  In  ordinary 
practice  a  second  mortgage  on  land  should  not  bring  the  total 
mortgage  issues  above  80%  of  its  value.  A  mortgage  based  in 
part  on  buildings  and  other  improvements  which  may  not  be 
easily  adapted  to  other  uses,  and  are  not  so  readily  salable  as 
land  alone,  cannot  safely  run  so  near  the  appraised  value. 

The  percentages  that  have  just  been  given  are  intended  to 
represent  an  ideal — or  at  any  rate,  the  most  exacting  standards  — 
rather  than  ordinary  commercial  practice.  The  following 
examples  picked  at  random  from  the  reports  of  many  different 
companies  operating  in  various  fields  and  carrying  on  various 
kinds  of  business,  show  provisions  that  have  been  found  accep- 
table by  some  of  the  good  banking  houses. 

The  Consumers  Power  Company  (Maine)  may  issue  its 
General  and  Refunding  Mortgage  Gold  bonds  only  for  refunding 
purposes  or  for  75%  of  expenditures  for  additional  properties. 

The  Mississippi  River  Power  Company  may  issue  bonds 
under  its  first  mortgage,  up  to  80%  of  the  cost  of  improvements, 
betterments,  and  extensions. 

The  New  York  Telephone  Company  may,  under  certain 
specified  conditions,  issue  additional  Refunding  Mortgage  6% 
bonds  to  secure  new  properties  up  to  "75%  of  the  actual  cost  of 
such  additional  property." 

The  Steel  Company  of  Canada,  Ltd.,  may  issue  additional 
bonds  to  the  extent  of  66  2/3%  of  the  appraised  value  of  new 
fixed  assets. 


628  CORPORATE  FINANCE  [Bk.  II- 

The  Steel  Tube  Company  of  America  may  issue  its  general 
mortgage  bonds  for  not  exceeding  75%  of  the  certified  cash  cost 
of  additions  and  improvements  to  the  property. 

The  American  Ice  Company  may  issue  the  balance  of  its 
Real  Estate  First  and  General  Sinking  Fund  Gold  6's  for  im- 
provements up  to  75%  of  the  cost. 

The  Manitoba  Power  Company,  Ltd.,  may,  under  prescribed 
conditions,  issue  additional  bonds  to  the  extent  of  80%  of  the 
cost  of  additions  and  betterments. 

Both  the  New  York  and  Cuba  Mail  Steamshio  Company  and 
the  New  York  and  Porto  Rico  Steamship  Company  are  per- 
mitted to  issue  additional  First  5's  for  80%  of  the  actual  cost  of 
new  property. 

The  General  Baking  Company,  incorporated  in  191 1,  a  com- 
bination of  twenty  large  baking  establishments  in  various  large 
eastern  cities,  is  permitted  to  issue  the  balance  of  its  authorized 
First  Mortgage  bonds  to  the  extent  of  70%  of  the  cost  of  perma- 
nent betterments,  improvements,  developments,  extensions,  and 
additions,  other  than  the  purchase  of  stocks  of  other  companies. 

The  International  Milling  Company  of  Minnesota  may, 
under  prescribed  conditions,  issue  bonds  up  to  75%  of  the  actual 
cost  of  the  establishment  of  new  mills. 

The  Commonwealth  Edison  Company  of  Chicago  may  issue 
First  Gold  5's  up  to  75%  of  the  cost  of  additions  and  extensions. 

The  Illinois  Bell  Telephone  Company  restricts  its  first 
mortgage  issue  to  50%  of  the  value  of  its  property,  or  60%  of 
the  value  of  its  real  estate  and  construction  accounts;  it  may 
issue  further  bonds  not  to  exceed  75%  of  the  cost  of  additional 
improvements  and  extensions. 

Nelson  and  Company,  Inc.,  can  issue  their  Reserved  First 
Sinking  Fund  Gold  6's  to  the  extent  of  75%  of  additions  and 
betterments.  n. 

In  general,  manufacturing  companies  are  supposed  to  preserve 
a  margin  of  safety  of  at  least  25%  between  the  cost  of  improve- 
ments and  the  amount  of  bonds  issued  to  fijiance  these  improve- 


Ch.  8]  SECURED  BONDS  629 

ments.  This  margin  may  be  reduced  to  20%  in  the  case  of  com- 
panies that  have  a  very  stable  business,  or  may  be  increased  to 
as  much  as  40%  or  50%  for  companies  that  do  not  claim  any 
especial  degree  of  stability  in  their  earnings. 

§  90.    Equipment  Trust  Bonds 

When  a  dealer  sells  a  piano  on  the  instalment  plan,  he  does 
not  ordinarily  give  his  customer  full  title  to  the  piano  until  full 
payment  has  been  made;  in  the  meantime  he  "leases"  the  piano 
at  a  rental  equal  to  the  amount  of  the  instalment  payments 
agreed  upon,  with  a  further  agreement  that  as  soon  as  the  pay- 
ments under  the  lease  equal  the  agreed  price,  these  payments 
shall  cease  and  full  title  shall  pass  to  the  customer.  By  this 
simple  device  he  protects  himself  in  part  against  an  unscrupulcus 
purchaser  who  might,  if  he  had  full  title,  dispose  of  the  piano, 
spend  the  cash  that  he  received  in  payment,  and  leave  the 
dealer  only  the  doubtful  privilege  of  suing  him  for  fulfilment  of 
his  contract.  Under  the  "lease'-'  arrangement,  the  customer  has 
no  right  to  resell  the  piano  until  his  own  payments  have  been 
fully  completed.  It  is,  of  course,  recognized  that  a  "lease"  of 
this  kind  is  essentially  a  legal  fiction — just  as  the  mortgage  which 
conveys  the  title  to  the  lender  of  money  is  a  legal  fiction.  Never- 
theless it  is  a  fiction  which  is  useful  and  indeed  indispensable. 

When  a  manufacturer  of  railroad  equipment  sells  some 
millions  of  dollars'  worth  of  cars  or  locomotives  to  a  railroad,  the 
purchasing  company  is  not  usually  ready  to  pay  the  very  large 
amount  in  cash.  The  manufacturer,  therefore,  protects  himself 
in  the  same  way.  The  title  is  retained  in  his  own  hands  or  in 
the  hands  of  a  trustee;  the  railroad  merely  "leases"  the  rolling 
stock  with  an  agreement  that  on  completion  of  the  payment  of 
a  certain  amount,  the  "lease"  shall  become  inoperative  and  the 
title  will  be  taken  by  the  railroad.  Thus  the  railroad  company — 
just  like  the  individual  who  buys  his  piano  on  the  instalment 
plan — is  unable  to  dispose  of  the  cars.  A  point  of  greater  prac- 
tical importance  is  that,  in  case  of  receivership  or  financial  em- 


630  CORPORATE  FINANCE  [Bk.  II- 

barrassment,  the  seller  of  the  cars  or  locomotives  can  take  them 
back  if  he  chooses;  they  belong  to  him,  not  to  the  railroad. 

The  chief  variation  in  this  procedure  consists  in  the  intro- 
duction of  a  financing  company  or  trustee  between  the  manu- 
facturer of  railroad  equipment  and  the  railroad  company  which 
purchases  the  equipment.  The  financing  company  takes  upon 
itseK  the  burden  of  paying  the  manufacturer,  and  receives  title 
to  the  cars  or  locomotives.  This  title  it  may  ofifer  as  security 
for  an  issue  of  equipment  trust  obligations  in  the  form  of  notes, 
bonds,  or  certificates;  the  equipment  is  leased  to  the  railroad. 

.  .  .  Equipment  obligations  are  peculiar  in  form,  in  security, 
and  in  economic  position.  They  may  be  bonds  similar  to  other 
railroad  bonds,  they  may  be  certificates  of  participation  in  a  con- 
tract to  purchase  and  hold  a  specific  lot  of  rolling  stock,  or  they 
may  be  shares  in  a  permanent  association.  They  are  secured  by 
tangible  property,  yet  a  kind  of  property  which  is  movable  from 
place  to  place  and  declines  in  value  more  rapidly  than  any  other 
used  as  a  basis  of  corporate  obligations.  They  rest  on  the  general 
credit  of  the  corporation  using  the  equipment,  yet  this  general 
credit  has  little  to  do  with  determining  their  investment  position, 
which  is  as  a  whole  stronger  than  that  of  any  other  form  of  cor- 
porate security.  Their  legal  status  has  never  been  fully  determined 
by  the  courts,  yet  their  legality  has  never  been  seriously  questioned 
and  they  have  been  given  priority  over  first  mortgage  bonds  in  the 
ultimate  test  of  relative  strength.* 

Equipment  obligations  are  issued  under  two  distinct  plans. 
First  the  title  is  taken  by  some  individual  trust  company  or  other 
organization,  which  issues  equipment  obHgations  secured  on  the 
property,  sells  them  and  with  the  proceeds  pays  the  original 
owners.  The  equipment  is  then  leased  to  the  railroad  under 
such  terms  that  the  interest  and  principal  of  the  equipment 
obligations  are  properly  taken  care  of.  When  all  are  paid  in  full 
a  bill  of  sale  vests  the  ownership  of  the  equipment  in  the  railroad. 
Under  the  second  plan  the  railroad  buys  the  equipment  and 
gives  a  mortgage  on  it  to  secure  the  equipment  obligation. 

'  I  Dewing  on  Finan.  Pol.  of  Corp.,  p.  90. 


Ch.  8]  SECURED  BONDS  631 

"  Equipment  obligations  are  readily  sold  and  enjoy  an  excellent 
reputation  for  safety. 

Even  though  a  railroad  may  go  into  receivers'  hands  and  be- 
come almost  a  total  financial  wreck,  it  cannot  afford  under  any 
conditions  to  give  up  its  rolling  stock,  and  must  therefore  main- 
tain its  annual  payments.  For  this  reason  it  happens  that 
equipment  trust  bonds,  even  of  railroads  that  are  actually  in 
receivership  and  that  have  defaulted  on  practically  all  of  their 
other  obligations,  frequently  sell  on  a  basis  of  5%  to  6%.  The 
equipment  trust  bonds  of  sound  railroad  corporations  are  in 
great  demand  and  are  selling  at  the  present  time  on  a  basis  of 
5.30  to  5.75  according  to  date  of  maturity. 

It  has  been  at  times  suggested  that  the  same  principle  might 
be  more  widely  applied,  as  for  instance  in  selling  machinery  and 
other  essential  equipment  to  manufacturing  corporations.  The 
difficulty,  however,  arises  that  outside  the  railroad  field,  trans- 
actions which  could  be  financed  by  equipment  trust  obligations 
are  of  comparatively  small  size,  and  could  not  easily  be  standard- 
ized in  such  a  way  as  to  make  them  appeal  to  the  investing  public. 
The  average  investor,  and  even  the  bank  official,  well  acquainted 
with  financial  practice,  does  not  care  to  spend  much  time  in 
analyzing  and  investigating  propositions  that  are  put  up  to  him 
when  he  goes  into  the  market  to  buy  a  security.  He  wants  to 
get  something  that  is  standardized  and  familiar.  Under  such 
conditions  it  is  ordinarily  only  after  years  of  effort  that  a  new 
financial  method  can  be  introduced.  For  this  very  reason  there 
is,  perhaps,  a  real  opportunity  which  someone  will  sooner  or 
later  seize,  to  apply  the  equipment  trust  method  more  widely 
and  thus  facilitate  the. sale  of  many  kinds  of  machinery. 

i-rni    'Jir,    ?.■ 

§  91.    Collateral  Trust  Bonds 

The  issue  of  long-term  obligations  secured  by  marketable 
stocks  and  bonds  is  comparatively  a  modern  practice.  There  is 
a  fundamental  distinction  between  the  use  of  such  collateral  for 
long-term  and  short-term  loans,     qiuj  juo  ^^a  jib-ii^.ijvj  jiA  -i^i- 


632  CORPORATE  FINANCE  [Bk.  II- 

Short-term  obligations  are  ordinarily  secured  by  stocks  and 
bonds  which  are  active  and  which  in  many  cases  the  borrower 
is  holding  temporarily  for  resale.  Long-term  bonds,  on  the 
other  hand,  should  be  secured  by  stocks  and  bonds  that  it  is 
intended  to  hold  permanently.  Ordinarily  these  securities, 
posted  as  collateral,  are  those  of  subsidiary  corporations  or  of 
other  corporations  in  which  the  borrowing  company  expects  to 
maintain  a  permanent  interest.  Sometimes  nearly  all  the 
stocks  and  bonds  of  subsidiary  companies,  held  in  the  treasury 
of  the  parent  company,  are  "bunched"  and  posted  in  one  lot. 
A  good  illustration  of  this  practice  was  afforded  by  the  Missouri 
Pacific  First  Collateral  Mortgage  bond  of  1920,  of  which  $9,636,- 
000  were  outstanding,  secured  by  the  deposit  of  first  mortgage 
bonds  of  twenty  subsidiary  companies.  These  subsidiary  mort- 
gage bonds  had  little,  if  any,  independent  market. 

It  is  a  curious  fact  that  a  collateral  trust  issue  will  generally 
sell  at  a  better  price  than  will  the  stocks  and  bonds  which  are 
posted  as  collateral.  The  reason  is  to  be  found  in  the  fact  that 
the  parent  company  is  adding  its  quota  of  credit  to  the  credit 
standing  of  its  various  subsidiaries,  and  also  in  the  fact  that  the 
collateral  trust  issue  is  comparatively  large  and  therefore  com- 
mands more  attention  and  a  better  market. 

Inasmuch  as  the  amount  and  quality  of  the  collateral  posted 
as  security  for  a  bond  issue  of  this  nature  is  seldom  examined 
with  much  care  by  investors,  there  is  always  a  chance,  unless  the 
banking  syndicate  which  sells  the  issue  is  very  careful,  that  the 
collateral  will  eventually  be  found  of  less  value  than  was  origi- 
nally supposed.  The  general  pubhc,  in  fact,  has  no  method  of 
securing  reliable  information  as  to  the  status  and  prospects  of 
subsidiary  companies  whose  securities  are  posted.  It  must 
regretfully  be  admitted  that  the  collateral  trust  device  has  some- 
times been  used  to  obtain  credit  for  corporations  that  were  not 
worthy  of  credit. 

A  collateral  trust  bond  issue  is  the  favorite  method  of  financ- 
ing the  purchase  by  one  corporation  of  the  securities  of  another 


Ch.  8]  SECURED  BONDS  633 

corporation.  The  purchase  may  be  made  in  the  first  place  with 
temporary  bank  loans,  which  in  their  turn  are  repaid  as  soon  as 
the  collateral  trust  bonds  can  be  sold  to  the  investing  public.  It 
was  in  this  way,  for  instance,  that  the  Northern  Pacific  and  Great 
Northern,  acting  together,  financed  their  purchase  of  stock  of 
the  Chicago,  Burlington  and  Quincy  Railroad  Company.  The 
collateral  trust  bond  issue  based  upon  this  stock,  refunded  in 
192 1,  was  highly  regarded.  In  the  same  way  the  Atlantic  Coast 
Line,  in  part,  purchased  the  stock  control  of  the  Louisville  and 
Nashville  Railroad. 

While  the  collateral  trust  bond  issue  is  used  most  extensively 
by  railroad  corporations,  it  is  common  also  among  public  utility 
holding  companies  and  is  used,  though  to  a  less  extent,  by 
industrial  combinations.  The  customary  rule  is  to  make  the 
collateral  trust  bond  issue  about  80%  of  the  appraised  market 
value  of  the  securities  posted  as  collateral.  This  is  the  same 
percentage  that  is  commonly  regarded  as  proper  among  banks  in 
granting  short-term  collateral  loans. 


>!     fT- 


'J3it3$i^  iteilgxia     'IQ  g 


CHAPTER  IX 
UNSECURED  BONDS 

§  92.    Debenture  Bonds  ^ 

A  debenture — to  give  its  literal  and  also  its  technical  legal 
meaning— may  be  defined  as  any  acknowledgment  of  debt,  which 
of  course  implies  a  promise  to  repay  the  debt.  In  financial 
practice,  however,  the  word  has  become  gradually  restricted, 
until  now  it  means  only  an  unsecured  promise  to  pay  a  debt,  and 
the  term  "debenture"  as  ordinarily  used  refers  to  a  direct  credit 
obligation  of  the  corporation,  unsecured  by  any  pledge  of  prop- 
erty. In  other  words,  a  debenture  bond  is  in  effect  merely  the 
corporate  promise  to  pay  a  certain  sum  of  money  at  a  specified 
time  with  interest  meanwhile  at  a  stated  rate.  The  debenture 
therefore  rests  entirely  on  the  general  credit  of  the  corporation. 

At  first  sight  the  debenture  bond  might  seem  to  be  a  very 
unsatisfactory  form  of  security,  inasmuch  as  it  has  no  mortgage 
security  and  therefore  no  right  oi  foreclosure.  This  objection, 
however,  is  more  in  appearance  than  reality,  for  a  default  in 
payment  of  either  interest  or  principal  of  a  debenture  gives  cause 
of  action  against  the  corporation,  and  leads  to  failure  and 
receivership, 

§  93.    English  Practice 

In  England  a  distinction  is  made  between  debenture  bonds — 
generally  called  simply  "debentures" — and  debenture  stock. 
Debenture  bonds  are  in  fixed  amounts  (say  £20,  £100,  £200, 
£1,000,  etc.),  while  debenture  stock  may  be  transferred  in  any 
amount  that  suits  the  convenience  of  buyer  and  seller.    Under 


'  See  Book  I,  J{  502,  512. 

634 


Ch.  9]  UNSECURED  BONDS  635 

English  practice  a  man  may  hold  debenture  stock  in  an  amount, 
let  us  say,  of  £1263  6s.  3d.,  and  may  sell  £563  4s.  2d.,  if  he  will; 
while  of  debenture  bonds  his  holdings  and  his  sales  must  as  in 
this  country  be  in  fixed  amounts  depending  on  the  conditions  of 
issue.  Thus  it  will  be  seen  that  in  England  the  distinction 
between  debenture  bonds  and  debenture  stock  is  much  the  same 
as  between  ordinary  shares  and  ordinary  stock. 

The  use.  of  the  term  debenture  in  England  is  somewhat  dif- 
ferent from  that  usual  in  this  country,  as  the  debenture  may  be 
either  secured  or  unsecured.  Thus  in  discussing  the  presenta- 
tion of  a  prospectus  an  Enghsh  author  says : 

A  debenture  stock  or  bond  should  be  secured  by  a  trust  deed 
giving  it  a  definite  mortgage  on  the  real  property  of  the  company, 
which  should  be  valued  at  at  least  half  as  much  again  as  the 
amount  of  debt  secured  on  it.  Thus,  £500,000  of  debenture  stock 
secured  by  a  first  charge  on  freehold  land  and  buUdings  valued  at 
£750,000  may  be  considered  sound  if  the  valuation  is  fairly  recent; 
....  The  debenture  stock  or  bond  should  also  have  a  floating 
charge  on  the  other  assets  of  the  company,  and  should  carry  with 
it  the  right  of  foreclosure,  that  is  to  say,  it  should  be  within  the 
power  of  the  trustees  representing  the  debenture  holders,  in  the 
event  of  the.  interest  not  being  paid  On  any  due  date,  immediately  to 
take  possession  of  the  property  and  sell  it.* 

§  94.    Use  of  Debenture  Bonds 

In  the  United  States  debenture  bonds  are  commonly  used  in 
railroad  reorganizations  in  the  general  scaling  down  of  claims 
upon  the  assets  and  income  of  the  corporation.  Notwithstand- 
ing this,  the  debenture  cannot  be  considered  a  sign  of  financial 
weakness.  Some  American  corporations  in  high  credit  have 
issued  debenture  bonds  simply  because  they  preferred  the  sim- 
plicity of  the  debenture  form  and  were  able  by  reason  of  their 
general  credit  to  sell  such  bonds  on  a  satisfactory  basis.  Thus 
in  1918,  Armour  and  Company  issued  $7,641,000  6%  Serial 
Convertible  Gold  Debentures,  and  again  in  1920  issued  $60,000,- 

'  Hartley  Withers  on  Stocks  and  Shares,  pp.  89,  90. 


636  CORPORATE  FINANCE  [Bk.  II- 

000  of  7%  10- Year  Convertible  Gold  notes,  both  issues  unse- 
cured by  mortgage.  Also,  so  long  as  their  credit  was  suflficient 
to  sustain  unsecured  bonds,  some  of  the  New  England  railroads 
declined  to  mortgage  their  main  lines,  and  issued  nothing  but 
debentures.  This  was  the  case  with  the  New  York,  New  Haven 
and  Hartford,  and  the  Boston  and  Maine,  and  Boston  and 
Albany  railroads. 

Still  another  case  that  calls  for  debenture  bonds  exists  when 
a  small  corporation  which  has  a  relatively  small  amount  of 
tangible  assets,  but  possesses  good-will  and  other  intangible 
assets  of  high  value,  desires  to  make  a  long-term  loan.  Inas- 
much as  a  corporation  of  this  type  does  not  have  the  proper 
basis  for  either  a  mortgage  bond  issue  or  a  collateral  trust  bond 
issue,  it  usually  falls  back  on  a  debenture  bond  issue. 

The  possibilities  in  this  direction  are  not  generally  recognized. 
In  many  instances,  where  small  corporations  are  now  borrowing 
up  to  the  limit  of  safety  at  a  bank  and  yet  are  cramped  for  funds, 
it  would  be  entirely  possible  to  market  a  small  issue  of  debenture 
bonds  among  people  who  are  acquainted  with  the  corporation 
and  recognize  its  solidity,  and  thus  relieve  the  situation. 

§  95.     Special  Provisions  Protecting  Debentures 

Debenture  bonds,  although  not  secured  by  the  pledge  of 
specific  properties,  are  usually  issued  under  an  agreement  or 
indenture  which  recites  the  conditions  of  the  obligation.  Some 
of  these  bonds  are  protected  by  special  provisions  which  may  give 
them  an  advantage  over  holders  of  wholly  unsecured  and  unpro- 
tected obligations  in  case  of  reorganization.  For  instance,  the 
American  Cotton  Oil  Company  has  outstanding  an  issue  of  de- 
benture bonds  the  principal  of  which  becomes  due,  in  case  there 
is  a  default  in  payment  of  interest,  on  the  written  request  of  a 
majority  of  the  holders  of  the  bonds.  Also  no  mortgage  lien  may 
be  placed  upon  the  company's  property — which  is  now  free  from 
mortgage  indebtedness — save  with  the  consent  of  the  holders  of 
80%  of  the  outstanding  debentures,  which  must  then  be  secured 


Ch.  9]  UNSECURED  BONDS  637 

under  the  mortgage  equally  and  ratably  with  all  other  indebted- 
ness secured  by  such  mortgage. 

Similarly  a  recent  announcement  offers  for  sale  $25,000,000 
Canadian  Pacific  Railway  Company  4%  Coupon  Consolidated 
Debenture  stock,  non-callable,  secured  by  a  first  charge  on  the 
entire  undertaking,  subject  to  certain  priorities  stated  below: 

The  Canadian  Pacific  Railway  Company  4%  Consolidated 
Debenture  Stock  is  authorized  by  Act  of  Pariiament  of  the  Do- 
minion of  Canada  passed  in  1889  and  subsequent  Acts. 

By  the  terms  of  the  Act  the  stock  is  a  first  charge  upon  and  over 
the  whole  undertaking,  railways,  works,  rolling  stock,  plant,  prop- 
erty and  effects  of  the  Company,  excepting  lands  received  by  way 
of  subsidy,  subject  however  to  the  payment  of  working  expenses 
and  to  certain  priorities  in  respect  to  charges,  which  now  consist  of 
securities  aggregating  approximately  $38,651,724,  issued  in  respect 
to  only  1,642  miles  of  raUroad,  while  the  lines  embraced  in  the 
Canadian  Pacific  Railway's  traffic  returns  aggregate  13,402.2  miles. 

The  American  Tobacco  Company's  Gold  Debenture  6's  and 
4's  are  not  secured  by  lien  or  mortgage  on  properties,  but  a 
charge  is  imposed  in  favor  of  the  trustees  acting  for  the  debenture 
bondholders,  upon  the  property  and  upon  all  the  present  and 
future  net  incomes  of  the  corporation.  This  gives  the  owners  of 
these  debentures  an  advantage  over  the  owners  of  any  subsequent 
debenture  or  other  obligations  that  the  company  may  incur. 

There  are  some  few  instances  of  so-called  debenture  bonds 
issued  in  this  country  and  in  Canada,  which  are  not,  in  fact, 
debentures  at  all  as  the  term  is  used  in  the  United  States,  but 
possess  a  mortgage  security.  For  example,  the  Canadian 
Niagara  Power  Cpmpany  issued  a  6%  debenture,  Series  "A" 
and  "B"  of  which  were  secured  by.  a  first  mortgage,  and  series 
*'C"  by  a  second  mortgage.  The  Wabash  Railroad  Company 
also  has  a  secured  issue  of  bonds  outstanding,  known  as  Income 
Non-Cumulative  Debenture  "B"  6's,  which  are  really  second 
mortgage  bonds  on  part  of  its  property  and  third  mortgage  bonds 
on  another  part. 


638  CORPORATE  FINANCE  [Bk.  II- 

As  has  been  remarked  before,  it  is  unsafe  to  place  any  reliance 
upon  the  names  given  to  securities  unless  they  are  used  in  a 
strictly  legal  sense.  The  use  of  the  term  "debenture"  in  the 
cases  mentioned  above  was  doubtless  to  facilitate  the  sale  of  the 
bonds  in  the  English  market. 

§  96.    Income  Bonds 

Income  bonds  may  or  may  not  be  secured  as  to  principal  by 
a  mortgage  lien  of  some  kind;  their  distinguishing  feature  is 
the  absence  of  any  claim  for  interest  payments  except  as  and 
when  there  are  net  profits  in  excess  of  all  prior  claims. 

The  income  bond  is  a  hybrid,  half-way  between  a  preferred 
stock  and  a  bond,  and  possesses  few  of  the  attractive  features 
either  of  ordinary  bonds  or  of  stock.  It  is  seldom  accepted  by 
investors  from  choice.  Most  of  the  issues  of  income  bonds  now 
outstanding  are  the  products  of  reorganization.  In  the  general 
scaKng  down  of  creditor's  claims  which  attends  every  successful 
reorganization,  some  of  the  bondholders  are  likely  to  be  required 
to  give  up  their  claim  to  a  fixed  income,  and  to  accept  thh  claim 
of  the  income  bond  to  payment  of  interest  only  when  it  is  earned. 

Theoretically,  this  arrangement  is  fair  enough  and  offers 
junior  bondholders  of  an  insolvent  corporation  all  that  they  cau 
reasonably  expect  to  obtain.  When  income  bonds  wera  first 
issued  extensively  in  the  United  States,  during  the  numerous 
railroad  reorganizations  of  the  eighties,  they  were  generally 
regarded  as  an  ingenious  and  praiseworthy  device,  but  later 
experience  has  not  confirmed  this  favorable  first  impression. 

Sometimes  the  holders  of  income  bonds  are  given  some  of 
the  rights  of  stockholders.  The  income  bondholders  of  the  New 
York  Railways  Company,  which  owns  a  number  of  the  surface 
street  railway  lines  in  New  York  City,  have  the  right  to  vote  as 
do  the  stockholders  of  the  company — one  vote  for  each  $100 
bond  held — and  the  absolute  right  to  elect  five  out  of  eleven 
directors  of  that  company,  their  rights  to  continue  until  the  full 
income  has  been  paid  on  the  bonds  for  a  period  of  three  years. 


Ch.9]  UNSECURED  BONDS  639 

Among  industrial  corporations  income  bonds  are  rarely  to 
be  found.  Out  of  forty  or  more  industrial  security  issues  dis- 
cussed in  Dewing's  "Corporate  Promotions  and  Reorganiza- 
tions," only  two  are  income  bonds,  those  of  the  Mount  Vernon 
Woodberry  Company  and  the  Standard  Rope  and  Twine  Com. 
pany.  The  Mount  Vernon-Woodberry  bonds,  secured  by  a 
second  mortgage  on  all  the  fixed  assets,  were  also  a  direct  Hen 
on  all  the  merchandise  and  quick  assets.  They  proved  a  con- 
stant source  of  controversy  and  greatly  handicapped  the  com- 
pany in  securing  the  short-term  bank  credit  so  essential  in  textile 
manufacturing.  The  indenture  of  these  income  bonds  was 
faulty  in  that  it  made  no  provision  for  allowing  depreciation 
before  figuring  net  earnings,  thus  giving  rise  to  many  impossible 
demands  on  the  part  of  the  dissatisfied  income  bondholders. 

§  97.    Interest  Payments  on  Income  Bonds 

The  interest  on  the  income  bond  may  be  cumulative,  that 
is,  if  there  are  no  profits  from  which  it  may  be  paid  in  any  year, 
the  unpaid  interest  is  not  entirely  lost  to  the  owner  of  the  bond 
but  cumulates  or  becomes  a  charge  against  profits  and  must  be 
paid  when  profits  applicable  thereto  are  made ;  or  it  may  be  non- 
cumulative  and  the  interest  be  lost  to  the  bondholders  entirely 
in  any  year  in  which  profits  applicable  thereto  are  not  made. 

In  any  case  interest  on  income  bonds  is  not  paid  unless 
earned,  and  with  non-cumulative  bonds,  if  the  interest  for  any 
year  is  not  earned,  it  is,  as  stated*  for  that  year  lost  entirely. 
Under  such  conditions  difficulties  continually  arise  out  of  the 
fact  that  the  determination  of  net  earnings  in  a  large  corporation 
is  not  a  purely  mathematical  process,  but  involves  much  dis- 
cretion and  constantly  gives  rise  to  differences  of  opinion.  It  is 
to  the  interest  of  the  common  stockholders,  who  usually  have 
control  of  the  corporation,  to  defer  payments  to  holders  of  non- 
cumulative  income  bonds  as  long  as  possible,  or  until  the  time 
arrives  when  dividends  may  be  distributed  also  to  the  stockhold- 
ers.    It  is  easy  enough  for  the  directors  of  the  company  to  pre- 


640  CORPORATE  FINANCE  [Bk.  II- 

vent  payment  of  interest  on  income  bonds  if  they  so  desire,  by 
instructing  the  auditor  to  charge  many  expenditures  of  a  capital 
nature  into  operating  expenses,  or  by  excessive  charges  to  de- 
preciation, or  by  other  devices  of  similar  nature  which  reduce 
the  nominal  showing  of  net  earnings. 

The  best-known  case  of  this  kind  is  that  of  the  Central  of 
Georgia  Railway  Company,  which  issued  in  its  reorganization 
of  1895,  three  series  of  income  bonds,  all  falling  due  in  1945. 
For  several  years  the  holders  of  the  income  bonds,  to  whom  no 
payments  were  made,  protested  that  they  were  not  receiving  fair 
treatment.  Finally  in  1913,  after  long  litigation,  an  auditor  was 
appointed  by  the  court  and  found  that  the  Ocean  Steamship 
Company,  all  of  the  stock  of  which  was  owned  by  the  Central  of 
Georgia  Railway  Company,  had  been  earning  large  profits  which 
were  never  taken  into  the  published  accounts  of  the  Central 
of  Georgia  Railway  Company,  but  were  turned  over  to  the 
parent  corporation  under  the  fiction  of  a  "loan"  which  was 
never  intended  to  be  repaid.  Counsel  for  the  Railway  Company 
did  not  deny  the  facts  but  argued  on  the  strictly  technical  ground 
that,  so  long  as  dividends  had  not  been  declared  by  the  directors 
of  the  Ocean  Steamship  Company,  it  was  impossible  to  include 
these  earnings  in  the  income  account  of  the  Central'of  Georgia 
Railroad  Company.  It  is  a  relief  to  find  that  the  court  disre- 
garded this  shallow  pretext  and  took  the  common-sense  view  that* 
the  earnings  of  the  Central  of  Georgia  Railway  included  the  earn- 
ings of  its  subsidiary  compjcny,  and  ordered  payment  of  interest 
to  the  holders  of  the  income  bonds.  It  was,  however,  a  long  and 
hard  battle  and  offers  little  encouragement  to  investors  to  put 
their  money  into  securities  of  this  type. 

Under  the  plan  and  agreement  of  November  i,  192 1,  for  the 
reorganization  of  the  Missouri,  Kansas  and  Texas  Railway 
Company,  so-called  "adjustment"  bonds  are  to  be  issued,  and 
bear  4%  interest  payable  out  of  the  net  earnings  of  the  company. 
These  bonds  are  nothing  more  than  income  bonds  and  it  is 
interesting  to  observe  the  precautions  to  determine  what  net 


Ch.  9l  UNSECURED  BONDS  641 

income  is  and  then  what  disposition  may  be  made  of  this  net 
income.  The  following  quotation  is  from  the  published  plan  of 
reorganization : 

The  Adjustment  Mortgage  will  provide  that  the  net  income  of 
the  New  Company  applicable  to  the  payment  of  interest  on  the 
Adjustment  Mortgage  Bonds  shall  be  deemed  to  be  net  income  as 
that  term  is  defined  in  the  accounting  rules  of  the  Interstate  Com- 
merce Commission  from  time  to  tirhe  in  force,  but  without  deduc- 
tion in  ascertaining  net  income  for  interest  on  the  Adjustment 
Mortgage  Bonds;  and  wUl  further  provide  that  only  such  portion 
of  the  net  income  of  the  New  Company  for  each  year  beginning 
January  i,  as  the  board  of  directors  in  its  discretion  may  determine, 
but  not  less  than  fifty  per  cent  of  such  net  income  for  each  year 
ending  prior  to  January  i,  1925,  shall  be  required  to  be  applied,  so 
far  as  necessary  therefor,  to  the  payment  of  interest  on  the  Adjust- 
ment Bonds,  and  that  any  remaining  net  income,  to  the  extent  of 
any  difference  between  the  full  interest  on  the  Adjustment  Mort- 
gage Bonds  and  the  interest  actually  paid  thereon,  shall  be  carried 
into  a  separate  account  available  only  for  expenditures  chargeable 
to  capital  account  under  the  accounting  rules  of  the  Interstate 
Commerce  Commission  from  time  to  time  in  force. 

For  the  purpose  of  determining  the  net  income  of  the  New 
Company  for  any  such  year,  which  or  any  part  of  which  may 
elapse  before  the  mortgaged  lines  of  railroad  embraced  in  the  plan 
shall  have  been  delivered  to  the  New  Company,  the  gross  income 
of  the  Receivers  of  the  System  for  such  period  shall  be  deemed  gross 
-J?;,  income  of  the  New  Company  for  such  period  and  shall  be  subject 
only  to  such  deductions  as  would  have  been  made  if  the  mortgaged 
lines  of  railroad  had  been  owned  and  operated  by  the  New  Com- 
pany for  such  period  and  the  new  securities  presently  to  be  issued 
and  delivered  under  the  plan  had  been  issued  and  delivered  Janu- 
ary I,  1922. 

§  98.    Convertible  Bonds 

Most  purchasers  of  high-grade  bonds  are  primarily  interested 
in  the  safety  of  their  principal  and  are  satisfied  with  a  moderate 
rate  of  return.  Most  purchasers  of  shares,  on  the  other  hand, 
are  primarily  interested  in  large  returns,  and  in  securing  profits 
due  to  the  enhancement  of  the  value  of  their  holdings.     If  they 


642  CORPORATE  FINANCE  [Bk.  II- 

purchase  stock  with  their  eyes  open,  they  reaUze  that  they  are 
incurring  more  or  less  risk.  Between  these  two  main  bodies  of 
purchasers  of  corporate  securities,  there  are  a  great  many 
investors  who  wish  to  secure  reasonable  safety  combined  with  a 
fair  chance  for  appreciation  in  the  value  of  their  holdings.  Pre- 
ferred shares  are  intended  in  part  to  meet  the  wishes  of  this 
intermediate  class.  Convertible  and  participating  bonds  are 
designed  also  to  appeal  to  this  group. 

The  convertible  bond,  as  the  term  is  ordinarily  understood, 
is  one  which  gives  its  holder  the  privilege  of  exchanging  his 
bonds  within  certain  time  limits  and  at  a  rate  fixed  in  advance, 
for  the  corporation's  common  shares.  The  bondholder,  if  his 
bonds  are  well  chosen,  obtains  under  this  arrangement  a  safe 
and  sound  security  yielding  a  moderate  rate  of  return  and  has 
a  chance  of  speculative  profit  due  to  the  possible  enhancement 
of  the  value  of  the  companies'  shares.  A  classic  and  favorable 
example  of  the  convertible  bond  is  that  of  the  Union  Pacific 
Railroad,  which  in  1901  issued,  to  secure  funds  for  the  purchase 
of  the  Southern  Pacific  and  the  Northern  Pacific,  $100,000,000 
worth  of  4%  bonds  convertible  into  common  stock  at  its  face 
value  at  any  time  before  May,  1906.  The  bonds  sold  at  par, 
a  higher  price  than  the  Union  Pacific  could  have  sold  its  ordinary 
bonds.  The  operation  of  the  Union  Pacific  Railway  was  very 
successful  and  its  stock  rose  within  a  few  years  after  the  issue 
of  these  bonds  to  $150  a  share.  Practically  all  the  issue  was 
converted  at  a  very  substantial  profit  to  the  bondholders.  Again 
in  1907,  the  Union  Pacific  put  out  an  issue  of  convertible  bonds, 
exchangeable  at  the  rate  of  $175  for  each  $100  share  of  stock. 
Of  the  bonds  issued,  over  $73,762,000  were  sold,  and  of  this 
amount  over  $47,000,000  face  value  have  been  converted  into 
common  stock. 

There  is  of  course  a  drawback  to  the  convertible  bond,  in  that 
the  conversion  privilege,  if  it  is  really  valuable^or  likely  to  be 
valuable — increases  the  selling  price  of  the  bonds  and  thereby 
lowers  slightly  the  yield  on  the  investor's  capital.     However, 


Ch.  9]  UNSECURED  BONDS  643 

the  largest  buyers  of  bond  issues  are  for  the  most  part  institutions 
which  are  not  attracted  by  the  possibility  of  speculative  profits 
and  do  not  specially  esteem  convertible  bonds,  and  it  therefore 
happens  that  those  who  desire  such  bonds  are  frequently  able  to 
get  them  at  very  reasonable  prices. 

There  are,  naturally,  all  shades  of  variations  in  the  desirability 
of  convertible  bonds.  Most  of  them  are  so  adjusted  as  to  be 
really  attractive.  Occasionally  though,  such  bonds  are  con- 
vertible into  common  stock  at  so  high  a  rate  of  exchange  that 
there  is  but  little  probability  of  the  conversion  privilege  ever 
becoming  valuable.  Such  a  case  is  that  of  the  Erie's  General 
Mortgage  Convertible  Gold  4's  which  are  exchangeable  for 
common  stock  of  the  company  at  varying  prices  for  the  different 
series,  ranging  from  $50  to  $60.  Under  the  terms  of  the  mort- 
gages none  may  be  issued  convertible  at  a  less  conversion  rate 
than  $48.50  for  each  share  of  stock.  Erie  stock  has  never  since 
reached  that  figure;  the  current  quotations  range  from  $10  to 
$13  a  share. 

§  99.    Advantages  and  Disadvantages  of  Convertible  Bonds 

From  the  corporation's  point  of  view,  there  are  both  advan- 
tages and  disadvantages  in  the  convertible  bond.  A  corporation 
is  frequently  able  to  sell  convertible  bonds  when  it  could  not  sell 
stock  at  a  satisfactory  figure.  Then  if  the  corporation  is  suc- 
cessful, as  the  stock  increases  in  value  and  reaches  the  convers- 
ion figure,  the  bonded  liability  of  the  bonds  is  automatically 
extinguished.  Some  of  the  railroads  of  the  country  have  been 
largely  financed  in  this  way.  Thus,  in  building  up  the  Union 
Pacific  system,  Harriman  made  excellent  use  of  the  convertible 
bond.  These  would  be  issued  from  time  to  time  at  a  price  well 
above  that  of  the  stock,  and  the  proceeds  be  used  to  build  up 
the  road  or  acquire  needed  properties.  This  would  naturally  in- 
crease the  value  and  the  earning  power  of  the  road  and  bring  the 
price  of  the  stock  up  to  or  above  the  rate  at  which  the  bonds  were 
profitably  convertible.      Then   the   bonds   were  exchanged  for 


644  CORPORATE  FINANCE  [Bk.  II- 

stock  and  the  road  thus  relieved  of  its  bonded  obligation  was 
again  in  a  position  to  issue  and  sell  convertible  bonds. 

On  the  other  hand,  it  may  be  well  argued  that  the  corpora- 
tion is  taking  chances.  If  its  business  moves  along  successfully 
and  its  stock  increases  in  value,  the  holders  of  convertible  bonds 
share  in  its  prosperity  without  having  shared  in  the  preliminary 
risks.  On  the  other  hand,  in  case  some  unforeseen  misfortune 
reduces  the  company's  earnings,  the  convertible  bondholder 
naturally  enforces  his  claim  with  the  same  rigor  as  any  other 
creditor.  As  a  matter  of  fact,  convertible  bonds  are  seldom 
issued  except  in  periods  when  the  demand  for  capital  is  large 
and  when  it  is  necessary  for  corporations — even  those  in  high 
standing — to  make  concessions.  In  the  United  States  these 
securities  were  first  issued  during  and  after  the  Civil  War.  The 
financing  of  the  Chicago,  Milwaukee  and  St.  Paul  Railroad 
Company  from  i860  to  1880  was  chiefly  effected  through  issues 
of  convertible  bonds,  and  it  is  stated  that  as  late  as  1896  there 
were  twelve  separate  convertible  issues  of  this  company  out- 
standing. From  1880  to  1900,  on  the  other  hand,  the  practice 
was  discontinued  and  was  generally  thought  to  have  become 
obsolete.  After  1900  there  was  a  revival  of  convertible  issues, 
which  is  to  be  explained  chiefly  on  the  ground  of  increased 
demand  for  capital.  For  the  same  reason,  since  the  Great  War 
many  convertible  bonds  have  been  issued. 

Among  the  better-known  convertible  bonds  may  be  men- 
tioned : 

Chesapeake  and  Ohio, 'Convertible  30- Year  Secured  Gold  5's, 
convertible  into  common  stock,  on  or  before  April  i,  1920,  at 
$75  per  share;  April  i,  1923,  at  $80  per  share;  April  i,  1926,  at 
$90  per  share;  and  thereafter  up  to  April  i,  1936,  at  $100  per 
share. 

Chili  Copper  Company's  Collateral  Trust  Convertible  Gold 
6's,  Series  "A,"  convertible  into  common  stock  at  any  time  up 
to  their  due  date,  April  i,  1932,  at  the  rate  of  $35  face  value  of 
bonds  for  each  $25  face  value  of  stock. 


Ch.  9]  UNSECURED  BONDS  645 

American  Telegraph  and  Telephone  Company,  7-Year  6% 
Convertible  Gold  bonds,  convertible  into  common  stock  at  any 
time  after  August  i,  1920  and  until  August  i,  1925  at  par  plus 
$6  fqr  each  share  of  stock  taken  over,  interest  and  dividends  to 
be  adjusted. 

§  100.    Participating  Bonds 

Participating  bonds  attempt  to  offer  a  speculative  attraction 
by  giving  to  the  bondholders  some  right  to  share  in  profits  after 
all  the  obligations  of  the  company  have  been  provided  for.  They 
are  unlike  income  bonds  inasmuch  as  it  is  obligatory  on  the  part 
of  the  company  to  pay  their  fixed  rate  of  interest  whether  earned 
or  not,  the  participating  feature  applying  only  to  excess  pay- 
ments. The  best-known  issue  of  this  kind  was  the  Oregon 
Short  Line  Cumulative  Trust  Participating  4's,  issued  in  1903 
but  almost  immediately  retired,  which  were  to  receive  4% 
interest  plus  whatever  dividends  in  excess  of  this  amount  were 
declared  upon  the  stock  of  the  Northern  Securities  Company 
deposited  as  collateral. 

A  present-day  bond  of  this  nature  is  the  6%  Debenture  Gold 
bond  of  the  Beneficial  Loan  Society  of  New  York  City.  As 
stated  in  the  company's  announcement: 

Profit  Sharing  in  Addition  to  6%  Interest — The  recorded 
owner  of  each  Gold  Bond  receives  a  Corresponding  Certificate  of 
Profit  Sharing.  This  entitles  him  to  share  in  the  profits  of  the 
Society  each  year,  ending  December  31,  until  the  bonds  are  re- 
deemed, for  an  amount  equal  to  his  pro  rata  of  at  least  one-third 
of  the  entire  profits  (including  any  gain  in  value  of  securities 
owned).  Profit  Sharing  in  any  one  year  is  limited  to  not  over  8% 
(in  addition  to  the  6%  interest  on  the  bonds)  and  is  paid  last  of 
February  yearly. 

As  to  the  working  of  the  plan,  the  company  makes  the  fol- 
lowing statement: 

What  the  Investors  Have  Received — Since  1913,  the  parent 
Society  has  .  .  .  shared  yearly  profits  with  its  bondholders,  in  ad- 


646  CORPORATE  FINANCE  [Bk.  II- 

dition  to  bond  interest  (disbursing  about  $800,000  of  profits)  as 
follows: 


For 

Interest  Paid 

Profit  Sharing 

Total  Yield 

Total  Amount 

Year 

on  Bonds 

Paid 

on  Par 

Paid 

1914 

6% 

1% 

7% 

$      2,732.Id 

191S 

6% 

2% 

8% 

ii,83S-i9 

1916 

6% 

S% 

11% 

24,066.54 

1917 

6% 

5% 

.     11% 

70,931.11 

1918 

6% 

5% 

11% 

111,035.09 

1919 

6% 

5% 

11% 

153,425.88 

1920 

6% 

•     S% 

11% 

226,408.28 

1921 

6% 

5%  (Due  in 

Feb.) 

A  recent  and  ingenious  participating  bond  is  the  $4,000,000 
issue  of  10- Year  First  Loan  Gold  8%  Participating  Sinking  Fund 
Production  bond  offered  to  the  public  by  the  United  Oil  Pro- 
ducers Corporation  in  August,  192 1.  The  participating  feature, 
as  stated  in  the  company's  announcement,  is  as  follows: 

This  bond  provides  a  participation  in  addition  to  its  guaran- 
teed rate  of  of  Eight  Per  Cent  per  annum.  This  participation  is 
of  such  a  nature  that  the  bondholder  may  know  his  position  every 
day,  without  waiting  for  the  Company's  periodical  reports.  Sim- 
ply look  at  the  market  price  of  oU  in  your  daily  newspaper.  Today 
the  market  price  of  Mid-Continent  oil  is  One  Dollar  per  barrel. 
You  would  know  this  means  a  total  of  Nine  Per  Cent  interest  on 
your  bond  and  every  advance  of  Twenty-five  cents  per  barrel  in  the 
price  of  this  crude  oil  would  add  Two  and  one-quarter  Per  Cent 
p>er  annum  to  your  interest  rate,  until  oil  selling  at  Two  and  one- 
quarter  Dollars  per  barrel  would  give  the  bondholder  a  total  of 
Twenty  and  one-quarter  Per  Cent  per  annum  interest  on  his  bond. 


CHAPTER  X 

SHORT-TERM  NOTES 

§  1 01.    Short-Term  Notes  and  Bonds;  Bank  Loans 

There  is  no  clear-cut  hne  of  demarcation  between  a  short- 
term  note  and  a  bond.  The  distinction  is  ordinarily  based  on 
the  length  of  time  for  which  the  security  is  issued.  The  usual 
short-term  note  runs  from  i  to  5  years;  a  bond  from  10  to  100 
years  or  more.  Yet  in  the  summer  of  1921,  Swift  and  Company 
sold  a  $25,000,000  issue  of  so-called  short-term  notes  maturing 
in  1 93 1 — 10  years  from  the  date  of  issue — and  a  month  later  the 
Toledo  Traction,  Light  and  Power  Company  sold  $2,500,000 
face  value  of  so-called  bonds  maturing  December  i,  1922,  but 
little  more  than  a  year  from  the  date  of  issue.  The  general  dis- 
tinction, however,  holds  good,  that  issues  maturing  in  less  than 
10  years  are  called  "short-term  notes,"  and  issues  running  10 
years  and  over  are  called  "bonds." 

Again,  the  exact  line  of  difference  between  corporate  notes 
delivered  to  note-brokers  and  by  them  sold  to  banks,  and  cor- 
porate notes  delivered  to  private  banking  houses  and  by  them 
sold  to  the  general  public,  may  seem  somewhat  hazy.  As  a  mat- 
ter of  fact,  there  is  no  difficulty  in  classifying  a  note  as  belonging 
to  one  or  the  other  of  these  two  groups.  A  note  intended  for 
sale  to  bankers  seldom  runs  more  than  90  days  and  never  more 
than  six  months.  A  short-term  note,  on  the  other  hand,  intended 
for  wider  distribution,  customarily  runs  from  i  to  5  years.  The 
business  of  the  note-brokers  who  sell  notes  of  the  first  class  is 
entirely  different  from  that  of  the  stock-  and  bond-brokers  and 
private  banking  firms  that  handle  notes  of  the  second  class, 

647 


648  CORPORATE  FINANCE  [Bk.  II- 

though  the  note-broker  may  also  sell  securities  of  the  second 
class.  Also,  as  stated  in  a  preceding  chapter,  the  notes  of  a  short- 
term  issue  are  of  specified  amounts,  commonly  $1,000,  $500,  and 
$100  face  value,  and  all  together  make  up  a  specified  total  as 
$500,000  or  $1,000,000;  while  the  ordinary  bankable  notes  us- 
ually have  no  relation  of  any  kind  to  other  notes  of  the  same 
concern,  and  the  public  rarely  knows  just  how  much  their  aggre- 
gate may  be. 

§  102.    Purpose  of  Short-Term  Notes 

Short-term  securities  for  sale  to  the  public  may  be  legitimately 
issued  for  one  of  two  purposes:  (i)  in  anticipation  of  a  later 
issue  of  long-term  securities;  or  (2)  in  order  to  finance  purchases 
or  improvements  which  can  be  provided  for  at  maturity  out  of 
the  corporate  income — in  some  cases  out  of  the  normal  income; 
in  other  cases,  in  whole  or  in  part  out  of  the  income  arising  from 
the  purchases  or  improvements  made  possible  by  the  issue  of 
notes. 

To  the  first  class  belong  the  $2,500,000  short-term  bonds  of 
the  Toledo  Traction,  Light  and  Power  Company,  referred  to 
above;  to  the  second  class  belong  the  $40,000,000  of  short-term 
notes  issued  by  the  Copper  Export  Association  in  the  early  part 
of  192 1,  maturing  in  i,  2,  3,  and  4  years,  and  secured  by  400,- 
000,000  pounds  of  copper,  the  proceeds  from  the  sale  of  this  cop- 
per, or  any  part  of  it,  to  be  applied  to  the  redemption  of  the 
notes  as  long  as  any  of  them  are  outstanding  or  are  unprovided 
for. 

In  order  to  facilitate  their  payment,  short-term  notes  running 
for  3  to  5  years  or  longer  are  sometimes  issued  in  series;  that  is 
to  say,  an  equal  proportion  or  a  specified  amount  of  the  issue 
matures  each  year.  Thus,  of  the  notes  of  the  Copper  Export  As- 
sociation referred  to  above,  $6,000,000  matured  and  were  paid 
February  15,  1922,  $10,000,000  mature  February  15,  1923,  $12,- 
000,000  Feburary  15,  1924,  and  the  final  $12,000,000  February 
15,  1925- 


Ch.  lo]  SHORT-TERM  NOTES  649 

§  103.    Use  of  the  Short-Term  Note 

Short-term  notes  have  been  a  feature  of  practically  every 
financial  crisis  since  the  Civil  War  with  the  exception  of  that  of 
1884.  During  the  period  of  the  Great  War  and  since,  such  issues 
have  been  nunierous.  This  was  due  at  the  time  to  the  difficulty 
of  floating  long-term  loans,  but  more  often  to  the  exceptionally 
high  rates  of  interest  that  prevailed.  No  one  expected  these  high 
rates  of  interest  to  continue  for  any  long  period,  and  established 
corporations  of  good  credit  were  therefore  naturally  desirous  of 
avoiding  the  issue  of  long-term  bonds  at  such  a  time,  either  to 
raise  fixed  capital,  working  funds,  or  to  refund  outstanding  issues 
as  they  fell  due,  and  short-term  notes  were  the  obvious  recourse. 
As  interest  rates  faU,  short-term  notes  are  likely  to  be  less 
common. 

A  feature  of  the  short-term  note  that  has  been  largely  re- 
sponsible for  its  popularity — especially  in  times  of  financial 
stringency — is  the  comparative  ease  with  which  such  notes  may 
be  sold.  A  corporation  in  fairly  good  condition  is  not  likely  to 
get  into  serious  financial  difficulty  in  the  few  years  for  which  the 
ordinary  short-term  note  runs,  and  the  notes  are  therefore  not 
scrutinized  so  keenly,  or  subjected  to  the  rigid  requirements  as 
to  security  that  are  customary  in  the  case  of  bonds.  Accord- 
ingly, the  habit  of  putting  out  note  issues  has  grown  even  among 
the  conservative  companies  to  such  an  extent  that  it  is  some- 
times a  real  source  of  danger. 

The  danger  that  exists  is  shown  by  the  experience  of  the  Erie 
Railroad  Company  in  1908.  This  company,  in  order  to  tide  over, 
had  to  put  out  one-year  notes  in  the  middle  of  the  crisis  of  1907, 
these  notes  maturing  April  8,  1908.  As  the  redemption  date  ap- 
proached, the  cash  to  pay  off  the  notes  was  not  available.  No 
refunding  arrangement  had  been  made  or  notice  given  until  April 
4,  1908,  4  days  before  due  date,  when  J.  P.  Morgan  and  Com- 
pany, as  the  railroad's  financial  agents,  published  a  notice  to  the 
effect  that  the  notes  would  be  refunded  provided  they  were  all 
deposited  on  or  before  April  8.    As  some  of  the  notes  were  in 


650  CORPORATE  FINANCE  [Bk.  II- 

Europe,  compliance  with  this  request  was  impossible.  The  8th 
of  April  came.  Some  of  the  notes  were  presented  and  payment 
demanded.  The  money  for  their  redemption  was  not  at  hand. 
To  all  appearances  another  bankruptcy  was  impending.  Then 
suddenly  E.  H.  Harriman,  from  his  sick-bed,  telephoned  that  he 
would  take  the  whole  burden  upon  himself.  Immediately  he  ar- 
ranged for  a  refunding  issue  of  3-year  notes.  His  standing  and 
ability  was  sufficient  to  carry  the  matter  through  and  bring  about 
-  a  satisfactory  redemption  of  the  previous  issue. 

It  was  one  of  the  most  dramatic  incidents  in  the  history  of 
American  finance.  The  occurrence  serves  to  illustrate  clearly  the 
dangers  that  beset  every  corporation  that  relies  too  much  on 
short-term  notes  which  it  cannot  hope  to  meet  except  by  issuing 
other  securities.  As  was  remarked  by  Guy  E.  Tripp,  chairman 
of  the  Westinghouse  Electric  Manufacturing  Company:  "It  is  a 
bad  thing  to  have  a  debt  that  you  never  intend  to  pay  and  never 
can  pay;  and  that  is  what  some  short-term  notes  are." 

A  more  recent  instance  of  the  dangers  of  short-term  note 
financing  is  that  of  the  Ingersoll  failure  in  the  early  part  of  1922. 
This  had  been  ascribed  in  some  quarters  to  over-advertising— 
an  explanation  which  brought  out  the  following  statement : 

Robert  H.  Ingersoll  &  Brother  are  one  of  these  unfortunate  vic- 
tims of  Kaiserism.  Their  capital  was  adequate  for  peace-time  re-  :ifi 
quirements.  But  it  was  not  sufficient  for  the  extraordinary  needs 
of  the  war.  The  cost  of  raw  materials  moved  skyward.  In  some 
cases  the  advance  amounted  to  several  hundred  per  cent.  Labor, 
an  important  item  in  the  cost  of  a  watch,  also  went  up.  To  meet 
these  conditions  more  money  was  needed.  But  instead  of  increas- 
ing its  capitalization  or  engaging  in  long-term  financing,  the  firm 
floated  short-maturity  notes  to  satisfy  its  current  requirements. 
This  was  a  mistaken  policy,  for  when  the  depression  came,  these 
notes  began  to  mature  and,  of  course,  could  not  be  met.  What  was 
worse,  the  materials,  both  raw  and  manufactured,  offsetting  these 
notes  began  to  decline  in  price  at  the  same  time  that  sales  slowed 
up.  Thus  the  assets  back  of  the  notes  rapidly  shrunk.  In  other  ''*1 
words  the  Ingersoll  firm  had  to  take  a  heavy  loss  in  inventories, 
just  as  every  one  else  did,  but  its  position  was  worse  than  most 


Ch.  lo]  SHORT-TERM  NOTES  651 

concerns,  because  the  number  and  the  amount  of  the  maturing 
notes  it  had  out  were  grossly  out  of  proportion  to  its  capital.  In- 
cidently  the  fact  that  these  notes  were  in  more  than  200  hands  was 

another  disturbing  factor.  ^ 

»'■' 

§  104.    Yield  of  Short-Term  Notes 

Before  the  Great  War  the  highest  grade  short-term  notes  of 
large  railroad  and  industrial  corporations,  ordinarily  sold  on  a 
basis  of  4%  to  sH%-  The  present  rate  is  much  higher,  ranging 
from  7%  to  8%.  The  Swift  and  Company  notes  already  referred 
to,  issued  in  192 1,  bear  7%  interest;  the  notes  01  the  Copper 
Export  Association,  Inc.,  also  issued  in  1921,  carry  8%;  $20,- 
000,000  of  lo-year  notes  issued  by  the  United  States  Rubber 
Company  in  1920  call  for  7}4%  interest;  and  even  the  collateral 
notes  of  the  Pennsylvania  Railroad  issued  in  1920  bear  6%.  In 
all  these  cases  the  notes  sold  at  a  discount  from  their  face  value, 
thereby  increasing  the  rate  of  interest  actually  paid. 

At  the  present  writing,  some  of  the  less  secure  "securities"  of 
this  type  are  being  quoted  to  yield  as  high  as  10%,  12%,  and 
15%.  Some  buyers  of  these  high-yield  notes  have  made  a  great 
deal  of  money  on  them,  but  they  are  to  beregarded  as  dangerous 
in  the  extreme  for  anyone  who  is  not  intimately  acquainted  with 
the  issuing  company. 

A  specialist  in  these  notes  says  that  he  regards  a  note  yielding 
such  abnormally  high  returns  as  the  rankest  kind  of  speculation, 
and  "much  more  dangerous  than  active  stocks  which  can  gen- 
erally be  sold  within  one  point  of  previous  sales.  A  loss  on  a 
note  when  it  comes,  is  like  a  fire  loss;  it  is  generally  total." 

Aside  from  the  danger,  continuous  financing  through  short- 
term  notes  is  apt  to  be  expensive.  The  interest  payment  may  not 
be  too  high,  but  each  issue  must  be  underwritten,  and  as  this 
must  be  done  every  few  years  the  cost  of  selling  shortly  becomes 
a  heavy  burden. 

As  short-term  notes  approach  within   six  months  or  less 


'  Printers'  Ink,  January  s,  1922. 


652  CORPORATE  FINANCE  [Bk.  II- 

of  maturity,  they  come  into  an  entirely  different  class,  for  they 
become  available  for  the  use  of  banks.  Hence,  they  sell  at  prices 
which  make  their  yield  approximate  the  yield  of  commercial 
paper  of  the  highest  class.  Also,  as  a  note  comes  very  close  to 
maturity,  a  curious  situation  arises,  due  to  the  fact  that  fluctua- 
tions of  as  little  as  even  1/8  or  1/16  in  the  purchase  price  may 
make  a  considerable  difference  in  the  yield;  consequently  the 
tendency  is  for  such  notes  nearing  maturity  to  keep  out  of  the 
market. 

Some  short-term  notes  are  secured  by  collateral;  others  rest 
solely  upon  the  credit  and  reputation  of  the  issuing  company. 
Curiously  enough,  some  of  the  notes  which  command  the  best 
price  and  have  the  broadest  market  have  no  collateral  behind 
them.  The  fact  that  collateral  is  posted  is  looked  upon  as  indi- 
cating that  the  company  has  already  used  up  all  its  unsecured 
credit. 

§  105.     Short-Term  Notes  as  Funded  Debt 

Professor  Ripley  has  directed  attention  to  what  he  well  calls 
"the  most  deceptive  practice"  of  carrying  short-term  notes  in 
corporation  balance  sheets  as  a  portion  of  the  funded  debt  in- 
stead of  including  them  among  the  current  liabilities.  This  has 
been  true  even  of  corporations  of  the  standing  of  the  Erie  Rail- 
road, and  the  Baltimore  and  Ohio  Railroad.  Notes  running  as 
long  as  4  or  5  years  are  not,  it  is  true,  in  exactly  the  same  class  as 
bank  loans  and  accounts  payable,  most  of  which  fall  due  within 
30  to  90  days,  but  they  are  by  no  means  a  funded  obligation. 
They  must  be  met  either  out  of  income  or  by  the  issuance  of 
long-term  loans.  They  are  properly  offset  and  secured,  not  by 
the  permanent  property  and  investments  of  the  issuing  corpora- 
tions, but  by  the  assets  which  are  readily  convertible  into  cash. 


CHAPTER  XI 
REDEMPTION  OF  BONDS— SINKING  FUNDS 

§  1 06.    Theory  vs.  Practice 

A  corporate  bond,  as  stated,  is  nothing  more  than  a  note — 
the  corporate  promise  to  repay  the  principal  amount  of  the  bond 
at  a  specified  date  and  meanwhile  to  pay  interest  at  the  times 
and  at  the  rate  prescribed.  Theoretically,  when  a  bond  is 
secured  the  purchaser  is  not  concerned  with  the  means  resorted 
to  by  the  corporation  to  meet  it  at  maturity.  Presumably  it 
will  be  paid  just  as  any  other  corporate  obligation  is  paid,  and 
if  the  corporation  is  not  ready  to  pay  it  when  due,  the  mortgage 
will  be  foreclosed  and  the  bond  paid  from  the  proceeds  of  the 
sale  of  the  mortgaged  property. 

In  practice,  however,  this  theory  does  not  always  work  out. 
The  amount  of  the  bond  issue  is  usually  large,  human  nature  is 
improvident,  and  foreclosure  of  a  mortgage  is  usually  a  very 
uncertain  and  unsatisfactory  method  of  collecting  a  debt — so 
much  so,  that  when  it  comes  to  the  large  amounts  usually  bor- 
rowed by  a  corporate  bond  issue,  the  lender  wants  to  know  in 
advance  just  how  the  corporation  proposes  to  pay  the  loan  when 
it  matures. 

There  is  a  difference  here  as  to  practice.  Most  industrial 
bond  issues  and  some  railroad  issues  are  paid  off  when  due,  out 
of  past  earnings.  The  majority  of  railroad  issues  are,  however, 
usually  taken  up  by  some  refunding  operation;  usually  another 
issue  is  sold  and  the  proceeds  used  to  redeem  the  matured  issue. 
Not  uncommonly  an  issue  of  railroad  bonds  will  be  extended 
when  it  comes  due. 

In  the  case  of  a  private  corporation  these  refunding  opera- 
tions are  not  always  feasible.     The  investor  is  not,  as  a  rule, 

653 


654  CORPORATE  FINANCE  [Bk.  II- 

willing  to  take  chances  on  a  refunding  of  the  loan  when  it 
matures,  and  wants  some  more  specific  provision  for  payment. 
Usually  this  provision  takes  the  form  of  an  agreement  that  reser- 
vations will  from  time  to  time  be  made  out  of  the  corporate  prof- 
its, at  least  to  the  extent  of  securing  the  bonds  at  maturity. 
Such  a  reservation  of  profits  is  known  as  a  "sinking  fund."i  In 
popular  usage  this  term  is  applied  almost  indiscriminately  to  any 
method  of  providing  for  repayment  of  a  long-term  loan,  by 
setting  aside  for  that  purpose,  before  maturity,  a  predetermined 
amount  at  regular  periods. 

§  107.     SinMng  Funds 

The  sinking  fund  principle  first  came  into  prominence  in  the 
latter  part  of  the  eighteenth  century,  when  it  was  advocated  and 
applied  by  William  Pitt  as  the  best  and  easiest  means  of  pro- 
viding for  the  repayment  of  the  United  Kingdom's  huge  national 
debt.  It  was  heralded  by  many  people  of  that  day  as  a  remark- 
able method  whereby  a  loan  might  be  repaid  without  any  serious 
sacrifice.  As  a  matter  of  fact,  this  is  correct  and  experience  has 
shown  that  some  such  systematic  method  of  providing  for  the 
large  amounts  required  to  meet  maturing  bond  issues  is  very 
necessary.  As  intimated  earlier  in  the  chapter,  corporations  are 
run  by  human  beings  Who  are  more  than  likely,  if  left  to  their 
own  devices,  to  make  inadequate  provision  for  the  future.  The 
officers  of  a  corporation  which  has  just  floated,  let  us  say,  a  loan 
of  $10,000,000  to  be  repaid  in  20  years,  are  likely  to  consider  that 
their  duty  has  been  done;  their  corporation  has  received  a  large 
amount  of  fresh  capital  which  can  be  profitably  used,  and  the 
earnings  of  which  (after  deducting  the  interest  payments)  will 
go  to  increase  the  yield  on  outstanding  stock.  It  is  easy  for  them 
to  think  that  the  time  of  repaying  the  loan  is  far  distant  and  it 
is  not  their  part  to  worry  about  it.  When  it  begins  to  approach 
maturity,  they  or  their  successors  will  consider  how  it  shall  be 
handled.  ,jj       ,j>j,; 

»  See  Book  III,  Part  IV,  "Bonds  and  Funds." 


Ch.  ii]  BONDS— SINKING  FUNDS  655 

Against  this  every-day  human  attitude  of  directors  and  man- 
agers of  borrowing  corporations,  there  are  opposed  the  interests 
of  the  buyer  of  the  bond  and  of  his  representatives  in  the  pre- 
hminary  negotiations,  the  bankers  who  undertake  to  dispose  of 
the  bond  issue.  As  stated,  the  investor  wants  to  be  assured  that 
his  money  will  be  repaid  when  due.  Further  than  that,  he 
wants  to  be  assured  that  there  will  be  no  depreciation  in  the  mar- 
ket value  of  his  holdings.  He  is  well  aware,  as  every  lender  must 
be,  that  the  borrower's  natural  instinct  is  to  let  the  future  take 
care  of  itself.  If  he  is  prudent,  he  will  therefore  insist  that  some 
definite  measures  be  taken  to  provide  for  repayment  of  the  loan 
and  secure  himself,  as.  fully  as  may  reasonably  be  asked,  against 
the  possible  carelessness  or  easy-going  optimism  of  the  people  to 
whom  his  money  has  been  entrusted. 

§  108.     Principle  of  the  Sinking  Fund  , 

This  wise  demand  on  the  part  of  the  investor  can  be  met  by 
a  sinking  fund  without  great  difficulty  or  hardship,  since  a  com- 
paratively small  amount  set  aside  each  year  out  of  the  corpora- 
tion's earnings  will  assure  repayment  of  the  entire  loan,  if  the 
corporation  has  not  overborrowed.  The  annual  reservation, 
used  perhaps  to  buy  in  the  bonds  if  they  can  be  had  at  a  reason- 
able price,  or  otherwise  put  out  at  compound  interest,  will  not 
be  a  serious  burden.  Accumulating  at  the  rate  of  6%,  a  sinking 
fund  of  approximately  4.3%  of  the  face  of  the  loan  per  year,  will 
provide  for  its  repayment  at  the  end  of  15  years;  accumulating 
at  a  rate  of  as  little  as  3%,  a  sinking  fund  of  2.8%  per  annum  will 
provide  for  repayment  of  a  loan  at  the  end  of  25  years.  To 
express  it  in  another  way,  a  bond  issue  of  $1,000,000  maturing 
in  15  years,  may  be  met  by  a  yearly  reservation  of  $43,000  put 
out  at  6%  interest,  compounded  annually,  or,  if  it  matures  in 
25  years,  by  a  yearly  reservation  of  $28,000  at  3%  compounded 
annually. 

A  corporation,  if  it  is  reasonably  prosperous,  should  be  able 
to  withhold  these  amounts  and  yet  have  ample  funds  remaining. 


656  CORPORATE  FINANCE  [Bk.  li- 

lt is  clear  from  the  approximate  figures  cited,  that  the  repay- 
ment of  borrowed  money  by  annual  deductions  from  income  is 
especially  appropriate  in  the  case  of  loans  running  from  20  to  50 
years.  The  length  of  the  loan  will  of  course  depend  upon  the 
character  and  stability  of  the  business.  A  loan  to  a  railroad 
company  may  properly  run  for  as  long  as  50  years.  A  loan  to 
an  industrial  corporation  will  ordinarily  run  not  longer  than  1 5  to 
25  years.  Inasmuch  as  the  profits  of  an  industrial  corporation 
are  expected  to  average  much  higher  than  the  profits  of  a  trans- 
portation company,  it  is  clear  that  these  latter  should  be  able  to 
make  a  larger  sinking  fund  reservation. 

§  109.    Sinking  Fund  Methods 

The  primary  purpose  of  the  sinking  fund  is  to  provide  for  the 
payment  of  the  bonds  to  which  it  applies.  In  doing  this  it 
usually  increases  the  equity  behind  the  bond  and  therefore  makes 
it  safer  and  more  attractive.  There  are  four  principal  methods 
by  which  the  purpose  of  the  sinking  fund  is  attained : 

1.  The  borrower  may  turn  over  fixed  cash  payments  at 

regular  periods,  usually  once  a  year  or  once  every  six 
months,  to  a  trustee ;  the  trustee  may  deposit  or  invest 
the  money  at  his  discretion  within  the  limits  deter- 
mined in  the  original  agreement. 

2.  The  borrower  may  set  aside  fixed  sums  at  regular  inter- 

vals and  deposit  or  invest  these  sums  at  his  own  dis- 
cretion within  the  hmits  of  the  agreement. 

3.  The  borrower  may  set  aside  sums  at  regular  intervals 

and  use  them  solely  for  the  repurchase  of  the  bonds 
which  are  being  amortized. 

4.  The  bonds  may  be  arranged  to  mature  in  series  so  that  a 

predetermined  proportion  will  fall  due  each  year,  thus 

forcing  the  borrower  to  repay  the  bonds  gradually 

during  the  life  of  the  whole  issue. 

The  first  two  methods  are  the  sinking  fund  plans  originally 

used.    They  are  still  employed  to  a  considerable  extent  in  the 


Ch.  ii]  BONDS— SINKING  FUNDS  657 

repayment  of  municipal  and  some  other  governmental  loans, 
but  are  seldom  used  by  private  corporations.  The  third  and 
fourth  methods  are  similar  in  effect,  since  the  sums  set  aside  out 
of  income  are  used  under  both  methods  for  the  redemption  of  the 
borrower's  own  obligations,  not  for  the  purchase  of  outside 
securities. 

Under  the  third  method,  the  bonds  which  are  repurchased 
by  the  corporation  are  frequently  kept  alive  and  interest  pay- 
ments on  them  are  maintained.  This  is  the  case,  for  instance, 
with  the  redeemed  bonds  of  the  United  States  Steel  Corporation 
which  are  held  alive,  the  interest  on  these  bonds  increasing  the 
annual  amount  available  for  sinking  fund  purchases.  In  other 
instances  the  bonds  that  have  been  redeemed  are  canceled. 

§  no.     Objections  to  Discretionary  Investment  of  Sinking  Funds 

There  are  certain  objections  to  the  first  two  of  these  methods 
which  may  briefly  be  stated.  When  the  plan  of  turning  over 
regular  payments  to  a  trustee  is  followed,  there  is  always  the 
possibility  that  the  trustee  may  invest  the  funds  with  a  view  to 
his  own  advantage,  or  may  make  unsound  investments,  in  which 
case  it  is  quite  possible  that  the  fund  may  not  accumulate  as 
rapidly  as  had  been  expected  or  even  that  it  may  be  lost  in  part. 
The  possibility  of  making  unwise  investments  is  almost  equally 
to  be  feared  under  the  second  method.  Furthermore,  the 
average  rate  of  return  on  high-class  investments  varies  consider- 
ably over  a  long  period  of  years,  and  this  may  interfere  with  the 
anticipated  rate  of  accumulation.  It  is,  in  fact,  a  matter  of  com- 
mon knowledge  that  sinking  funds  invested  in  outside  securities 
seldom  come  up  to  the  expectations  of  those  by  whom  they  are 
established.  The  final,  and  perhaps  most  serious  objection  to 
both  the  first  and  second  methods  is  that  high-grade  investments 
which  are  the  only  ones  suitable  for  sinking  funds — yield  a 
comparatively  small  rate  of  return;  as  a  matter  of  fact,  the  rate 
of  interest  received  on  such  securities  usually  is  considerably  less 
than  the  interest  which  is  being  paid  by  the  corporation  on  its 
own  obligations. 


658  CORPORATE  FINANCE  [Bk.  II- 

§  III.  Serial  Redemption  or  Annual  Purchase  )^  iiiamvysGOT 
These  objections  to  investment  of  the  sinking  fund  instal- 
ments in  outside  securities  have  proved  so  powerful  and  well 
founded  that  it  has  come  to  be  almost  universally  accepted  as 
correct  practice  to  carry  on  amortization  through  the  redemption 
of  the  bonds  which  are  being  amortized.  The  practical  question 
for  most  corporations  to  consider  is  whether  it  is  best  to  set  aside 
fixed  amounts  for  investment  in  the  securities  to  be  amortized, 
or  to  arrange  for  serial  maturity  of  these  securities.  For  short- 
term  loans  the  convenience  and  simplicity  of  the  last-named 
method  makes  it  very  suitable.  For  long-term  loans  the  former 
method,  i.e.,  the  annual  expenditure  of  a  fixed  sum  in  the  pur- 
chase of  the  outstanding  bonds,  is  probably  better. 

There  are  two  fundamental  reasons  for  the  preference  of  the 
fixed  annual  expenditure  when  long-term  loans  are  to  be  provided 
for:  (i)  when  an  issue  of  long-term  bonds  is  arranged  serially, 
with  different  dates  of  maturity  for  each  series,  it  is  necessary  to 
fix  a  distinct  price  for  each  maturity,  which  is  inconvenient  and 
interferes  with  the  ready  marketabihty  which  should  attach  to 
all  large  bond  issues;  and  (2),  unless  the  amount  falling  due  at 
each  date  of  maturity  is  arranged  on  a  graduated  scale  so  that  the 
amounts  become  progressively  larger,  the  burden  on  the  cor- 
poration is  unequal,  being  heaviest  at  the  beginning  when  interest 
payments  on  the  whole  issue  must  be  met,  and  gradually  lighten- 
ing as  more  and  more  of  the  bonds  are  redeemed  and  interest 
payments  are  thereby  reduced.  It  is  far  better,  if  possible,  to 
have  all  the  bonds  of  one  issue  of  uniform  maturity;  also  to  have 
an  equal  distribution  of  the  burden  of  payment  over  a  period  of 
years. 

§  112.    Advantages  of  Annual  Sinking  Fund  Purchases 

The  simplest  and  the  most  popular  sinking  fund  device  is  to 
reserve  a  specified  amount  annually  and  invest  this  fund  solely 
in  the  bonds  that  are  being  amortized.  Among  the  advantages 
of  this  method  are  the  following :  t 


Ch.  ii]  BONDS— SINKING  FUNDS  659 

1.  The  corporation  is  protected  against  any  loss  due  to  unwise 
investment.  It  is  buying  its  own  bonds,  and  thereby  reducing 
its  outstanding  obligations.  It  is  certainly  in  no  danger  of  losing 
its  money. 

2.  The  rate  of  interest  earned  is  the  same  as  the  yield  of  the 
market  price  of  the  bonds.  The  customary  provisions  are  that 
the  bonds  may  be  redeemed  for  the  sinking  fund  at  par  or  at  some 
specified  higher  figure,  the  premium  ranging  in  different  cases 
from  1%  to  25%  or  even  30%.  Usually  the  bonds  may  be  pur- 
chased in  the  open  market  at  the  option  of  the  corporation,  in  case 
the  market  price  is  below  the  fixed  redemption  price.  If  the  bonds 
are  selling  on  a  6%  or  7%  basis,  it  is  clear  that  the  sinking  fund 
will  accumulate  at  the  same  rate,  or  if  the  purchased  bonds  are 
canceled,  what  is  equivalent,  that  the  6%  or  7%  on  the  canceled 
bonds  does  not  have  to  be  paid. 

3.  Under  the  customary  provisions  just  referred  to,  the 
market  price  of  the  bonds  is  maintained  by  the  corporation's 
repurchases  or  redemption,  and  in  this  way  the  credit  of  the 
corporation  is  supported  and  at  the  same  time  the  salability  of 
all  the  outstanding  bonds  is  increased. 

4.  There  is  nothing  to  prevent  the  fixing  of  a  definite  price 
at  which  all  bonds  in  the  issue  may  be  purchased  by  the  corpora- 
tion. It  is  often  done.  If  it  buys  in. the  open  market  the  cor- 
poration takes  whatever  bonds  happen  to  be  for  sale  at  the 
market  price  up  to  the  desired  amount.  If  it  redeems  a  fixed 
proportion  of  bonds  each  year,  the  bonds  to  be  redeemed  are 
customarily  determined  by  lot.  In  this  last  practice  there  is  a 
slight  element  of  uncertainty  which  might  be  considered  objec- 
tionable, but  it  is  of  small  practical  importance.  When  this  is 
done  the  redemption  price  is  usually  above  the  face  value  of  the 
bond. 

5.  If  allowance  be  made  for  interest  on  the  bonds  redeemed, 
the  burden  on  the  corporation  is  equally  distributed  during  the 
life  of  the  bond  issue.  The  simplest  plan  for  accomplishing  this" 
result  is  to  keep  alive  all  the  bonds  purchased  for  the  sinking  fund, 


6(56'  CORPORATE  FINANCE  [Bk.  II- 

so  that  the  corporation  pays  out  the  same  amount  of  interest 
each  year.  As  the  number  of  bonds  held  in  the  sinking  fund 
increases  more  and  more,  interest  payments,  it  is  clear,  go  to 
swell  the  sinking  fund,  and  thus  to  increase  the  annual  purchases 
or  redemptions.  But  so  far  as  the  burden  on  the  corporation  is 
concerned,  it  remains  the  same  year  after  year. 

There  seems  to  be  little  room  for  question  that  among  all  the 
methods  of  amortization,  the  best  and  simplest  is  the  one  just 
described  of  establishing  a  sinking  fund  which  is  used  for  the 
repurchase  and  redemption  of  all  the  bonds  that  are  being  amor- 
tized, and  keeping  alive  the  bonds  that  are  taken  into  the  sinking 
fund.  ''i> 

§113.    Diminishing  Assets 

Bond  issues  put  out  by  land,  limiber,  and  mining  companies, 
and  other  concerns,  the  chief  property  of  which  consists  of 
diminishing  or  "wasting  assets" — that  is,  assets  which  in  the 
ordinary  course  of  business  are  sold,  or  used  up  and  not  replaced 
—  are  customarily  protected  by  sinking  funds  calculated  on  the 
annual  wastage.  In  the  case  of  land  companies  the  sinking  fund 
requirements  usually  involve  the  redemption  of  bonds  in  pro- 
portion to  the  sales,  either  a  fixed  amount  for  each  lot  or  acre 
sold,  or  a  percentage  of  the  selling  price.  Timber  bonds  which 
are  secured  by  tracts  of  standing  timber  are  customarily  issued 
up  to  about  50%  of  the  market  value  of  the  timber,  or  sometimes 
up  to  a  certain  amount  per  thousand  feet  of  timber,  as  in  the 
case  of  the  Tennessee  Stave  and  Lumber  Company  where  the 
mortgage  must  not  exceed  $4  for  each  thousand  feet  of  timber  on 
the  mortgaged  property.  In  such  cases  the  mortgage  securing 
the  bonds  contains  strict  provisions  to  insure  the  regular  deposit 
of  the  agreed  amount  per  thousand  feet  for  all  timber  cut,  which 
should  be  sufficient  to  retire  all  the  bonds  when  about  one-half 
of  the  timber  is  consumed. 

The  same  principle  is  followed  in  accumulating  sinking  funds 
for  mines.     For  example,  the  Monongohela  River  Consolidated 


Ch.  ii]  BONDS— SINKING  FUNDS  66l 

Coal  and  Coke  Company  sets  aside  for  this  purpose  5  cents  for 
each  ton  of  i^  inch  coal  mined  and  shipped;  the  Consolidation 
Coal  Company  sets  aside  for  the  redemption  of  its  First  and 
Refunding  Sinking  Fund  Gold  5's,  2  cents  per  gross  ton,  run  of 
mine  coal,  taken  from  the  property  for  the  first  5  years,  3  cents 
per  ton  for  the  next  15  years,4  cents  per  ton  for  the  next  loyears, 
and  5  cents  thereafter  till  the  bonds  are  redeemed.  The  North- 
western Iron  Company  sets  aside  25  cents  for  each  ton  of  iron  ore 
mined.  The  Philadelphia  Company's  First  Refunding  and 
Collateral  Trust  Mortgage  6%  Gold  bonds  are  protected  by  an 
annual  sinking  fund  of  3  cents  on  each  thousand  cubic  feet  of  gas 
sold,  the  minimum,  however,  to  be  3%  of  the  total  issued  bonds. 

§  114.     Special  Sinking  Fund  Provisions 

There  are  many  different  special  provisions  for  the  main- 
tenance of  sinking  funds  and  for  giving  greater  security  and 
attractiveness  to  the  bonds.  The  Goodyear  Tire  and  Rubber 
Company  sold  its  $30,000,000  First  Sinking  Fund  Gold  8's  in 
1 92 1  with  the  sinking  fund  provision  that  $750,000  should  be 
appropriated  each  six  months  with  which  outstanding  bonds, 
selected  by  lot,  should  be  redeemed  at  1 20.  In  other  words,  the 
entire  issue  must  be  redeemed  at  a  20%  premium.  The  con- 
ditions of  the  company  at  the  time— a  reorganization  was  just 
completed— explains  this  unusual  provision.  In  1899  the  old 
New  England  Cotton  Yarn  Company  issued  $6,500,000  5% 
First  Mortgage  bonds,  now  practically  all  retired,  which  were 
covered  by  a  sinking  fund  of  1%  on  the  outstanding  amount, 
payable  before  any  dividend  disbursements  on  the  preferred 
stock,  with  an  extra  4%  for  the  sinking  fund,  payable  before  any 
dividend  disbursements  on  the  common  stock.  The  Baldwin 
Locomotive  Works  has  an  authorized  issue  of  $10,000,000  First 
Sinking  Fund  Gold  5's,  the  mortgage  of  which  provides  that  the 
net  quick  assets  of  the  corporation  shall  at  all  times  equal  the 
aggregate  indebtedness  including  the  outstanding  bonds.  The 
Fisk  Rubber  Company,  in  connection  with  its  issue  of  First  20- 


662  CORPORATE  FINANCE  [Bk.  II- 

Year  8%  Sinking  Fund  Gold  bonds  of  1941,  agrees  always  to 
maintain  net  quick  assets  equal  to  at  least  125%  of  the  amount  of 
the  bonds  outstanding. 

The  embarrassment  sometimes  caused  by  these  special  pro- 
visions for  the  protection  of  outstanding  securities  is  well  illus- 
trated by  the  experience  of  the  Cuba  Cane  Sugar  Corporation. 
One  of  the  provisions  of  the  indenture  securing  its  $25,000,000 
lo-Year  7%  Convertible  Debentures,  issued  in  1920,  pledges  the 
company  not  to  place  a  mortgage  or  lien — save  purchase  money 
mortgages — on  any  of  its  property  or  plants  as  long  as  any  of 
the  debentures  are  outstanding.  In  the  summer  of  1921,  owing 
to  the  abnormally  low  price  of  sugar  and  the  difficulty  of  dis- 
posing of  its  crop,  the  company  found  itself  without  the  necessary 
funds  to  continue  operations  and  it  could  not  raise  new  funds 
because  of  the  restrictive  provision  mentioned.  Under  these 
conditions  the  following  appeal  was  addressed  to  the^  stock- 
holders in  an  effort — which  was  successful — to  meet  the  situation; 

To  THE  Holders  of  7%  Convertible  Debentures  of 
Cuba  Cane  Sugar  Corporation 

The  Cuba  Cane  Sugar  Corporation  has  arranged  with  a  group 
of  bankers  to  secure  at  once  a  loan  of  $10,000,000  under  an  arrange- 
ment which  requires  the  subordination  of  the  debentures  to  the 
new  money  for  the  period  of  said  loan  and  of  any  renewals,  substi- 
tutions or  refundings  thereof.  As  a  consideration  therefor,  the 
Corporation  is  offering  to  increase  the  rate  of  interest  on  assenting 
debentures  from  7  per  cent  to  8  per  cent  per  annum  from  July  i, 
192 1,  to  the  maturity  of  the  debentures,  provided  the  plan  becomes 
eflfective.  .  .  . 

Debenture  holders  are  urgently  requested  forthwith  to  assent 
to  the  plan  by  depositing  their  debentures  at  the  offices  of  any  one 
of  the  three  institutions  above-named.  Temporary  negotiable  re- 
ceipts will  be  issued  therefor,  and  application  will  be  made  at  once 
to  list  these  receipts  on  the  New  York  Stock  Exchange. 

By  order  of  the  Directors. 

Cuba  Cane  Sugar  Corporation, 
By  W.  E.  OgUvie,  President. 
September  27,  1921. 


Part  III — The  Financial  Organization 


CHAPTER    XII 
CAPITALIZATION—  BASIS 

§  115.    Capital,  Capitalization,  and  Capital  Assets' 

'•'  The  different  forms  of  organization  of  business  enterprises 
a,nd  the  various  types  of  security  issues  which  are  exchanged  for 
cash  or  for  other  property  acquired  by  the  business  have  been 
considered.  The  total  par  value  of  all  the  security  issues  out- 
standing at  any  given  time — stock  and  bonds^is  usually  referred 
to  as  the  "capitalization"  of  an  enterprise.  In  some  jurisdictions 
there  is  a  legal  meaning  attached  to  the  word  "capitalization" 
which  is  wholly  distinct  from  its  popular  meaning;  it  being,  in 
the  legal  sense,  the  total  par  value  of  the  authorized  capital  stock 
of  a  corporation.  Wherever  the  word  is  used  in  this  volume, 
however,  it  may  be  understood  in  its  popular  sense. 

"Capitalization"  must  be  distinguished  from  "capital"  or 
"capital  funds,"  by  which  we  mean  the  actual  value  of  the  in- 
vestment in  the  business.  The  vague  expression  "overcapitaliza- 
tion," so  frequently  used,  is  intended  to  indicate  a  state  of  affairs 
where  the  nominal  value  of  the  outstanding  stocks  and  bonds  is 
in  excess  of  the  real  value  of  the  investment — that  is,  the  capi- 
talization is  larger  than  the  capital.  As  a  matter  of  fact,  there 
is  seldom  ahy  close  correspondence  between  "capitalization"  and 
"capital"  or  the  "capital  funds"  actually  invested. 

Another  phrase  frequently  used  is  "capital  assets,"  under 
which  term  are  included  those  assets  of  a  business  which  are  of  a 

» See  Book  I,  Ch.  IX,  "The  Capitalization."  '  'T'   '  1    '  '  '  ■ 

663 


664  CORPORATE  FINANCE  [Bk.  II- 

permanent  nature  and  which  are  essential  to  its  continuance. 
"Capital  assets,"  or  fixed  assets,  are  distinguished  from  "current 
assets."  If  a  manufacturing  concern,  for  instance,  has  a  plant 
worth  $i,ooo,cxx),  inventories  of  $300,000,  and  cash  and  accounts 
receivable  of  $200,000,  we  should  say  that  its  capital  assets  were 
$1,000,000  and  its  current  assets  $500,000. 

The  capital  stock  of  an  enterprise  is  in  a  sense  a  valuation  on 
the  part  of  the  organizers  of  the  net  worth  of  the  enterprise.  At 
the  beginning  it  is  supposed  to  be,  at  least  as  a  matter  of  legal 
theory,  a  fairly  accurate  valuation.  As  time  goes  on,  it  is  recog- 
nized that  there  will  necessarily  be  changes  in  the  status  and 
value  of  the  various  assets  and  liabilities;  and  the  financial  re- 
sults of  these  changes  are  supposed  to  be  shown  in  the  surplus  or 
profit  and  loss  accounts.  The  capital  stock  plus  the  surplus 
theoretically  measures  the  exact  value  of  the  permanent  invest- 
ment in  the  business.  However,  the  necessary  inaccuracies  and 
arbitrary  estimates  of  accounting  practice  make  it  very  difiicult 
even  to  approach  this  theoretical  relation  in  every-day  practice. 

§  116.    Three  Bases  of  Capitalization 

The  question,  "What  is  the  right  basis  of  capitalization?"  is 
almost  identical  with  the  question,  "What  is  the  proper  measure 
of  wealth?"  To  this  latter  question  there  are  three  possible 
answers. 

I.  Cost  Plus  Increase. — The  first  and  most  obvious  is  that 
wealth  is  measured  by  the  cost  of  the  property  which  is  owned, 
plus  whatever  surplus  value  has  been  accumulated.  Thus,  if  a 
farm  cost  $10,000  and  is  improved  to  the  extent  of  $500  a  year, 
it  should,  in  the  course  of  two  years,  be  worth  $1 1,000.  But  sup- 
pose that  before  the  end  of  the  two  years  oil  were  discovered 
upon  the  property.  It  would  then  immediately  acquire  a  value 
which  would  have  very  Httle  reference  to  the  original  value  or  to 
the  original  investment  and  the  accumulation  of  betterments. 
In  practice,  unexpected  factors  wholly  outside  the  control  of  the 
owner  of  property  are  continually  modifying  its  value,  so  that 


Ch.  12]  CAPITALIZATION  665. 

it  is  out  of  the  question  for  anyone  to  depend  wholly  on  the  book 
record  of  his  investments  and  accumulations  as  a  method  of 
measuring  his  wealth. 

2.  Reproduction  Cost. — The  second  method  is  to  measure 
wealth  by  the  cost  of  reproducing  property.  If  a  man  has  a  fac- 
tory which  has  been  running  for  twenty  years,  he  may  be  ready 
to  grant  that  his  records  of  investments  and  accumulations 
would  be  of  little  use  in  determining  its  value,  but  he  might  sug- 
gest that  the  present  cost  of  purchasing  similar  property  in  the 
same  neighborhood  and  of  duplicating  his  plant  thereon  would 
be  a  correct  measure  of  its  value.  This  may  be  accepted  as  satis- 
factory so  far  as  strictly  tangible  assets  are  concerned.  But  to 
every  piece  of  property  there  attaches  a  certain  intangible  value. 
A  man  running  a  successful  retail  shop  would  not  be  willing  to 
part  with  it,  ordinarily,  in  exchange  for  another  shop  which  was 
just  as  well  fitted  up  and  carried  the  same  stock  but  which  had 
been  unsuccessful.  A  street  railway  company  that  was  running 
smoothly  and  in  harmony  with  the  public  sentiment  of  its  terri- 
tory, would  not  accept  in  exchange  for  its  track  and  rolling  stock 
the  exactly  similar  assets  of  some  other  company  which  had  in- 
curred public  ill-will.  It  is  possible — at  least  theoretically — to  re- 
produce physical  assets,  but  it  is  a  far  more  difficult  proposition 
to  reproduce  good-will,  organization,  prestige,  and  the  like. 
Hence,  the  attempt  to  measure  wealth  by  figuring  the  cost  of 
reproducing  properties  breaks  down  as  soon  as  we  begin  to 
measure  the  value  of  intangible  assets. 

3.  Earning  Power. — The  third  method  is  the  capitalization 
of  earning  power.  One  man  owns  a  piece  of  real  estate,  which 
brings  him  a  clear  net  income  under  a  long-term  lease  of,  say, 
$50,000  a  year;  another  man  owns  a  piece  of  property  for  which 
he  paid  just  as  much,  which  yields  but  $10,000  a  year.  Assuming 
that  these  two  incomes  are  equally  stable,  can  there  be  a  question 
in  anyone's  mind  that  the  first  property  is  worth  five  times  as 
much  as  the  second?  Note  the  assumption  that  the  two  incomes 
are  equally  stable.     The  likelihood  of  continuance  of  earning 


6dd  CORPORATE  FINANCE  [Bk.  II- 

power  and  the  ease  with  which  it  may  be  transferred  are,  of 
course,  important  factors  to  be  considered.  To  what  extent  they 
should  be  allowed  for,  and  in  what  way  the  value  of  any  given 
property  is  to  be  determined  on  the  basis  of  its  earning  power, 
are  questions  to  be  discussed  a  little  farther  on  in  this  chapter. 
It  is  enough  here  to  point  out  that  earning  power  is  the  chief 
result  of  tangible  and  of  intangible  assets.  If  we  take  into  account 
not  merely  current  earnings  but  also  potential  earnings,  then  we 
have  here  a  measure  of  wealth  which,  dependent  upon  the  ac- 
curacy with  which  this  income  is  determined,  must  be  a  true  and 
satisfactory  measure. 

After  all,  in  buying  property  for  business  reasons,  what  do  we 
buy?  Not  merely  so  much  real  estate  or  so  many  articles.  We 
are  buying  income.  In  the  same  way  a  man's  individual  wealth 
is  shown,  not  by  what  he  has  invested — which  may  have  been 
chiefly  wasted — but  by  what  he  is  getting  out  of  his  investments. 
If  the  answer  that  earning  power  is  the  best  measure  of  wealth  is 
granted,  and  if  the  proposition  that  "capitalization"  of  an  enter- 
prise is  an  approximate  estimate  of  its  wealth  is  accepted,  then  it 
would  seem  to  follow  that  the  correct  basis  of  "capitalization"  is 
earning  power.  This  answer,  however  simple  and  sound  it  may 
appear  to  us,  is  not  a  principle  of  the  law  governing  corporations, 
which,  on  the  contrary,  assumes  that  investment  is  the  only  cor- 
rect basis  of  capitalization.  Out  of  this  conflict  between  legal 
theory  and  business  practice  grow  may  difficulties  and  evasions. 

§  117.    Investment  as  a  Basis  of  Capitalization 

Small  and  close  corporations  of  the  more  stable  type  are 
usually  started  by  a  few  men  who  are  personally  acquainted  with 
each  other.  Each  one  of  these  men  subscribes  to  a  certain 
amount  of  stock  of  the  new  corporation  and  pays  for  his  stock 
either  in  cash  or  by  turning  over  property  at  a  value  agreed 
upon  with  his  associates  in  the  enterprise.  With  few  exceptions, 
corporations  of  this  type  issue  their  bonds  and  capital  stock  at 
a  par  value  exactly  or  nearly  equivalent  to  the  cash  or  cash  value 


Ch.  12]  CAPITALIZATION  667 

which  the  corporation  receives.  Thus  at  the  beginning  there  is 
an  actual  correspondence  between  the  capitalization,  the  invest- 
ment, and  the  actual  net  worth  of  the  corporation's  assets.  If 
the  enterprise  operates  along  well-established  lines,  has  the  cor- 
rect amount  of  capital,  earns  a  normal  rate  of  return, -and  most 
of  this  income  is  paid  out  as  dividends,  there  will  be  little  diver- 
gence from  this  system  of  approximate  equality  among  the  three 
factors  mentioned.  Ordinarily,  however,  the  vicissitudes  of  busi- 
ness soon  bring  about  variations.  With  the  more  speculative 
small  corporations,  and  with  most  of  the  larger  corporations  as 
well,  there  is  usually  no  very  close  correspondence,  even  at  the 
beginning.  Nearly  always  the  new  company  starts  with  a  bur- 
den on  its  back.  Either  it  may  spend  a  great  deal  in  order  to 
get  its  capital,  or  pay  a  great  deal  for  the  good-will  of  an  estab- 
lished business,  or,  if  of  a  speculative  nature,  must  pay  a  large 
price  for  property  of  a  large  potential  value. 

§  118.     Capitalization  of  Earning  Power 

We  have  already  touched  upon  the  fundamental  reasons  for 
regarding  earning  power  as  the  proper  basis  of  capitalization. 
This  principle  is  generally  accepted  as  correct  among  the  finan- 
ciers of  this  country.  As  to  the  practice  in  other  countries,  Paul 
M.  Warburg  some  years  ago  wrote  as  follows: 

Stock-watering,  that  is,  capitalization  of  earning  power  or  good- 
will, is  permitted  in  England  and  France,  while  it  is  not  allowed  in 
Germany.  While  personally  I  prefer  the  German  system,  it  is  a 
mistaken  idea  to  think  that  the  capitalization  of  earning  power  nec- 
essarily means  taking  advantage  of  somebody.  If  the  German  sells 
at  200%  an  industrial  stock  paying  10%  dividends,  it  amounts  to 

' '      the  same  as  if  the  Englishman  had  sold  at  par  twice  the  amount 

1 :      of  shares  on  which  5%  dividend  is  paid. 

Capitalization  on  the  basis  of  earning  power  is  not  neces- 
sarily the  result  of  a  carefully  thought  out  plan.  On  the  con- 
trary, it  usually  is  the  by-product  of  an  effort  on  the  part  of  the 
organizers  of  corporations  to  make  the  corporate  stock  attractive 


668  CORPORATE  FINANCE  [Bk.  II- 

so  as  to  be  able  to  sell  it  at  the  highest  possible  price.  It  is  for 
this  reason  that  corporations  which  have  shares  that  are  actively 
dealt  in  are  more  generally  capitalized  on  an  earning  power  basis 
than  are  the  corporations  which  are  closely  held. 

§  119.    The  Magic  of  Par  Value 

The  reason  for  the  adoption  of  earning  power  as  a  basis  of 
capitalization  is  well  expressed  by  a  recent  writer  who  does  not 
believe  the  basis  a  sound  one. 2 

But  if  the  earning  power  basis  of  capitalization  is  both  unsound 
in  theory  and  impracticable  in  application,  why  is  it  so  generally 
supported  by  American  financiers?  The  answer  is  fairly  clear:  It 
is  that  the  earning  power  basis  of  capitalization  gives  promoters 
the  opportunity  to  set  the  nominal  capital  at  whatever  figure  they 
think  wiU  give  the  securities  their  highest  market  value.  One  of 
the  strange  but  well-recognized  phenomena  of  the  financial  market 
is  that  an  enterprise  capitalized  at  a  liberal  figure  is  very  apt  to 
seem  more  valuable  to  the  investing  public  than  would  that  very 
same  enterprise  if  capitalized  at  a  lower  amount.  The  "magic  of 
par  value"  often  has  a  decided  influence.  American  promoters  are 
past  masters  in  the  art  of  taking  advantage  of  this  preference  for 
a  large  nominal  amount  of  stocks  and  bonds.  And  in  this  game 
their  best  aUy  is  the  highly  sanctioned  theory  that  capitalization 
should  be  determined  by  earning  power.  For  by  estimating  future 
earnings  at  an  extravagant  figure  and  then  by  capitalizing  these 
earnings  at  a  very  low  rate,  the  promoters  are  able  to  justify  an 
issue  of  securities  far  in  excess  of  the  actual  cost  of  the  property. 

§  120.    Advantages  of  Low-Price  Shares 

The  earning  power  value  is  a  very  real  influence,  for  it  has 
been  found  through  long  experience  that  shares  which  sell  at  or 
below  par  have  a  readier  market  and  command  a  higher  price  in 
proportion  to  their  yield  than  do  shares  which  are  quoted  far 
above  par.  If  a  company  is  earning  and  paying  dividends  of  40% 
on  its  common  stock,  it  will  be  difficult  to  sell  such  shares  at  a 
price  commensurate  with  their  intrinsic  value.    But  if  the  same 


*  James  C.  Bonbright,  in  Quarterly  Journal  of  Economics,  May    192 1. 


Ch.  12]  CAPITALIZATION  669 

company  should  quadruple  its  capitalization  so  that  the  divi- 
dends on  its  stock  amount  to  but  10%,  it  may  safely  be  assumed 
that- — ignoring    any   temporary   fluctuations — the   new   shares 
would  sell  for  more  than  25%  of  the  market  price  of  the  old 
shares. 

There  is  very  little,  if  any,  sound  reason  for  the  preference 
generally  shown  for  shares  that  sell  near  or  below  par.  Several 
explanations,  however,  may  be  offered: 

First,  there  is  a  somewhat  wider  market  for  low-priced  shares, 
due  to  the  fact  that  they  are  commonly  bought  and  sold  in  lots 
of  ten  or  more;  it  is  obvious  that  the  number  of  people  who  can 
buy  a  lot  of  ten  shares  worth  $40  each,  is  far  greater  than  the 
number  of  persons  who  can  buy  a  lot  of  ten  shares  worth  $400 
each. 

Second,  the  low  price  is  more  attractive  for  it  permits  a  diver^ 
sification  of  holdings  that  would  be  impossible  if  shares  of  a  high 
price  were  purchased. 

Third,  there  is  an  impression  in  the  mind  of  the  average  share- 
holder— a  vague  impression  but  powerful — that  his  stock  either 
had  or  will  have  a  real  value  about  equivalent  to  its  par  value. 
If  he  buys  below  par,  he  sees  a  prospect,  at  least,  of  appreciation 
in  the  value  of  his  holdings.  This  impression,  we  may  grant  at 
once,  is  based  on  a  misconception.  Many  shareholders  do  not 
seem  fully  to  understand  that  their  property  rights  consist,  prac- 
tically, only  of  an  equity,  and  that  the  corporation  is  under  no 
obligations  ever  to  return  or  account  for  the  par  value  of  their 
shares.  Nevertheless,  there  is  an  imaginative  appeal  in  the  magic 
term  "$ioo"  stamped  on  the  face  of  a  stock  certificate,  which 
undoubtedly  helps  to  sell  low-priced  shares.  oil  I 

§  121.    Percentage  Rate  of  Capitalization 

The  rate  of  capitalization  of  the  earning  power  of  a  corpora- 
tion depends  naturally  on  the  corporation's  stability  and  on  the 
nature  of  the  business.  A  railroad  or  public  utility  company 
may  find  stocks  which  yield  6%  to  7%,  selling  at  or  near  par. 


670  CORPORATE  FINANCE  [Bk.  II- 

The  shares  of  a  manufacturing  or  trading  company  must  usually 
pay  dividends  of  6%  to  8%  or  more  if  they  are  to  sell  at  par. 
These  percentages  refer  solely  to  dividends,  and  require  mate- 
rially larger  actual  net  earnings  of  the  corporation  after  all  claims 
prior  to  dividends  on  the  common  stock  have  been  met.  There 
is  of  course  no  definite  rule  for  determining  what  percentage 
should  or  will  be  used  in  working  out  the  capitalization.  That 
must  be  determined  by  observing  the  market  action  of  the  com- 
pany's shares  and  of  other  similar  shares. 

§  122.    Adjustment  of  Capitalization  to  Earnings 

Many  examples  of  the  adjustment  of  capitalization  to  earn- 
ings might  be  cited;  indeed,  almost  any  large  industrial  corpora- 
tion the  shares  of  which  are  widely  traded  in,  would  serve  this 
purpose.  At  the  time  of  its  organization,  the  United  States 
Realty  and  Construction  Company  had  tangible  property  worth 
approximately  $11,000,000,  and  cash  amounting  to  about  $11,- 
000,000,  against  which  was  issued  $27,500,000  in  preferred  stock 
and  $33,500,000  in  common  stock;  $61,000,000  in  all.  The  earn- 
ing power  of  the  two  companies  which  had  been  combined 
amounted,  however,  to  over  $3,500,000,  and  there  was  thought 
to  be  reasonably  good  prospects  for  growth  in  these  earnings. 
Even  in  view  of  these  earnings,  the  capitalization  was  regarded 
as  perhaps  somewhat  excessive  but  not  abnormal.  As  a  matter 
of  fact,  the  company  later  failed  disastrously,  due  in  part  to  un- 
favorable conditions  and  in  part  to  the  overestimates  that  had 
been  made  of  its  earning  capacity. 

A  striking  example  of  sudden  variation  in  earnings  quickly 
followed  by  readjustment  of  capital  is  furnished  by  the  Subma- 
rine Boat  Corporation.  This  corporation  was  originally  known  as 
the  Electric  Boat  Company,  and  for  many  years  was  regarded  as 
practically  a  failure.  It  had  an  authorized  capital  of  $5,000,000 
common  and  $5,000,000  preferred,  of  which  $4,999,600  common 
and  $2,667,500  preferred  were  outstanding.  The  company's  busi- 
ness was  to  build  submarines  for  which  it  held  valuable  patents, 


Ch.  12]  CAPITALIZATION  671 

and  also  high-powered  gasoHne  launches  which  might  be  used  as 
submarine  destroyers.  After  it  appeared  that  the  submarine  was 
to  become  a  highly  important  factor  in  the  European  conflict,  it 
quickly  became  evident  that  the  Electric  Boat  Company  was  in 
a  position  to  reap  enormous  profits  from  the  situation.  As  late 
as  the  winter  of  19 14,  the  common  stock  was  quoted  at  a  nominal 
price,  around  $10  a  share;  by  the  fall  of  191 5  it  had  risen  to  over 
$480  a  share. 

At  this  time  the  Submarine  Boat  Corporation  was  formed  for 
the  purpose  of  carr)ang  on  the  enlarged  business,  and  the  stock 
of  the  Electric  Boat  Company  was  taken  over  on  the  basis  of 
ten  shares  of  the  new  stock  for  each  one  of  the  old.  The  shares 
of  stock  of  the  new  corporation  were  issued  without  par  value 
and  for  this  reason  it  is  impossible  to  cite  exact  figures  showing 
the  extent  of  the  recapitalization.  However,  on  the  basis  of  the 
quoted  price  of  the  Electric  Boat  Company  shares,  the  new  capi- 
talization of  the  Submarine  Boat  Corporation  may  be  figured  as 
having  a  market  value  at  that  time  of  $35,000,000.  It  may  be 
added  that  the  hopes  of  those  interested  in  the  new  corporation 
were  never  realized,  and  the  stock  of  the  company  steadily  de- 
preciated in  value,  until  at  the  present  time  3  it  is  quoted  at  $5  a 
share — equivalent  to  $50  a  share  for  the  stock  of  the  Electric 
Boat  Company.  The  published  report  of  the  Submarine  Boat 
Corporation  for  the  year  ending  December  31,  192 1,  shows  a  net 
deficit  of  $2,199,476. 

There  can  be  little  doubt  in  the  mind  of  anyone  who  is  famil- 
iar with  such  occurrences,  as  to  the  truth  of  the  general  statement 
that  capitalization  tends  very  strongly  to  conform  to  earnings 
rather  than  to  actual  investment. 

§  123.    Estimates  of  Earning  Power 

In  what  has  been  said  in  the  preceding  section  as  to  adapting 
capitalization  to  earning  power,  it  has  been  assumed  that  there 

*  March  4,  1922. 


672  CORPORATE  FINANCE  [Bk.  II- 

will  be  no  difficulty  in  determining  earnings.  If  a  company  has 
been  doing  business  successfully  over  a  period  of  years  and  has 
had  reasonably  stable  earnings,  it  would  seem  to  be  an  easy  mat- 
ter to  estimate  the  probabilities  for  the  future;  yet  the  experi- 
ence gained  during  the  last  25  years  in  forming  combinations  of 
industrial  companies  indicates  quite  clearly  that  even  expert 
estimates  are  an  unsafe  guide. 

The  following  interesting  table*  "shows  the  disparity  between 
the  promised  and  the  actual  profits"  in  the  case  of  a  nuniber  of 
important  industrial  combinations.  The  aggregate  earnings  of 
the  subsidiary  companies  before  the  combination  are  taken  as 
100;  the  percentages  given  show  whether  these  prior  percentages 
were  exceeded  or  otherwise  under  the  combination. 

Mount  Vernon-Woodberry  Cotton  Duck  Company 166% 

National  Salt  Company 134 

New  England  Cotton  Yarn  Company 98 

International  Cotton  Mills  Corporation 56 

United  States  Ship  Building  Company 56 

United  States  Realty  &  Construction  Co 56 

Asphalt  Company  of  America 40 

American  Malting  Company 31 

American  Bicycle  Company 24 

The  somewhat  startling  results  shown  above  may  have  been 
due  in  part  to  padded  statements  of  earnings  on  the  part  of  the 
constituent  companies,  which  just  prior  to  the  combination  were 
trying  to  make  the  best  possible  showing  for  themselves;  to  some 
extent  they  are  due,  doubtless,  to  the  fact  that  combinations  are 
generally  organized  at  the  height  of  a  period  of  prosperity.  In 
general,  however,  they  seem  to  represent  a  tendency  toward  act- 
ual decline  in  efficiency  under  the  new  organization. 

§  124.    Earnings  as  Affected  by  the  Personal  Equation 

Wherever  the  personal  element  in  management  is  large,  esti- 
mates of  future  earnings  are  particularly  uncertain.  After  a 
strong,  going  organization  has  been  formed  and  methods  have 

♦  Dewing  on  Corp.  Prom,  and  Reorg.,  p.  547. 


Ch.  12]  CAPITALIZATION  673 

become  standardized,  this  element  of  uncertainty  becomes  less 
and  less  prominent.  Nevertheless,  in  some  lines  of  business  it  is 
especially  pronounced.  For  example,  bankers  are  sometimes  un- 
willing to  make  large  advances  to  companies  engaged  in  operat- 
ing chain  stores.  They  believe  that  the  success  of  these  stores 
depends  to  a  high  degree  upon  the  human  equation.  The  death 
of  the  executive  who  built  it  up  and  had  formed  his  personal  con- 
nections might  be  a  fatal  blow. 

§  125.    Legislation  as  Affecting  Dividends 

Another  source  of  uncertainty  in  businesses  where  earnings 
would  otherwise  be  remarkably  stable,  is  the  possibility  of  ad- 
verse legislation.  The  legislatures  of  several  states  have  in  recent 
years  passed  laws  fixing  rates  of  transportation  and  of  public 
utility  services  on  arbitrary  bases  which  have  introduced  a  sud- 
den and  wholly  unforeseeable  change  in  the  earnings  of  the  cor- 
porations affected.  The  principle  is  wrong.  Wherever  rates  re- 
quire regulation,  it  should  be  effected  by  some  systematic  and 
carefully  considered  method.  In  Great  Britain  there  is  no  such 
thing  as  public  rate  regulation  as  understood  in  America.  The 
two  methods  of  regulation  used  there  are  the  maximum  dividend 
method  and  the  sHding  scale  method,  both  of  which  operate  con- 
tinuously and  automatically. 

There  is,  perhaps,  no  safe  practical  rule  to  follow  in  making 
or  in  reviewing  estimates  of  future  earnings,  except  to  follow  the 
rule  of  conservatism  and  skepticism.  Sometimes  the  skepticism 
may  be  undeserved,  but  at  any  rate  the  banker  or  investor  can 
make  no  mistake  in  demanding  full  and  satisfactory  evidence  of 
the  conservatism  of  the  estimates.  This  remark  applies  especially 
to  promoters'  estimates  of  the  future  profits  of  their  concerns. 
"When  you  are  capitalizing  a  perhaps  which  you  believe  to  be 
infinite,"  says  Hartley  Withers  in  one  of  his  incisive  epigrams, 
"the  number  of  noughts  that  you  add  on  to  the  market  value  of 
the  company's  capital  is  a  matter  that  does  not  concern  you  as 
long  as  you  are  wrought  up  to  the  right  pitch  of  excitement." 


674  CORPORATE  FINANCE  (Bk.  II- 

§  126.     Overcapitalization 

It  is  plain,  from  what  has  been  said,  that  many  corporations, 
either  at  the  outset  or  at  some  later  stage  in  their  career,  are  faced 
with  a  wide  discrepancy  between  the  actual  value  of  all  their 
assets  and  the  nominal  net  worth  of  the  business  which  is  repre- 
sented by  their  capital  stock. 

For  example,  the  old  Glucose  Sugar  Refining  Company  was 
organized  in  1897  as  a  combination  of  six  glucose  refineries. 
Although  $7,500,000,  it  is  rehably  estimated,  would  have  fully 
covered  the  actual  value  of  the  plants  and  current  assets  ac- 
quired, the  company  started  with  a  capital  stock  issue  of  $37,- 
000,000.  In  1902  this  same  combination,  with  some  additions, 
was  reorganized  under  the  name  of  the  Corn  Products  Company, 
and  again  in  1906  under  the  name  of  the  Corn  Products  Refining 
Company.  This  last  company,  it  was  estimated,  had  assets  worth 
approximately  $15,000,000.  Against  these  assets  the  company 
issued  a  bonded  debt  of  $9,500,000,  preferred  stock  to  the  par 
value  of  $30,000,000,  and  common  stock  to  the  par  value  of 
$50,000,000. 

When  a  corporation  has  been  unsuccessful  over  a  period  of 
years,  an  effort  is  sometimes  made  to  improve  the  financial  status 
by  reducing  its  capital  stock  and  its  contingent  charges.  The 
Corn  Products  Refining  Company  was  not  conspicuously  suc- 
cessful at  this  time.  It  paid  5%  on  its  7%  preferred  stock,  the 
unpaid  2%  accumulating,  and  the  price  of  the  common  stock 
went  as  low  as  $10  a  share.  To  place  the  company  on  a  sounder 
and  more  conservative  basis,  Mr.  Bedford,  its  president,  advised 
a  reduction  of  its  capital  stock,  and  submitted  a  plan  which 
called  for  the  absolute  surrender  and  cancellation  of  four-fifths 
of  the  outstanding  $50,000,000  of  common  stock;  the  remaining 
one-fifth  of  common  and  all  the  preferred  stock  to  be  exchanged 
for  new  stock  of  one  class,  upon  which  it  was  proposed  to  pay 
dividends  at  the  rate  of  5%  per  year.  The  result  would  have 
been  to  cut  down  fixed  charges  and  permit  of  a  much  sounder 
balance  sheet.    However,  the  preferred  stockholders  saw  no  ad- 


Ch.  12]  CAPITALIZATION  675 

vantage  to  themselves  in  giving  up  part  of  their  claims  and  the 
plan  eventually  failed. 

The  subsequent  history  of  the  Corn  Products  Refining  Com- 
pany is  interesting  and  a  striking  tribute  to  the  value  of  good 
management — which  the  company  has  had.  In  spite  of  its  stag- 
gering burden  of  capitalization  it  has  been  successful.  At  the 
present  time  it  is  paying  regular  dividends  on  both  preferred  and 
common  stock;  in  192 1  it  bought  in  and  retired  $5,000,000  par 
value  of  its  preferred  stock;  its  profits  from  operations  for  1920 
were  over  $18,000,000;  it  had  a  surplus,  January  i,  1921,  of  over 
$43,000,000;  and  its  common  stock  is  now  selling  above  par. 

unuvm 


033A  lli* 


CHAPTER  XIII 

CAPITALIZATION^  GOOD-WILL,  SURPLUS 
AND  INITIAL  EXPENSES 

§  127.    Good- Will 

The  law  assumes  that  at  the  time  of  organization  the  assets 
of  a  corporation  are  valued  at  cost  or  at  their  actual  value  and 
that,  after  the  deduction  of  liabilities,  the  remaining  equity  in 
the  assets  is  represented  by  its  capital  stock. 

The  truth  of  the  case  is,  as  we  have  seen,  that  capitalization — 
at  least  for  the  companies  with  marketable  securities — is  more 
often  based  on  earning  power,  and  that  the  book  valuation  of 
the  company's  assets  is  then  adjusted  to  the  capitalization.  This 
tends  to  make  the  valuation  of  assets  for  accounting  purposes  a 
difficult  process.  When  it  is  not  desirable  to  place  an  arbitrary 
value  upon  tangible  assets,  or  when  the  capitalization  is  so  large 
that  any  arbitrary  value  within  reason  will  still  leave  a  gap,  then 
we  have  "Patents,"  "Copyrights,"  "Organization,"  "Good- 
Will,"  or  some  other  intangible  asset  entered  upon  the  books  and 
appearing  in  the  balance  sheet  at  a  valuation  sufficient  to  offset 
the  nominal  value  of  outstanding  capital  stock. 

§  128.    A  Good-Will  Account  "to  Order" 

The  valuation  of  an  intangible  asset  sometimes  comes  in  very 
conveniently  for  other  purposes.  For  instance,  some  years  ago 
a  company  publishing  a  well-known  popular  magazine  had  issued 
$300,000  face  value  of  stock  for  an  equivalent  amount  of  cash 
paid  in.  The  magazine  had,  however,  proved  unprofitable  and 
at  the  time  its  total  assets  over  and  above  the  liabilities  (except 
stock)  were  approximately  $250,000.     As  the  cash  originally  con- 

676 


Ch.  13] 


CAPITALIZATION 


677 


tributed  amounted  to  $300,000,  this  showed  a  loss  of  $50,000, 
which  appeared  on  the  asset  side  of  the  balance  sheet  as  an 
accumulated  deficit  of  practically  $50,000.  Its  balance  sheet  in 
a  highly  condensed  and  simplified  form  would  then  be : 


Assets 
Net  Capital  and  Current 

Assets $250,000.00 

Accumulated  Deficit 50,000.00 

Liabilities 
Capital  Stock 

$300,000.00 

Total $300,000.00 

$300,000.00 

When  the  magazine  had  reached  this  staj^e  and  its  proprietors 
were  greatly  discouraged,  it  started  a  series  of  feature  articles 
which  were  timely,  had  a  very  strong  appeal,  and  became  im- 
mensely popular.  The  circulation  and  advertising  receipts  of 
the  magazine  suddenly  jumped  to  figures  previously  unthought 
of.  In  the  first  year  after  this  sudden  change  of  fortune,  the 
corporation  earned  profits  of  approximately  $40,000,  and  the 
directors  desired  to  distribute  dividends  of  $30,000,  But  there 
was  no  surplus  out  of  which  to  declare  dividends;  on  the  con- 
trary, the  balance  sheet  still  showed  an  impairment  of  capital 
which  must  be  made  up  before  dividends  could  legally  be  de- 
clared. In  this  predicament  they  called  in  an  experienced 
accountant  who  solved  the  difficulty  by  directing  that  a  very 
simple  entry  be  put  into  the  company's  journal,  debiting  a  new 
Good- Will  accounr  to  the  amount  of  $100,000,  and  crediting 
Surplus  for  a  like  amount.  Thereafter  the  company's  balance 
sheet  in  its  highly  simplified  form,  appeared  as  follows: 


Assets 

Net  Capital  and  Current 

Assets $290,000.00 

Good-will 100,000.00 

Total $390,000.00 


Liabilities 

Capital  Stock $300,000.00 

Surplus 90,000.00 


$390,000.00 


678  CORPORATE  FINANCE  [Bk.  II- 

There  was  then  nothing  to  prevent  the  immediate  distribu- 
tion of  cash  profits  in  the  form  of  dividends.^ 

§  129.    F>roper  Valuation  of  Good- Will 

Good-will  is  not  necessarily  valued  in  quite  so  arbitrary  and 
casual  a  fashion.  Where  there  is  genuine  good-will  which  it  is 
desirable  to  show  in  one  form  or  another  on  the  balance  sheet,  a 
careful  valuation  should  be  made.  A  good  example  of  such  a 
valuation  arose  in  connection  with  the  appraisal  of  the  estate  of 
Joseph  PuHtzer,  former  proprietor  of  the  New  York  World  and 
of  the  St.  Louis  Post-Despatch.  The  appraiser,  first  of  all,  made 
a  careful  estimate  of  the  earning  power  of  each  one  of  the  news- 
paper properties.  For  this  purpose  he  took  the  average  annual 
earnings  of  each  corporation  for  four  years  preceding  Mr. 
Pulitzer's  death.  From  this  average  figure,  however,  he  de- 
ducted a  considerable  sum  by  reason  of  certain  very  favorable 
contracts  for  the  purchase  of  white  print  paper  which  were  about 
to  expire,  and  he  further  deducted  $100,000  as  being  a  reasonable 
estimate  of  the  value  of  the  services  of  Mr.  Pulitzer  himself.  He 
deducted,  also,  6%  on  the  actual  capital  invested.  This  left 
average  net  earnings  of  $196,411  for  the  St.  Louis  Post-Despatch, 
and  $81,180  for  the  New  York  World,  both  of  which  the  appraiser 
capitalized  on  a  10%  basis,  making  his  valuation  of  the  good-will 
of  the  first-named  paper  $1,964,110,  and  of  the  second-named 
paper  $811,800. 

§  130.    Legal  Appraisals  of  Good-Will  iuoj^ik  IIP//  ; 

In  court  appraisals  of  good-will  the  generally  accepted  prac- 
tice is  to  take  the  net  profits  of  the  business,  less  6%  on  invested 
capital,  for  a  term  of  years  immediately  preceding  the  valuation — 
usually  3  or  5  years — and  from  this  obtain  the  average  net  annual 
profits.  This  average  amount  is  to  be  multiphed  by  the  number 
of  years'  purchase,  i.e.,  the  number  of  years  that  the  good-will 
may  be  expected  to  continue,  the  result  giving  the  value  of  the 

1  The  case  just  cited  is  actual  but  the  figures  have  been  much  changed  in  order  to  simplify 
the  statement  and  to  avoid  identification. 


Ch.  13]  CAPITALIZATION  679 

good- will.  In  the  absence  of  evidence  to  the  contrary,  3  years' 
purchase  is  customarily  allowed. 

The  number  of  years'  purchase  varies  with  the  nature  of  the 
business.  Thus  in  a  case  involving  the  value  of  the  good-will 
of  Tiffany  and  Company,  the  well-known  New  York  jewelers 
whose  business  has  been  established  for  60  years,  the  court  held 
that  10  years'  purchase  was  fair,  stating  in  its  decision: 

It  is  contended  that  the  value  of  the  good-will  should  be  ascer- 
:        tained  by  multiplying  the  average  net  profit  by  3  or  5,  instead  of 
/       10.     The  cases  in  this  country  are  not  uniform  in  regard  to  the 
number  of  years'  purchase  by  which  the  average  annual  net  profits 
may  be  multiplied  for  the  purpose  of  determining  the  value  of  the 
good-wiU.    Most  of  the  American  cases  adopt  a  period  ranging 
'       from  two  to  six  years,  the  number  being  dependent  upon  the  nature 
-    •  of  the  business,  the  length  of  time  during  which  it  has  been  estab- 
lished at  a  particular  place,  and  the  extent  to  which  it  is  known  to 
the  public.  2 

In  the  Pulitzer  matter  already  referred  to,  the  number 
of  years'  purchase — though  expressed  on  a  percentage  basis — 
was  also  ten. 

§  131.    Nature  of  Good-Will 

^  In  this  discussion  no  attempt  has  so  far  been  made  to  give  an 
accurate  definition  of  the  vague  term  "good- will."  It  is,  in  fact, 
almost  incapable  of  definition  for  the  reason  that  it  is  continually 
used  in  many  varying  senses.  The  term  arose  undoubtedly  in 
connection  with  retail  trade  and  with  professional  practice, 
where  it  referred  to  the  habit  that  had  been  established  on  the 
part  of  many  people  who  were  accustomed  to  trading  with  a  good 
shop  or  with  an  established  professional  practitioner.  Experi- 
ence has  shown  that  this  habit  will  continue  to  carry  people  to 
that  same  shop  or  to  the  same  physician's  or  lawyer's  office  even 
after  the  original  proprietor  or  practitioner  has  withdrawn.  The 
vendor  of  a  business  or  a  practice  of  this  nature  usually  con- 


'  Matter  of  Moore,  97  Misc.  238;    162  Supp.  213,  as  reported  in  Gleason  and  Otis  on  In- 
heritance Taxation. 


68o  CORPORATE  FINANCE  [Bk.  II- 

tracted,  for  a  given  consideration,  to  recommend  his  successor 
and  thus  literally  sold  to  him  his  "good- will."  The  classical 
definition  of  good-will  is  that  attributed  by  Boswell  to  Johnson, 
who  when  assisting  in  the  sale  of  the  Thrale  brewery  remarked, 
"We  are  not  here  to  sell  a  parcel  of  boilers  or  vats,  but  the  poten- 
tiality of  amassing  wealth  beyond  the  dreams  of  avarice." 

When  a  modern  corporation  transfers  good-will  or  enters 
good-will  upon  its  books,  the  asset  which  is  thus  represented 
consists  of  something  even  more  intangible  than  the  kind  of 
good-will  that  accompanied  the  sale  of  the  little  retail  shop.  A 
corporation's  good-will  may  consist  in  part  of  estabHshed  trade 
and  of  the  habits  of  people  who  desire  to  buy  its  products;  it 
may  consist  in  part  of  an  efficient,  smoothly  working  internal 
organization;  it  may  consist  in  part  of  a  monopoly  of  its  field; 
it  may  consist  in  part  of  well-known  trade-marks  or  of  patents. 
An  adequate  definition  of  good-will  in  its  modern  sense  must 
cover  all  the  above  and  many  other  similar  variations  of  intan- 
gible assets.  The  one  definition  which  seems  to  cover  almost 
everything  is  this :  Good- will  is  the  capitalization  of  that  portion 
of  the  earning  power  of  a  business  which  is  not  credited  to  other 
assets. 

With  this  definition  in  mind,  the  question  as  to  the  right 
method  of  valuation  of  good-will  in  any  given  case  is  simplified. 
The  same  method  must  be  followed  that  was  used  by  the  ap- 
praiser of  the  Pulitzer  properties;  that  is,  to  ehminate  from 
average  earnings  those  which  are  to  be  ascribed  to  the  ownership 
of  tangible  assets  or  to  temporary  causes;  the  remaining  earn- 
ings may  then  be  capitalized  on  whatever  basis  is  suitable  for  the 
business  under  consideration.  If  the  percentage  method  is  used 
it  might  in  some  lines  of  business  be  as  low  as  6%  or  8%;  in 
others  io%,  and  in  others  12%,  13%,  and  even  20%. 

§  132.    Permanency  and  Amount  of  Good- Will 

The  definition  of  good-will  just  suggested  carries  with  it  a 
ready  explanation  of  the  fact  that  good-will  is  a  much  more  per- 


Ch.  13]  CAPITALIZATION  681 

manent  asset  in  some  lines  of  business  than  in  others.  Those 
Unes  of  business  which  employ  an  overwhelming  proportion  of 
fixed  capital  assets,  ordinarily  attribute  their  earnings  almost 
wholly  to  these  assets,  and  there  is  seldom  any  occasion  for  enter- 
ing such  an  item  as  good-will.  On  the  other  hand,  those  corpora- 
tions that  are  engaged  chiefly  in  trading,  their  earnings  being 
dependent  to  a  great  extent  upon  the  rapidity  of  their  turnover, 
or  upon  popular  favor,  may  find,  if  they  are  successful,  that  their 
earnings  mount  far  beyond  any  sum  that  can  reasonably  be 
attributed  to  their  capital  assets. 

In  this  latter  class  belong  such  concerns  as  the  F.  W.  "Wool- 
worth  Company,  with  its  great  chain  of  5  and  lo-cent  stores, 
which  carries  a  good-will  account  of  $50,000,000.  Many  pub- 
lishing companies  quite  properly  carry  good-will  as  one  of  their 
most  important  assets.  The  Butterick  Company,  out  of  total 
assets  of  $20,744,493,  has  $13,893,271,  or  over  one-half,  included 
under  the  heading  "Patents,  Good-Will,  Contracts,  Copyrights, 
Trade-Marks,  etc."  Silver-Burdett  and  Company  carry  "Pub- 
lishing Rights,  Contracts,  Copyrights,  etc.,"  at  $1,153,391  out 
of  total  assets  of  $2,578,343. 

There  are  many  cases,  also,  where  highly  profitable  and 
rapidly  growing  companies  may  have  trouble  in  valuing  their 
tangible  assets  at  a  figure  high  enough  to  offset  the  amount  of 
stock  which  their  directors  feel  should  properly  be  outstanding, 
and  good-will  must  be  resorted  to  for  a  balancing  item.  This  is 
the  case,  for  instance,  with  the  Hendee  Manufacturing  Com- 
pany of  Springfield,  Mass.,  which  on  August  31,  1920,  carried  a 
good-will  account  of  $5,000,000  out  of  total  assets  of  $12,368,053. 
The  American  Chicle  Company  at  the  end  of  1920  carried 
"Good-Will,  Trade-Marks,  etc.,"  at  $8,159,432  out  of  total 
assets  of  $23,493,563.  On  the  other  hand,  the  highly  successful 
and  long-established  Eastman  Kodak  Company,  which  is  paying 
dividends  that  average  over  30%,  and  is  earning  in  the  neighbor- 
hood of  70%  on  its  common  stock,  does  not  carry  a  cent  of  good- 
will, nor  does  it  carry  any  other  intangible  asset  account. 


682  CORPORATE  FINANCE  [Bk.  II- 

§  133.    Capitalization  of  Surplus 

In  cases  where  surplus  has  accumulated  to  a  considerable 
amount  but  the  directors  wish  to  keep  the  values  it  represents  in 
the  business  rather  than  to  distribute  them  in  the  form  of  cash 
dividends,  it  is  becoming  more  and  more  customary  for  the  cor- 
poration to  recognize  and  meet  the  situation  by  declaring  divi- 
dends payable  in  stock.  This  procedure  does  not  necessarily 
mean  increased  cash  returns  to  the  stockholders  except  in  the 
way  of  dividends  on  the  new  stock,  and  does  not  afTect  their 
relative  interests  in  the  corporation,  but  it  gives  them  concrete 
evidence  of  the  increased  value  of  their  holdings  in  the  company, 
and  in  case  they  wish  to  sell  their  stock,  enables  them — as  it  is 
difficult  to  sell  shares  above  par — to  get  a  better  price. 

An  example  of  stock  dividends  declared  for  this  purpose  is 
afforded  by  Sears,  Roebuck  and  Company  of  Chicago.  The 
company  was  organized  in  1906  with  a  total  stock  capitalization 
of  $40,000,000,  of  which  $10,000,000  was  preferred  and  $30,000,- 
000  common.  Since  then  common  stock  dividends  have  been 
paid  as  follows:  1911,  33}4%;  1915,  50%;  1917,  25%;  and  in 
1920  a  final  stock  dividend  of  40%,  bringing  the  total  common 
stock  capitaUzation  up  to  $105,000,000.  The  wisdom  of  this 
last  stock  dividend  is  questionable,  as  in  192 1,  owing  to  the  diffi- 
cult conditions  following  the  Great  War  and  particularly  the 
shrinkage  in  inventories,  the  company  lost  over  $16,000,000,  and 
was  only  saved  from  serious  embarrassment  by  the  action  of  its 
president  in  donating  to  the  company  50,000  shares  of  its  stock 
and  also  buying  from  it  real  estate  worth  many  millions  of  dollars. 

Another  good  example  of  stock  dividends  issued  for  the  pur- 
pose of  taking  up  surplus  is  afforded  by  the  Macmillan  Com- 
pany, the  New  York  publishers.  This  company  in  192 1  increased 
its  common  stock  from  $600,000  to  $1,800,000,  in  order  to  permit 
of  a  stock  dividend  of  200%.  Before  the  increase  was  made, 
the  president  in  explaining  the  matter  to  the  stockholders  said: 
"The  sole  purpose  of  this  proposed  action  is  to  convert  part  of 
the  accumulated  surplus  into  capital  stock." 


Ch.  13]  CAPITALIZATION  683 

Some  of  the  manufacturing  companies  have  also  had  remark- 
able stock  dividend  records.  Up  to  1900  the  capital  stock  of  the 
Singer  Manufacturing  Company  was  $10,000,000,  and  that 
year  a  stock  di\'idend  of  200%  was  declared,  making  it  $30,000,- 
000.  In  1910  another  stock  dividend  of  100%  was  declared, 
making  the  capital  $60,000,000;  and  in  November,  1920,  a  third 
stock  dividend  of  50%,  bringing  the  total  capitalization  up  to 
$90,000,000.  During  all  this  period  cash  dividends  have  been 
high.  In  1899,  just  before  the  first-named  stock  dividend,  cash 
dividends  were  100%;  in  1904  and  again  in  1909  they  were  as 
high  as  30%;  since  the  stock  advance  of  19 10  they  have  been 
averaging  12%  to  14%.  Swift  and  Company  originally  had  a 
nominal  capital  of  $300,000,  which  has  been  increased  at  various 
times  to  $3,000,000,  $5,000,000,  $7,500,000,  $15,000,000,  $20,- 
000,000,  $25,000,000  $35,000,000,  $50,000,000,  $60,000,000, 
$75,000,000,  $100,000,000  and  finally  in  1918  to  $150,000,000. 

Such  constant  changes  in  capitalization — which  are  always 
of  an  arbitrary  nature — -can  be  avoided  by  the  use  of  shares 
without  par  value. »  It  would  be  theoretically  possible  to  have 
no  shares  whatever  outstanding,  and  there  is  one  case  on  record 
of  an  English  enterprise  known  as  the  Undertakers  of  the  Aire 
and  Calder  Navigation  and  Steamship  Company,  which  until 
1895  had  no  shares.  The  capital  was  bought  and  sold  at  so 
many  years'  purchase  of  the  dividends.  The  modern  arrange- 
ment, however,  is  to  have  shares  bearing  no  par  value.  Shares 
without  par  value  are  permitted  in  a  majority  of  the  states.       '" 

§  134.    Capitalization  of  Initial  Expenses  and  Losses 

A  question  which  arises  in  the  early  history  of  most  corpora- 
tions, and  which  is  of  considerable  practical  importance,  con- 
cerns the  propriety  of  capitalizing  initial  expenses  and  losses. 
Every  new  corporation  must  expect  to  incur  a  loss  during  the 
period  between  the  time  it  starts  operations  and  the  time  its 


'See  Book  I,  Ch.  XIV,  "Shares  Without  Par  Value." 


634  CORPORATE  FINANCE  [Bk.  II- 

business  is  on  a  normal  basis.  This  period  may  be  long  or 
short,  depending  upon  the  nature  of  the  business.  With  many 
companies  such  as  railroads,  large  manufacturing  establishments, 
publishing  concerns,  developers  of  urban  real  estate,  and  the  like, 
the  period  is  apt  to  be  several  years  in  length.  With  trading 
companies  the  period  should  be  relatively  short.  The  initial 
expenses  and  the  losses  of  this  period  are  frequently  charged 
to  some  capital  account  or  accounts,  such  as  "Development 
Expense,"  "Good-Will,"  or  "Deferred  Expense."  When  a 
business  comes  to  a  normal  basis  and  is  earning  profits,  then 
initial  expenses  and  losses  may  be  written  off  either  directly  or 
over  a  term  of  years  as  may  seem  desirable. 

The  same  question  arises  in  connection  with  interest  pay- 
ments on  bonds  that  have  been  issued  during  the  process  of  con- 
struction and  development  of  a  company  and  in  connection  with 
discounts  on  bonds  sold  below  par.  In  a  well-known  English 
case  it  was  decided  that  "where  a  company  borrows  money  to 
construct  permanent  works  the  interest  paid  during  the  period 
of  construction  might  properly  be  treated  as  a  part  of  the  cost 
of  construction  and  charged  to  capital."* 

The  English  Companies'  Consolidation  Act  of  1908  specifi- 
cally provides  that  where  shares  are  issued  to  defray  expenses  of 
construction,  the  company  may  pay  interest  on  such  shares  and 
charge  the  payments  to  capital  accounts,  with  the  provisos  that 
the  payment  be  authorized  by  the  stockholders  and  by  the  Board 
of  Trade ;  that  it  shall  not  continue  more  than  six  months  after 
construction  is  complete;  that  the  rate  of  interest  shall  not 
exceed  4%;  and  that  the  transaction  be  clearly  shown  in  the 
company's  books  of  account.  In  this  country  much  the  same 
practice  is  found  as  in  England,  although  it  is  not  so  definitely 
authorized. 

There  seems  to  be  no  serious  objection  to  be  urged  against 
the  practice  of  charging  initial  expenses — those  necessary  ex- 
penses which  must  precede  profitable  operation,  and  which  from 


*  Hines  v.  Buenos  Aires  Grand  National  Tramways,  2  Ch.  654. 


Ch.  13]  CAPITALIZATION  685 

the  accounting  standpoint  represent  a  loss — to  capital  accrued, 
though  the  practice  is  one  that  may  be  very  easily  abused. 
Examples  might  be  cited  of  companies  which  have  little  or  no 
prospect  of  success  and  yet  have  gone  on  for  a  period  of  4  or  5 
years  charging  the  losses  on  their  normal  operations  to  a  fictitious 
capital  account,  thus  rendering  a  forced  statement  of  alleged 
profits  to  their  shareholders.  These  isolated  abuses,  however, 
are  hardly  to  be  taken  as  sound  objections  to  a  practice  which  is 
in  itself  correct.  We  are  probably  quite  justified  in  saying  that 
the  total  investment  in  an  enterprise  includes  a  reasonable 
allowance  for  expenses  and  losses  incurred  in  carrying  through 
the  initial  organization  and  development. 


,)n 


t6 


rs. 


;^T'iJ"»-5j. 


ronv.xi 


CHAPTER  XIV 

ai«T'jqo  jjitmo/nivnl  no 
FIXED  AND  WORKING  CAPITAL 

§  135.    Estimating  Capital  Requirements 

What  are  the  capital  requirements  of  the  business?  Pre- 
sumably this  question  is  answered  before  the  general  financial 
plan  is  formulated — ^that  is  to  say,  the  amount  of  capital  required 
has  been  estimated  and  the  financial  plan  made  to  fit  this  esti- 
mate. Right  here,  in  this  estimate,  is  a  frequent  source  of 
serious  error.  The  capital  required  may  not  be  estimated  at 
its  proper  amount.  It  is  easy  enough,  usually,  to  calculate  what 
will  be  needed  for  plant  and  machinery,  roadbed  and  equipment, 
office  furniture,  or  whatever  the  fixed  assets  of  the  business  may 
be.  It  is  not  so  easy  to  determine  the  amount  needed  for  work- 
ing capital  and  development  expenses. 

Sufficient  working  capital  must  be  provided  to  take  care  of 
the  normal  processes  of  purchasing  raw  materials  and  supplies, 
turning  out  finished  products,  selling  the  products,  and  waiting 
for  payment  to  be  made.  If  the  original  estimates  of  working 
capital  are  insufficient  for  these  necessary  operations,  some  emer- 
gency financing  must  be  resorted  to  or  the  business  will  come  to 
a  dead  stop. 

Also  the  losses  and  expenses  of  development  are  generally 
underestimated.  Every  new  organization  must  be  in  part  an 
experiment.  Men  will  be  employed  who  are  unsuited  for  their 
positions;  methods  of  production  and  of  sale  will  be  tried  that 
must  be  discarded;  machinery  will  be  installed  that  proves 
worthless;  advertisements  and  sales  booklets  will  be  written 
that  perhaps  do  harm  rather  than  good.  If  the  enterprise  is 
basically  sound,  all  these  expensive  mistakes  may  properly  be 
charged  as  a  part  of  the  initial  expense  of  getting  the  business  on 

686 


Ch.  14]  FIXED  AND  WORKING  CAPITAL  687 

its  feet.  The  experience  of  generations  has  proved  that  such 
losses  are  unavoidable  and  they  should  be  provided  for  in  the 
original  estimates  of  expenditure. 

These  remarks  apply — though  with  somewhat  less  force — 
when  planning  extensions  and  betterments  for  which  fresh 
capital  is  raised.  It  is  an  every-day  occurrence  for  a  manufac- 
turer when  planning  to  put  up  a  new  building  and  install  new 
machinery  that  will  increase  his  capacity,  let  us  say,  50%,  to 
overlook  entirely  the  necessity  for  a  corresponding  increase  in 
his  working  capital.  Also  he  frequently  overlooks  the  probability 
of  experiments  and  losses  in  construction  of  the  plant  and  in 
developing  the  sales  and  administrative  organization  which  will 
take  care  of  the  increased  output. 

§  136.    Fixed  Capital  and  Working  Capital 

~^'  The  distinction  between  fixed  capital  and  working  capital  is 
often  not  clearly  understood.  There  would  be  much  less  con- 
fusion if  it  were  possible  to  drop  the  adjective  "working,"  which 
in  this  connection  is  meaningless,  and  substitute  the  word 
"revolving."  "Fixed"  capital  and  "revolving"  capital  are 
almost  self-explanatory.  The  fixed  capital  is  that  which  has  been 
put  into  the  fixed  or  permanent  investment — the  plant,  equip- 
ment, and  other  similar  requirements  of  the  business,  which  are 
more  or  less  in  the  nature  of  permanent  investments  and  which 
are  not  to  be  sold  in  the  ordinary  course  of  business.  The 
revolving  capital  is  invested  in  raw  materials,  in  stocks  of  partly 
finished  and  finished  products,  in  accounts  receivable,  in  salable 
securities,  and  a  sufficient  proportion  of  it  should  be  in  the  form 
of  cash.  Capital  in  all  these  invested  forms  is  constantly  being 
converted — after  whatever  alterations  in  form  are  necessary — 
into  cash,  and  this  cash  flows  out  again  in  exchange  for  other 
forms  of  working  capital.  Thus,  it  is  constantly  revolving;  or, 
to  use  a  more  common  expression,  it  is  being  "turned  over."  ' 
'  Note  that  it  is  said  in  the  preceding  paragraph  that  the  work- 
ing capital — save,  of  course,  that  in  the  form  of  cash — is  invested 


6i8j$  CORPORATE  FINANCE  [Bk.  II- 

in  various  forms  of  assets  that  are  readily  convertible  into  cash. 
This  is  not  equivalent,  however,  to  saying  that  the  total  value  of 
the  cash  or  cashable  assets  measures  the  net  amount  of  the 
working  capital.  On  the  other  side  of  the  balance  sheet,  there 
may  be — and  usually  is — a  group  of  liabilities,  consisting  chiefly 
of  short-time  bank  loans  and  accounts  payable,  which  must  be 
deducted  from  the  total  of  the  working  assets  in  order  to  deter- 
mine the  net  working  capital.  If  this  were  not  done,  a  firm  which 
had  managed  to  pile  up  a  great  quantity  of  merchandise  debts, 
might  be  considered,  looking  only  at  its  assets,  to  be  well  pro- 
vided with  working  capital,  while  in  truth  it  had  little  or  no. 
surplus  of  working  capital  above  its  current  liabilities.  :  > 

Mention  is  frequently  made  of  "quick  assets"  and  "quick 
liabilities,"  and  the  question  is  sometimes  raised  as  to  the  dis- 
tinction between  them  and  "working"  or  "current"  assets  and 
liabilities.  As  a  matter  of  fact,  there  is  no  clear-cut  or  authori- 
tative distinction.  In  a  general  sense,  however,  the  adjective 
"quick,"  used  in  this  connection  is  reserved  for  assets  or  lia- 
bilities that  have  only  a  short  period — say  30  days  or  less^ — to 
run.  A  stock  of  finished  products  which  are  regarded  as  imme- 
diately salable  might  be  listed  as  a  quick  asset,  whereas  a  stock 
of  half-finished  products  or  of  raw  materials  could  not  be  de- 
scribed as  more  than  a  "working"  or  "current"  asset. 

§  137.    The  First  Westinghouse  Reorganization 

The  history  of  the  Westinghouse  Electric  and  Manufacturing 
Company  already  referred  to  in  an  early  chapter,  offers  a  clear 
and  most  striking  illustration  of  the  necessity  of  using  care  in  the 
investment  of  capital  funds,  and  especially  of  the  advisabiUty  of 
keeping  on  hand  an  ample  supply  of  working  capital.  The 
illustration  is  especially  apt,  because  this  company  has  always 
carried  on  an  extensive  and  profitable  business  and,  so  far  as 
industrial  processes  go,  has  been  conspicuously  well  managed. 
Yet  it  became  twice  embarrassed  as  a  direct  result  of  rapid  ex- 
pansion of  business  without  a  corresponding  increase  of  capital. 


Ch.  14]  FIXED  AND  WORKING  CAPITAL  689 

When  it  was  realized  by  the  officers  of  the  company  in  1890, 
that  the  steady  growth  of  the  business  was  leading  to  a  dangerous 
financial  situation — that  larger  and  larger  current  obligations 
which  could  not  be  met  were  piling  up— it  was  decided  as  an 
emergency  measure  to  increase  the  stock  from  $5,000,000  to 
$10,000,000,  and  to  offer  the  additional  $5,000,000  to  previous 
shareholders  at  the  bargain  price  of  $40  for  each  $50  share.  A 
radical  proposal  of  this  kind,  being  obviously  intended  to  relieve 
pressing  financial  demands,  naturally  aroused  distrust.  West- 
inghouse  himself  subscribed  for  $1,250,000,  other  subscriptions 
amounted  to  $530,400,  so  the  net  amount  realized  by  the  com- 
pany was  less  than  $1,800,000,  which  was  not  enough  to  create  an 
adequate  working  capital.  In  fact,  the  situation  rapidly  became 
worse.  In  the  summer  of  1890  the  company  had  outstanding 
about  $2,000,000  of  notes  covering  merchandise  purchases  and 
bank  loans.  By  the  early  part  of  1891  the  floating  debt  had 
become  over  $3,300,000.  A  financial  reorganization,  with  its 
attendant  frictions  and  losses,  was  then  recognized  as  inevitable. 

§  138.    The  Second  Westinghouse  Reorganization 

After  the  reorganization  of  1891,  the  company  continued  to 
expand  its  business  and  as  a  result  continued  to  meet  serious 
financial  problems.  These  problems  were  not  wholly  the  out- 
growth of  internal  development,  but  were  in  part  a  necessary 
feature  in  the  development  of  the  electrical  industry  as  a  whole. 
The  progress  of  electrical  invention  required  continual  and  exten- 
sive investment  of  capital  for  generating  stations,  transmission 
lines,  and  electrical  machinery.  Throughout  the  country  small 
lighting,  power,  and  traction  companies  were  endeavoring  to 
sell  their  securities  for  just  such  purposes,  but  frequently  without 
much  success.  Yet  it  was  evident  that  their  projects  in  most 
cases  were  sound  and  it  seemed  to  be  necessary  for  the  Westing- 
house  Company,  in  order  to  keep  up  and  develop  its  sales,  to 
assume  a  portion  of  the  burden  of  financing  its  customers.  This 
it  did  by  accepting  in  payment  for  equipment  the  notes  of  these 


6gd 


CORPORATE  FINANCE 


[Bk.  II- 


local  companies,  generally  secured  by  a  deposit  of  their  bonds  and 
stocks  as  collateral.  The  Westinghouse  Company  then  relied  on 
discounting  these  notes,  which  in  normal  times  could  readily  be 
arranged  for.  At  periods  of  credit  restriction,  however,  this 
could  not  be  done,  and  the  Westinghouse  Company  itself  was 
hard  pressed  for  funds  with  which  to  meet  its  own  obligations. 

Between  1891  and  1907,  this  growing  problem  was  success- 
fully solved  by  repeated  sales  of  capital  stock.  In  1896  the 
authorized  capital  was  increased  from  $10,000,000  to  $15,000,000, 
and  in  1901  from  $15,000,000  to  $25,000,000.  At  the  same  time, 
the  company  was  putting  out  several  million  dollars  of  collateral 
and  debenture  bonds.  Nevertheless,  notes  payable  grew 
steadily,  until  in  1901  they  aggregated  $5,000,000,  and  in  1905 
$14,000,000. 

The  company's  ratio  of  current  liabilities  to  current  assets,  of 
current  assets  to  total  assets,  and  of  current  liabilities  to  total 
liabilities,  for  a  period  of  16  years,  is  as  follows:  1 


Current  Liabilities 

Current  Assets 

Current  Liabilities 

to  Current  Assets 

to  Total  Assets 

to  Total  Liabilities 

Feb. 

29,  1892.  .  . 

46% 

12% 

6% 

Mar 

31,  1894... 

22 

34 

8 

« 

31,  1897... 

106 

II 

12 

u 

31,  19OI... 

83 

25 

21 

u 

31,   1902.. . 

71 

27 

19 

u 

31,  1903- •• 

88 

26 

23 

a 

31,   1904... 

lOI 

22 

23 

tt 

31,  1905... 

163 

18 

29 

u 

31,  1906..  . 

66 

22 

14 

u 

31,  1907... 

96 

16 

IS 

Oct. 

31,  1907. •  ■ 

86 

20 

17 

When  the  company  was  finally  compelled  in  1907  to  confess 
its  inability  to  meet  current  obligations  and  a  receiver  was 
appointed,  it  was  at  once  agreed  on  all  sides  that  the  prime  cause 
of  the  failure  was  the  lack  of  sufficient  working  capital. 

There  were,  however,  differences  of  opinion  as  to  the  extent 
of  the  remedy  that  should  be  applied.     The  creditors  were 


»  Dewing  on  Corp.  Prom,  and  Reorg.,  p.  i8r. 


Ch.  14]  FIXED  AND  WORKING  CAPITAL  691 

inclined  to  demand  not  only  the  immediate  relief  that  additional 
working  capital  would  afford,  but  a  more  permanent  relief  in 
the  way  of  a  radical  change  of  financial  policy.  Westinghouse, 
on  the  other  hand,  did  not  believe  that  there  was  anything  funda- 
mentally wrong  with  the  previous  financial  poUcy  of  the  com- 
pany and  sought  only  to  extricate  it  from  its  immediate  entan- 
glement. It  was  finally  agreed  in  the  interest  of  the  creditors 
and  of  all  those  who  were  disposed  to  insist  upon  sound  financing, 
that  a  new  management  should  take  the  reins. 

§  139.    Success  as  a  Cause  of  Failure 

..  There  are  not  many  instances  of  large  enterprises  where  mis- 
calculation and  recklessness  in  financial  affairs  were  combined 
with  so  much  unquestioned  ability  in  handling  mechanical  and 
industrial  affairs  as  in  the  case  of  the  Westinghouse  Company. 
Most  large  and  successful  companies  have  a  better-balanced 
management.  In  small  corporations,  however,  the  same  situa- 
tion is  frequently  found.  The  proprietor  and  manager  of  a 
business,  through  his  personal  energy  and  resourcefulness,  makes 
it  move  ahead  and  earn  good  profits.  To  take  care  of  his  in- 
creasing business  he  extends  his  plant  or  builds  up  his  store  or 
in  some  other  form  enlarges  his  fixed  capital  investment  and 
fixed  expenses.  Thereupon  he  suddenly  wakes  up  to  the  sur- 
prising fact  that,  on  account  of  his  prosperity,  he  is  pressed  harder 
and  harder  for  funds.  Unless  there  is  a  sudden  change  in  his 
methods,  it  is  more  than  likely  that  he  will  drive  rapidly  ahead 
into  bankruptcy.  A  sad  and  constantly  recurring  spectacle  in 
business  life  is  that  of  a  strong  man  beaten  into  failure  through 
his  own  energy  and  ability  in  producing  and  selling. 

§  140.    Estimating  Working  Capital  Requirements 

How  is  it  possible  to  calculate  in  advance  how  much  working 
capital  will  be  required,  and  thus  keep  on  the  safe  side  in  pro- 
viding capital  funds?  It  is  not  possible  to  give  an  exact  answer, 
but  an  approximate  answer  in  any  given  case  may  be  reached. 


692  CORPORATE  FINANCE  [Bk.  II- 

First  of  all,  it  is  clear  that  the  proportion  of  working  capital 
in  some  lines  of  business  is  far  greater  than  in  other  lines.  This 
may  be  illustrated  by  two  extreme  cases.  Telephone  companies 
necessarily  have  large  sums  invested  in  wiring,  poles,  central 
offices,  and  other  equipment.  For  instance,  the  New  York 
Telephone  Company,  December  31,  1920,  out  of  total  assets  of 
approximately  $418,500,000,  had  over  $300,000,000  invested  in 
fixed  assets.  Heavy  proportionately  as  this  investment  may 
seem,  it  is  more  in  seeming  than  reality,  for  after  a  complete  tele- 
phone plant  has  once  been  installed  in  a  community,  the  running 
expenses  consist  simply  in  maintenance  and  in  the  salaries  of 
officers  and  employees,  and  are  comparatively  light.  It  is  the 
custom  for  telephone  companies  to  render  bills  for  their  services 
once  a  month;  the  current  accounts  payable  also  come  in 
monthly  for  the  most  part;  in  consequence  of  this  the  money 
which  is  required  for  running  expenses  from  month  to  month  is 
provided  from  current  receipts.  Evidently  there  is  no  necessity 
in  this  instance  for  large  working  capital,  because  the  current 
receipts  may  safely  be  depended  upon  to  take  care  of  the  current 
outgo. 

On  the  other  hand,  let  us  take  a  retail  store  which  occupies 
rented  quarters.  The  only  fixed  assets  required  will  consist  of 
store  furniture  and  equipment;  all  the  other  assets,  including  the 
stocks  of  merchandise,  the  accounts  receivable,  and  the  cash, 
are  "current"  or  "working."  The  greater  portion  of  the  capital 
that  must  be  invested  in  such  an  enterprise  will  consist  of  work- 
ing capital.  Thus  Montgomery  Ward  and  Company,  at  the 
close  of  1920,  had  total  assets — less  investment  in  real  estate — of 
$47,853,579.  At  the  same  time  their  current  assets  aggregated 
over  $42,000,000.  This  same  preponderance  of  working  capital 
holds  for  practically  all  trading  enterprises,  and  is  particularly 
true  of  financial  enterprises.  Banks  must  keep  all,  or  nearly 
all  of  their  assets  in  such  a  form  as  to  be  converted  into  cash 
almost  at  a  moment's  notice. 

We  may  consider,  therefore,  as  the  first  factor  which  deter- 


Ch.  14]  FIXED  AND  WORKING  CAPITAL  693 

mines  the  requirements  of  working  capital,  the  general  nature  of 
the  business.  In  the  case  of  railroads,  pubUc  utilities,  and  the 
like,  all  or  nearly  all  of  the  investment  will  be  in  fixed  forms.  If 
the  business  is  manufacturing,  a  relatively  small  proportion  will 
consist  of  working  capital.  If  it  is  trading  or  financing,  the  chief 
requirement  will  be  for  working  capital. 

A  second  factor  obviously  is  the  volume  of  business.  Gener- 
ally speaking,  the  necessity  for  working  capital — except  in  the 
first  class  of  business  above  mentioned — will  vary  in  proportion 
to  the  volume  of  sales.  However,  this  statement  assumes  that 
the  factors  mentioned  below  are  uniform  in  their  operation. 
Making  the  assumption  that  methods,  expenses,  and  terms  of 
buying  and  selling  goods  and  of  producing  the  goods  are  stand- 
ardized, then  we  may  safely  say  that  a  50%  increase  in  output 
and  sales  will  necessitate  a  proportionate  increase  in  working 
capital. 

§  141.    Factors  Affecting  Working  Capital  Requirements 

Some  of  the  practical  considerations  that  require  thought  and 
are  helpful  in  making  estimates  of  working  capital  are : 

1.  Length  of  period  of  manufacture. 

2.  Turnover. 

3.  Terms  of  sale. 

4.  Terms  of  purchase. 

5.  Facilities  for  converting  working  assets  into  cash. 

6.  Seasonal  variations  in  business. 

The  procedure  involved  in  making  proper  allowances  for  all 
these  factors  and  of  calculating  in  advance  the  volume  of  working 
capital  that  will  be  needed,  is  of  so  much  importance  that  the 
next  chapter  is  devoted  entirely  to  this  subject. 

§  142.    Estimating  Fixed  Capital  Requirements 

It  has  been  stated  earlier  in  the  chapter  that  it  is  compara- 
tively easy  to  calculate,  before  an  enterprise  is  started,  how  much 
of  an  investment  will  be  required  in  order  to  provide  plant,  ma- 


694  CORPORATE  FINANCE  [Bk.  II- 

chinery,  and  other  fixed  capital.  This  statement  is  true,  assum- 
ing that  the  enterprise  is  simple  and  unified,  and  that  the  pro- 
moters and  managers  know  exactly  what  they  intend  to  do,  and 
do  this  and  nothing  more. 

Unfortunately  this  last  condition  does  not  always  exist.  It 
is  a  common  occurrence  to  find  that  a  company  which  was  started 
to  manufacture  a  given  line  of  goods,  gradually  engages  in  the 
manufacture  of  something  entirely  different.  Or  it  may  con- 
tinue to  manufacture  a  given  line  but  discovers  that  some  new 
process  is  required.  Again,  after  a  company  has  once  developed 
its  own  special  business  successfully,  its  managers  almost  in- 
variably begin  to  thirst  for  fresh  conquests  and  begin  to  take  on 
"side  lines."  Or,  yet  again,  the  managers  of  a  company  which 
has  proved  successful  may  decide  to  make  use  of  the  surplus  that 
is  accumulating,  instead  of  distributing  it  to  the  stockholders,  and 
may  built  up  a  large  account  under  the  head  of  "investments." 

In  figuring  the  requirements  for  fixed  capital,  therefore,  we 
have  to  consider  not  only  the  original  plant  and  equipment 
required  to  bring  the  business  into  existence,  but  also  later 
acquisitions  or  developments  along  any  one  of  the  following  lines: 

1.  Extensions  of  the  original  plant. 

2.  Increases  or  changes  in  equipment. 

3.  Adoption  of  side  lines. 

4.  Outside  investments. 

It  is  in  connection  with  subsequent  changes  or  developments 
along  these  lines  that  most  of  the  opportunities  for  mistakes  and 
miscalculations  in  the  investment  of  capital  in  fixed  forms  arise. 
The  subject  of  such  investments  is  considered  in  some  detail  in  a 
subsequent  chapter.2 

§  143.    Relative  Amounts  of  Fixed  and  Working  Capital 

This  chapter  has  been  devoted,  in  part,  to  emphasizing  the 
necessity  for  providing  adequate  working  capital.     The  result 


« Ch.  XXXIV,  "Expansion." 


Ch.  14]  FIXED  AND  WORKING  CAPITAL  695 

may  be  to  restrict  the  investment  in  fixed  forms  and  thus  to 
Hmit  the  output  and  profit-making  possibilities  of  the  business. 
Nevertheless  such  a  policy  would  insure  a  degree  of  safety,  even 
in  the  presence  of  emergencies,  which  comes  only  from  the 
possession  of  an  adequate  working  capital. 

The  popular  impression  seems  to  be  that  it  is  absolutely 
essential  for  a  corporation  to  possess  fixed  assets  which  will 
enable  it  to  turn  out  its  product,  whatever  that  product  may  be, 
and  that  whatever  sum  is  left  over  will  necessarily  have  to  serve 
as  working  capital.  There  is  probably  no  more  dangerous  fallacy 
in  the  whole  range  of  business  thought  and  action.  The  fact  of 
the  case  is  that,  for  most  corporations,  adequate  working  capital 
is  essential,  while  adequate  fixed  capital  becomes  desirable  and 
necessary  only  after  the  success  of  the  business  has  been  fully 
demonstrated.  This  last  statement  is  not  intended  to  apply,  of 
course,  to  those  lines  of  business,  particularly  transportation  and 
public  utilities,  in  which  a  large  working  capital  is  not  a  requisite. 

To  make  the  case  concrete,  let  us  suppose  that  a  water  power 
company  is  working  out  a  fully  completed  project  for  installing 
a  power  plant  and  for  serving  manufacturing  and  public  utility 
enterprises  throughout  a  given  district.  We  will  assume  that 
contracts  for  delivery  of  all  the  power  that  can  be  produced  have 
already  been  assured  and  that  the  payments  on  these  contracts 
are  to  be  made  monthly  in  advance.  Under  these  conditions,  we 
have  an  instance  of  a  corporation  which  must  have  an  amount  of 
fixed  capital  that  can  be  closely  estimated  in  advance,  and  which 
must  be  sufficient  to  enable  it  to  complete  its  whole  installation. 
It  needs  but  little  working  capital,  for  the  monthly  cash  receipts 
will  be  more  than  sufficient  to  meet  its  monthly  outgo. 

But  let  us  take  also  the  very  common  case  of  a  corporation 
which  is  designed  to  produce  and  sell  a  patented  device.  Fre- 
quently the  first  step  is  to  raise  whatever  fixed  capital  is  required 
to  build  a  plant  and  install  equipment.  Even  though  the  com- 
pany may  have  sufficient  working  capital,  it  is  more  than  likely 
to  find  out  a  little  later  that  the  device  itself,  or  the  methods  by 


696  CORPORATE  FINANCE  [Bk.  II- 

which  it  is  made,  are  not  in  their  final  form  and  much  of  the 
fixed  capital  will  be  wasted. 

A  far  more  sensible  procedure  in  such  cases  would  be  to  have 
the  device  manufactured  during  the  first  year  or  two  by  some 
company  already  equipped  for  work  of  the  kind,  and  then  devote 
all  the  available  capital  to  building  up  a  selling  plan  and  selling 
organization,  to  financing  sales,  to  establishing  the  credit  of  the 
new  corporation,  and  to  working  out  whatever  mechanical  or 
business  improvements  are  found  desirable.  That  is  to  say,  all 
the  resources  at  the  beginning  should  be  kept  in  the  form  of 
working  capital.  After  the  selling  problem  has  been  solved  and 
the  final  form  of  the  product  has  been  determined,  it  will  be  time 
enough  to  proceed  with  the  erection  of  a  plant.  If  this  pro- 
cedure were  more  generally  followed,  there  would  be  fewer 
set-backs  and  failures  in  business. 

A  closely  related  fallacy  is  the  common  idea  that  "more 
capital"  is  needed  in  order  to  make  a  business  move  ahead  suc- 
cessfully, whereas  the  real  need,  ordinarily,  is  for  a  better  use  of 
the  capital  already  available,  and  for  a  demonstration  on  a  small 
scale  that  the  enterprise  can  be  made  a  profit-maker.  After 
that  demonstration  has  been  given,  it  is  usually  comparatively 
easy  to  raise  fresh  capital. 


CHAPTER  XV 

WORKING  CAPITAL  REQUIREMENTS— TIME, 
TURNOVER  AND  TERMS  OF  PURCHASE 

§  144.    Factors  Affecting  Working  Capital 

In  the  preceding  chapter  the  necessity  for  adequate  working 
capital  has  been  emphasized.  The  question  as  to  what  is  to  be 
considered  "adequate"  in  any  given  case,  however,  has  been 
left  open.  It  would  be  too  much  to  expect  that  this  chapter 
should  present  an  exact  arithmetical  answer,  or  even  a  formula 
for  arriving  at  the  answer.  There  are  too  many  variable  factors 
to  be  considered.  It  is  possible,  however,  to  list  and  discuss 
the  most  important  of  these  factors,  and  perhaps  in  this  way 
throw  additional  light  on  one  of  the  most  difficult  and  most  vital 
•problems  in  the  field  of  business  financing. 

As  stated  in  the  preceding  chapter,  the  factors  which  require 
chief  consideration  when  the  amount  of  working  capital  required 
by  a  manufacturing  enterprise  is  to  be  calculated  are  as  follows  : 

1.  Amount  and  cost  of  raw  material. 

2.  Cost  of  labor. 

3.  Overhead. 

4.  Length  of  period  of  manufacture. 

5.  Turnover. 

6.  Terms  of  purchase. 

7.  Terms  of  sale. 

8.  Facilities  for  converting  current  assets  into  cash. 

9.  Seasonal  variations  in  the  business. 

§  145.    Ratio  of  Current  Assets  to  Current  Liabilities 

It  may  be  well  to  repeat  at  this  point  the  definition  of  working 
capital  as  "excess  of  current  assets  over  current  liabilities."     In 

697 


698  CORPORATE  FINANCE  [Bk.  Il- 

transportation  and  other  enterprises  which  do  not  carry  any 
considerable  excess  of  assets  over  liabilities  there  is  but  httle 
working  capital;  in  manufacturing  enterprises  it  is  generally 
considered  that  the  proportion  of  assets  to  liabilities  should  not 
be  lower  than  100  to  75,  or  100  to  80.  Sometimes  the  same  ratio 
is  expressed  in  the  reverse  order,  and  it  is  stated  in  mortgage 
indentures  that  current  assets  shall  never  be  less  than  1333^% 
or  125%  of  current  liabilities.  These  ratios  are  not  in  them- 
selves fixed  and  final  standards.  It  would  be  far  better  to 
determine  the  amount  of  working  capital  in  some  more  definite 
manner;  if  the  amount  is  sufficient,  we  may  be  certain  that  the 
ratio  of  current  liabilities  to  current  assets  will  always  be  well 
within  the  limits  of  safety. 

§  146.    Manufacturing  Costs 

A  company  turning  out  a  product  which  requires  a  consid- 
erable, time  to  manufacture  will  not  only  be  compelled  to  pur- 
chase raw  materials,  pay  for  labor  and  other  expenses  incident 
to  manufacture,  but  also  to  wait  for  a  long  period  before  the 
finished  product  is  ready  to  sell  or  dehver.  Large  amounts  of 
capital  will  necessarily  be  tied  up  in  the  process  of  manufacture 
itself.  As  an  extreme  instance,  take  shipbuilding.  To  build 
and  equip  a  large  vessel  may  require  three  or  four  years.  The 
outlay  may  amount  to  several  millions  of  dollars.  In  case  several 
vessels  are  under  construction  at  the  same  time,  it  is  clear  that 
the  amount  of  capital  invested  by  someone  in  raw  materials, 
partly  finished  products,  and  other  forms  of  working  assets  will 
become  enormous.  This  condition  also  obtains  in  the  erection 
of  large  buildings  or  other  important  pieces  of  construction  which 
may  require  several  years'  time  and  the  investment  of  millions 
of  dollars  before  the  product  is  completed. 

In  these  extreme  instances  the  responsibility  of  providing 
the  expenses  of  construction  is  thrown  in  large  part  upon  the 
purchaser.  Contracts  for  construction  involving  heavy  in- 
vestment in  work  in  process  almost  invariably  provide  for  in- 


Ch.  15]  WORKING  CAPITAL  REQUIREMENTS  699 

spection  and  acceptance  of  the  work  that  has  been  completed 
up  to  given  stages,  or  at  given  intervals,  and  for  payment  on 
account  by  the  purchaser  of  a  proportionate  share  of  the  contract 
price.  This  arrangement  is  customary  even  with  comparatively 
small  pieces  of  construction,  such  as  the  installation  of  bank 
vaults,  the  erection  of  dwellings,  and  the  like, 
i  ,  Even  with  this  proviso,  it  is  usually  the  case  that  construction 
and  contracting  firms  are  called  upon  to  lay  out  large  sums  and 
to  wait  for  a  considerable  period  before  they  are  reimbursed, 
and  it  is  quite  necessary,  therefore,  that  their  working  capital 
should  be  correspondingly  ample.  There  is  scarcely  any  line  of 
business  in  which  insolvencies  are  more  frequent  than  in  con- 
tracting. The  explanation  is  nearly  always  the  same;  the 
working  capital  of  the  contracting  firm  was  not  sufficient  to 
"swing"  its  undertakings.  This  is  a  difficulty  which  is  peculiarly 
apt  to  confront  enterprising,  progressive, and  otherwise  successful 
contractors. 

§  147.    Time  as  a  Cost  Factor 

In  the  extreme  instances  that  have  just  been  cited,  the 
necessity  of  securing  either  an  exceptionally  large  working 
capital  or  a  series  of  payments  on  account  in  advance  of  de- 
livery of  the  finished  product,  is  universally  recognized.  But 
there  are  numerous  less  extreme  cases  in  which  the  importance 
of  this  factor  seems  to  be  overlooked.  In  many  processes  of 
manufacture,  time  is  one  of  the  important  elements.  This  is 
true  particularly  in  handling  "green"  products  such  as  lumber 
and  hides;  in  making  pianos  where  seasoned  materials  must  be 
used;  in  developing  suburban  real  estate ;  and  so  on  indefinitely. 
The  moment  an  effort  is  made  to  rush  the  process  of  turning  out 
a  finished  product  in  any  of  these  lines,  the  result  is  either  a 
great  increase  in  expense  or  an  impairment  in  quality.  And  in 
most  cases  it  is  not  practicable  to  secure  payment  from  the  pur- 
chaser in  advance  of  delivery  of  the  finished  product.  Under 
such  conditions  large  sums  of  working  capital  must  be  provided. 


700  CORPORATE  FINANCE  [Bk.  II- 

§  148.    Price  Variations 

Moreover,  there  is  a  danger  connected  with  long-process 
manufacturing,  not  on  contract  but  for  the  general  market,  that 
fluctuations  in  prices  may  diminish  or  wipe  out  expected  profits. 
To  take  care  of  such  fluctuations  and  to  carry  the  company 
through  periods  of  distress  which  may  result,  it  is  essential  both 
that  the  average  profits  should  be  high  and  that  the  supply  of 
working  capital  should  be  ample. 

This  was  one  of  the  main  sources  of  trouble  for  the  United 
States  Leather  Company  when  the  combination  was  first  formed ; 
between  the  date  of  purchase  of  green  "packer"  hides  in  this 
country  and  the  actual  sale  of  the  finished  leather,  from  six  to 
twelve  months  usually  elapsed.  Between  the  purchase  of 
Argentine  hides  and  the  sale  to  a  foreign  consumer,  this  period 
might  be  extended  to  a  year  and  a  half  or  more.  At  a  time  of  fall- 
ing prices,  the  prices  of  hides  may  lag  behind  that  of  leather.  As  a 
result  of  such  a  condition,  in  the  middle  nineties,  the  United 
States  Leather  Company  repeatedly  sold  leather  for  less  than  its 
cost  of  production.  In  1920  huge  losses  were  again  suffered  by 
the  leather  companies.  For  the  Central  Leather  Company — 
successor  to  the  United  States  Leather  Company — a  net  profit 
of  $15,748,837  in  1919  turned  into  a  deficit  of  $21,075,290  in 
1920. 

§  149.    Variations  of  Demand 

Still  another  handicap  to  a  business  in  which  the  period  of 
manufacture  is  lengthy,  is  the  impossibiUty  of  making  quick 
adjustments  to  market  conditions.  By  way  of  contrast,  consider 
the  case  of  a  company  at  the  other  end  of  the  scale — a  bread- 
baking  company,  which  manufactures  overnight  the  product 
that  it  sells  the  next  morning.  If  there  were  to  be  a  sudden 
shifting  of  demand  from  one  kind  of  bread  to  another,  or  even 
away  from  bread  altogether  toward  some  other  kind  of  food,  the 
bakers  obviously  could  adjust  themselves  to  the  change  in  short 
order.     The  leather  manufacturer  has  no  such  advantage.     He 


Ch.  15]  WORKING  CAPITAL  REQUIREMENTS  701 

is  continually  tied  up  with  enormous  quantities  of  hides  and  of 
leather  in  the  various  stages  of  manufacture.  It  is  at  least 
expensive,  and  in  many  cases  impossible,  for  him  to  shift  from 
one  kind  of  product  to  another.  He  may  suffer — and  in  fact 
many  leather  manufacturers  have  suffered — severe  losses  due 
simply  to  changes  in  taste  on  the  part  of  the  consuming  public. 

It  is  clear  from  all  this,  that  the  length  of  period  of  manu- 
facture is  an  important  factor  in  determining  how  much  working 
capital  a  coiporation  will  need.  A  breadmaker  does  not  risk  as 
much  in  proportion  to  the  volume  of  his  business  as  does  the 
leather  manufacturer;  for  he  has  scarcely  paid  for  his  flour  and 
labor  before  the  receipts  from  his  sales  flow  back  to  him. 

One  important  improvement  in  automobile  manufacturing 
which  has  put  it  on  a  safer  and  more  stable  basis,  is  the  reduction 
in  the  length  of  time  required  for  turning  out  finished  cars. 

§  150.    Turnover 

A  factor  closely  related  to  the  time  element  is  the  rapidity  of 
turnover  of  working  capital.  Although  the  word  "turnover" 
has  come  to  be  highly  popular,  there  is  a  remarkable  absence  of 
clear-cut,  authoritative  definition.  Observation  of  customary 
usage,  however,  makes  it  plain  that  its  meaning  in  the  minds  of 
merchants  and  manufacturers  is  always-  the  same.  "The  turn- 
over of  a  merchant  or  manufacturer  represents  the  number  of 
times  his  capital  in  the  form  of  stock-in-trade  is  reinvested  in 
stock-in-trade  during  a  given  period. "1  It  is  the  figure,  in  other 
words,  which  shows  how  many  times  the  amount  invested  in 
goods  has  been  traded  in,  or  "turned  over"  during  the  year. 

We  hear  a  great  deal  about  turnover  in  trading- operations, 
particularly  in  retail  merchandising,  and  comparatively  little 
about  it  in  manufacturing  operations.  It  is,  to  be  sure,  relatively 
of  greater  importance  to  the  merchandiser  than  to  the  manu- 
facturer, but  it  is  by  no  means  unimportant  to  the  latter.  As 
has  previously  been  remarked,  almost  all  the  assets  of  a  trading 

'  1  Montgomery  on  Auditing,  p.  444. 


702  CORPORATE  FINANCE  [Bk.  II- 

concern  are  working  assets;  the  only  capital  invested  in  fixed 
assets  is  that  which  is  given  up  to  office  furniture,  store  equip- 
ment, and  the  like.  Both  the  wholesaler  and  retailer  customarily 
buy  on  fairly  liberal  terms  of  credit  and  endeavor  to  sell  the 
merchandise  and  make  collections  before  their  bills  for  the  mer- 
chandise fall  due.  If  they  could  always  be  sure  of  accomplishing 
this  result,  there  would  be  no  necessity  for  their  possessing  work- 
ing capital;  but,  as  we  shall  shortly  see,  there  is  a  strong  tendency 
in  this  country  toward  shortening  the  period  during^  which  mer- 
chandise bills  run  and  there  is  also  an  ever-present  uncertainty 
as  to  the  retailer's  ability  to  dispose  of  his  products  within  any 
fixed  period;  consequently,  for  both  these  reasons,  the  whole- 
saler is  called  upon  to  provide  a  certain  amount  of  working  capi- 
tal and  often  a  very  large  amount.  The  manufacturer's  pro- 
portion of  working  capital  to  fixed  capital  is  much  smaller  than 
the  trader's  proportion.  Nevertheless,  up  to  the  extent  of  his 
investment  in  working  capital,  he  is  interested  as  well  as  the 
trader  in  turnover. 

§  151.    Rapidity  of  Turnover 

It  is  clear  that  the  quicker  the  turnover,  the  larger  the  volume 
of  business  that  can  be  conducted  with  a  given  working  capital. 
If  a  retail  store,  for  instance,  is  handling  a  product  for  which  there 
is  a  great  demand  and  which  can  be  sold  almost  as  rapidly  as  it 
is  stocked,  the  gross  sales  will  be  large  and  the  investment  in 
stock  will  usually  be  small.  If  sales,  on  the  other  hand,  are 
irregular  and  slow,  the  amount  of  working  capital  invested  in 
stock  will  necessarily  be  comparatively  heavy. 

This  is  the  first  element  in  determining  the  rapidity  of  turn- 
over. A  daily  newspaper  stand  will  necessarily  have  a  very 
rapid  turnover,  for  most  of  the  capital  invested,  plus  the  dealer's 
profit,  will  be  realized  in  cash,  at  least  once  and  perhaps  several 
times  a  day.  The  turnover  for  the  newsdealer,  under  the  above 
conditions,  is  500  to  700  times  per  year.  As  soon  as  the  news- 
dealer adds  a  stock  of  magazines  and  books,  which  sell  more 


Ch.  15]  WORKING  CAPITAL  REQUIREMENTS  703 

slowly, investment  in  stock  increases  and  his  turnover  decreases. 
Far  towards  the  other  end  of  the  scale  is  a  great  jewelry  store  such 
as  Tiffany's,  in  which  it  is  necessary  to  provide  an  immense  stock 
of  valuable  goods  from  which  the  customer  may  choose,  while 
at  the  same  time  the  sales  are  comparatively  irregular  and  infre- 
quent. Evidently  the  turnover  in  a  business  of  this  kind  must 
be  slow. 

§  152.    Increasing  the  Turnover 

In  addition  to  the  timeliness  of  the  merchandise  that  is  carried 
for  sale  and  the  degree  of  standardization  of  the  merchandise, 
which  determines  how  much  stock  must  be  carried  in  order  to 
give  a  satisfactory  range  of  choice  to  the  customer,  another 
element  that  determines  rapidity  of  turnover  is  the  sales  policy 
of  the  merchandising  firm.  If  the  sales  efforts  are  strongly 
directed  toward  disposing  of  a  given  stock  of  goods  quickly — if 
necessary,  making  a  sacrifice  in  price  or  incurring  an  extraordin- 
ary selling  expense  in  order  to  achieve  this  result — the  rate  of 
turnover  will  clearly  be  higher  than  in  case  there  is  no  definite, 
clearly  thought-out  sales  policy.  Right  here  is  the  point  at  which 
the  financing  of  great  numbers  of  retail  stores  breaks  down.  If 
a  proprietor  fails  to  recognize  the  great  importance  of  achieving 
volume  of  sales  and  rapidity  of  turnover,  even  though  an  inci- 
dental sacrifice  of  profits  here  and  there  may  be  involved,  the 
result  is  that  his  shelves  gradually  become  loaded  with  unsalable 
goods;  his  receipts  are  not  sufficient  to  meet  promptly  all  his 
obligations  for  merchandise;  his  bills  accumulate  and  his  credit 
declines;  and  eventually  he  finds  himself — usually  to  his  own 
surprise — in  a  receivership  or  in  bankruptcy. 

§  153.    Manufacturing  Turnover 

Precisely  the  same  elements  determine  the  rapidity  of  turn- 
over in  manufacturing  concerns.  The  timeliness  or  immediate 
salability  of  the  manufactured  product  determines  whether  he 
keeps  his  stock  of  raw  materials,  half-finished  products,  and  fin- 


704  CORPORATE  FINANCE  [Bk.  II- 

ished  products  moving,  or  whether  it  piles  up  on  his  hands. 
Second,  by  standardization  of  his  product,  accompanied  by 
advertising  which  impresses  the  consumer  with  the  superiority 
of  the  standardized  product,  the  manufacturer  may  cut  down  the 
number  of  his  styles  or  varieties.  The  automobile  manufacturers 
have  learned  that  one  or  two  styles  of  chassis,  each  with  two  or 
three  styles  of  body,  is  an  ample  line  for  any  one  manufacturer. 
Those  that  have  been  most  successful  do  not  offer  even  this  much 
of  a  choice.  Thousands  of  manufacturers  are  still  turning  out  a 
large  variety  of  products  to  meet  the  tastes — often  the  whims — 
of  customers,  when  it  would  be  possible  for  them  to  standardize 
both  the  demand  and  their  own  output  and  thus  increase  to  a 
wonderful  extent  their  turnover.  The  third  element — definite 
sales  policy  which  endeavors  to  "clean  up"  accumulating  stock — 
is  almost  as  essential  to  the  successful  manufacturer  as  to  the 
merchandiser. 

In  determining  the  rapidity  of  turnover  the  manufacturer  is 
more  or  less  circumscribed  by  one  element  that  does  not  affect 
the  merchandiser,  namely,  the  length  of  period  of  manufacture. 
The  merchandiser  buys  only  finished  products,  and  in  order  to 
attain  a  satisfactory  turnover  has  only  to  stimulate  the  sales. 
The  manufacturer,  however,  if  his  period  of  production  is  lengthy, 
will  necessarily  have  a  small  ratio  of  turnover  no  matter  what 
sales  efforts  he  may  put  forth. 

§  154.    Rate  of  Turnover 

It  would  be  impossible  to  state  definite  figures  for  turnover  in 
the  various  lines  of  business.  In  general  retail  store  merchan- 
dising, the  turnover  has  been  known  to  go  as  high  as  8  or  10, 
but  this  is  exceptional.  Ordinarily  2,  3  or  4 — depending  on  the 
location  of  the  store,  the  class  of  goods  carried,  and  so  on — would 
be  regarded  as  a  satisfactory  turnover. 

Investigations  carried  on  by  the  Bureau  of  Business  Research 
of  Harvard  University  show  that  the  annual  rate  of  turnover  in 
retail  shoe  stores  ranges  from  .7  up  to  5.1.     The  turnover  in  a 


Ch.  15]  WORKING  CAPITAL  REQUIREMENTS  705 

large  number  of  these  stores  was  found  to  be  1.8,  and  the  Bureau 
considers  a  turnover  of  2.5  as  a  reaHzable  standard  in  the  average 
retail  shoe  store.  In  retail  hardware  the  rate  of  turnover 
ranged  from  .85  to  5.75,  a  common  figure  was  1.8  but  "enough 
stores  turn  their  stock  at  least  2.5  times  to  indicate  that  this  is 
a  fairly  realizable  goal."  In  retail  groceries  the  turnover 
ranged  from  3.5  to  23.8,  with  7  as  a  common  figure  and  12  as  a 
standard  to  be  aimed  at.  For  wholesale  groceries  the  turnover 
ranged  from  2.8  to  11.6  times  a  year,  with  5.7  as  a  common 
figure. 

§  155.    Terms  of  Purchase — ^Discounts 

If  an  enterprise  is  paying  cash  for  everything  it  buys  and  is 
selling  on  credit,  it  will  obviously  need  a  working  capital  sufficient 
to  purchase  outright  its  entire  stock  of  goods,  including  every- 
thing that  has  been  sold  but  not  yet  paid  for.  On  the  other 
hand,  if  the  enterprise  is  able  to  buy  on  long  credit  and  sell  for 
cash,  it  can  provide  its  whole  stock  with  no  immediate  outlay 
and  will  pay  its  bills  as  they  mature  out  of  receipts  from  its  own 
sales.  Ordinarily  neither  one  of  these  extreme  arrangements 
prevails.  Goods  are  both  bought  and  sold,  at  least  in  part,  on 
a  credit  basis. 

The  tendency  within  the  United  States,  however,  during  the 
last  two  or  three  decades — and  especially  during  the  time  of  the 
Great  War — has  been  strongly  toward  reducing  the  length  of 
credit  available  to  purchasers  of  raw  materials  and  of  goods  for 
resale.  This  reduction  in  the  period  of  credit  has  for  the  most 
part  been  brought  about,  not  by  an  exercise  of  pressure,  but  by 
granting  special  "concessions"  to  those  who  were  able  to  pay 
cash  or  to  pay  within  10  to  30  days.  Gradually,  as  these  conces- 
sions have  come  to  be  more  and  more  accepted,  the  competition 
among  retailers  has  made  it  more  and  more  necessary  that  they 
should  be  accepted.  Moreover,  the  increasing  tendency  in  this 
direction  has  now  made  it  the  custom  in  many  lines  of  business 
to  purchase  for  cash  or  on  short  time,  and  has  therefore  placed 


7o6  CORPORATE  FINANCE  [Bk.  li- 

the sellers  of  merchandise  in  a  position  to  insist  upon  prompt 
payment. 

In  retail  stores,  for  example,  40  years  ago  it  was  not  uncom- 
mon, nor  was  it  considered  improper,  for  a  retail  merchant  to 
purchase  a  line  of  goods  on  six  months'  time.  Sometimes  he  was 
compelled  to  ask  for  further  extensions.  A  little  later  some  of 
the  wholesalers  who  felt  the  need  of  more  available  cash  in  their 
own  business  began  to  offer  liberal  discounts  for  payment  within 
30  to  60  or  90  days ;  and  well-to-do  retail  merchants  gladly  took 
advantage  of  these  discounts.  Other  merchants,  as  will  be  more 
fully  explained  later  on,  saw  the  advantage  to  themselves  of 
borrowing  from  their  local  banks  at  fairly  low  rates  of  interest 
to  secure  funds  with  which  they  could  take  advantage  of  the 
discounts  offered  them.  After  this  custom  became  firmly 
established,  the  wholesalers  began  to  expect  prompt  payment, 
and,  although  the  terms  were  still  nominally  three  months  to 
six  months  with  a  discount  for  anticipating  payment,  the 
wholesaler  based  his  calculations  on  the  cash  price  and  the  so- 
called  "discount"  came  to  be  more  and  more  in  the  nature  of  a 
penalty  imposed  upon  those  who  failed  to  pay  their  bills  within 
10  to  30  days.  So  well  is  this  understood  at  the  present  time, 
that  a  merchant  who  fails  to  take  advantage  of  the  cash  discount 
offered  to  him  is  soon  looked  upon  with  suspicion. 

The  discount  plan  is  made  possible  in  this  country  only  by 
the  existence  of  great  numbers  of  local  banks.  The  local  mer- 
chant is  in  position  to  borrow  from  these  banks  and  thus  to  take 
upon  his  own  shoulders  the  whole  burden  of  financing  his  pur- 
chases of  goods. 

The  effect  on  working  capital  of  this  trend  towards  the  cash 
discount  system  is  self-evident.  When  the  purchases  of  a  firm 
are  made  on  long-term  credits  and  money  is  collected  from  sales 
before  the  corresponding  obligations  fall  due,  working  capital  is 
required  only  to  take  care  of  emergencies.  But  when  the  pur- 
chaser undertakes  to  discount  his  bills  for  goods,  i.e.,  pay  cash, 
he  must  either  possess  so  much  working  capital  that  he  can  make 


Ch.  is]  working  capital  REQUIREMENTS  707 

payment  out  of  his  own  resources,  or  at  least  he  must  possess 
enough  to  provide  a  margin  of  safety  which  will  enable  him  to 
borrow  from  banks  without  question  and  on  favorable  terms. 
The  shorter  the  period  of  credit  that  is  customarily  used  by  a 
firm  in  making  purchases,  the  larger  must  be  the  working  capital 
of  the  firm. 

§  156.    The  Trade  Acceptance  • 

Another  variation  of  method  in  financing  a  purchase  of  goods 
is  by  means  of  the  trade  acceptance.  This  is  a  draft,  usually  at 
30,  60  or  90  days,  drawn  by  the  seller  upon  the  purchaser  at  the 
time  the  goods  are  purchased  and  accepted  by  the  purchaser. 
This  gives  a  two-name  paper  readily  discountable.  Under  this 
system  the  seller  of  the  goods,  either  through  his  own  resources  or 
through  his  banking  connections,  attends  to  the  financing  of  the 
transaction.  There  is  in  this  country  a  trend  towards  the  use  of 
the  acceptance  when  goods  are  sold. 


CHAPTER  XVI 

WORKING  CAPITAL  REQUIREMENTS— TERMS 
OF  SALE,  SPECIAL  PROBLEMS 

§  157.    Terms  of  Sale 

Looking  now  at  dealings  in  raw  materials  and  merchandise 
from  the  seller's  point  of  view,  let  us  consider  the  effect  upon 
working  capital  of  the  customary  or  average  terms  of  sale. 

So  far  as  dealings  between  producers  and  those  who  purchase 
for  manufacture  or  resale  are  concerned,  these  dealings  have  been 
discussed  at  sufficient  length  in  the  preceding  pages.  It  is 
enough  here  to  state  the  corollary  of  the  conclusion  therein 
reached,  viz.,  the  longer  the  period  of  credit  which  it  is  necessary 
to  extend  in  effecting  sales,  the  larger  must  be  the  amount  of 
working  capital. 

Take  for  instance  the  conditions  that  obtain  in  the  export 
trade.  In  this  the  European  custom  is  followed  of  drawing 
a  draft  upon  the  purchaser  at  the  time  the  goods  are  shipped.  In 
the  South  American  trade  this  draft  is  usually  due  for  payment 
90  days  after  the  goods  have  arrived  at  their  destination;  on 
arrival  of  the  goods,  therefore,  it  is  expected  that  the  purchaser 
will  promptly  inspect  them  and,  if  they  are  in  accordance  with 
his  order,  will  "accept"  the  draft  which  in  the  meantime  will 
have  been  presented  to  him  for  the  purpose  by  one  of  his  local 
banks.  Inasmuch  as  it  requires  at  least  a  month,  or  usually 
more  on  an  average,  to  secure  delivery  of  shipments  from  this 
country  to  South  American  countries,  and  another  month  is 
required  before  funds  paid  at  a  South  American  city  can  be 
transferred  by  mail  to  a  city  within  the  United  States,  there  is  an 
interval  of  at  least  five  months  to  be  bridged  over  between  the 

'  708 


Ch.  i6]  WORKING  CAPITAL  REQUIREMENTS  709 

date  of  shipment  and  the  date  of  receiving  payment — one  month 
for  the  shipment  and  draft  to  reach  destination,  three  months 
until  maturity  of  the  draft,  and  one  month  thereafter  until  pay- 
ment reaches  the  shipper  in  the  United  States.  It  should  be 
borne  in  mind,  also,  that  five  months  is  almost  the  minimum 
period.  In  case  it  is  desirable  or  necessary  to  renew  the  draft,  or 
in  case  communication  requires  more  than  one  month,  the  period 
before  final  payment  is  received  may  drag  out  to  six  or  nine 
months  or  even  more. 

Under  such  conditions,  if  a  manufacturer  is  to  build  up  export 
trade  as  an  important  feature  of  his  business,  it  is  evident  that 
he  must  either  provide  a  great  addition  to  his  working  capital  or 
he  must  have  assistance  of  some  kind  in  financing  this  export 
trade.  Usually  he  arranges,  either  by  discounting  his  drafts  or 
by  securing  loans  on  the  strength  of  his  export  business,  to  make 
it  finance  itself,  in  part  at  least. 

b.7t;rn'} 
§  158.    Instalment  Sales 

A  highly  important  feature  of  modern  American  business 
practice  which  calls  for  special  consideration,  is  the  custom  of 
making  retail  sales  of  high-priced  goods  on  the  instalment  plan. 
Originally,  selling  on  the  instalment  plan  was  confined  largely 
to  high-priced  sets  of  books  and  a  few  other  articles  of  luxury. 
At  the  present  time,  however,  it  is  the  customary  plan  of  sale 
in  such  widely  separated  lines  as  pianos,  suburban  real  estate, 
agricultural  machinery,  courses  of  instruction,  and  sewing 
machines.  It  is  being  introduced  more  and  more  also  in  selling 
clothing,  furniture,  jewelry,  motor  cycles,  automobiles,  and 
many  other  articles. 

A  serious  financial  problem  confronts  the  manufacturer  or 
retailer  who  adopts  the  instalment  plan.  Frequently  it  has 
been  adopted  without  the  slightest  realization,  apparently,  that 
it  involves  any  financial  problem.  As  a  result,  hundreds — 
thousands — of  instalment  houses  in  various  lines  of  business  have 
found  the  burden  of  carrying  instalment  sales  too  heavy  and  have 


7IO  CORPORATE  FINANCE  [Bk.  II- 

been  wound  up  in  bankruptcy  proceedings.    As  a  result  of  this, 
the  whole  method,  no  matter  how  it  may  be  applied,  has  come  to 
be  looked  upon  by  bankers  with  much  distrust.     Here,  again^,.. 
some  discrimination  should  be  used.       rjim'idic  'at>i  inam 

The  financial  difficulty  arises  out  of  the  simple  fact  that-  the  i 
whole  cost  of  the  product  that  is  being  sold,  plus  the  cost  of  r 
selling  and  of  overhead  administration,  is  paid  out  or  carried  in  i 
some  way  by  the  instalment  house  before  the  product  is  delivered  ] 
to  the  customer;   whereas  payment  for  the  product  is  received 
only  in  small  periodic  amounts  extending  usually  over  several 
months.     In  disposing  of  real  estate  on  the  instalment  plan,  it 
is  not  uncommon  for  payments  to  be  spread  over  five  to  ten  years 
or  even  longer.     In  selling  pianos   the  payments   frequently 
spread  over  as  long  as  three  years;  in  selling  furniture,  agricul- 
tural machinery,  and  the  like,  the  term  of  payment  is  customarily 
about  one  year. 

A  secondary  financial  difficulty  arises  out  of  the  fact  that  a 
certain  proportion  of  the  sales  will  be  made  to  people  who  can- 
not, or  will  not,  live  up  to  their  contracts.  The  manufacturer 
or  retailer  may  then  proceed  to  take  back  his  goods,  but  they  will 
usually  be  in  a  damaged  condition.  In  any  case  the  expense  of 
making  and  handling  the  sale  and  of  attempting  to  collect  the 
instalment  payments  will  have  been  incurred  and  cannot  be 
recovered.  The  expenses  and  losses  of  collection  together  con- 
stitute an  item  that  must  be  carefully  calculated  and  taken  into 
consideration  in  every  instalment  business. 

The  simplest  and  one  of  the  most  common  forms  of  instal- 
ment contract  is  an  agreement  on  the  part  of  the  purchaser  to 
pay  the  fixed  price  of  the  article  he  acquires  at  the  periods  and  in 
the  amounts  agreed  upon,  in  return  for  which  the  purchaser 
obtains  full  possession  of  and  title  to  the  goods.  The  seller  under 
this  agreement  has  practically  nothing  except  an  open  account 
against  the  purchaser. 

Where  the  amount  involved  in  each  sale,  however,  is  large, 
or  where  it  is  desirable  to  reserve  as  full  protection  as  possible  for 


Ch.  i6]  WORKING  CAPITAL  REQUIREMENTS  71 1 

the  selling  house  in  order  to  satisfy  bankers'  requirements,  two 
variations — both  designed  for  the  protection  of  the  seller — may- 
be introduced.  One  of  these  variations  consists  in  retaining 
title  to  the  property  even  though  it  is  in  the  hands  of  the  pur- 
chaser, until  after  the  agreed  price  has  been  paid  in  full.  This 
is  legally  allowable  in  most  of  the  states  and  is  the  arrangement 
when  equipment  is  sold  to  railroad  companies.  It  is  customary 
in  selling  pianos,  furniture,  real  estate,  and  many  other  high- 
priced  articles. 

The  second  variation  is  that  of  requiring  the  purchaser  to 
give  a  series  of  notes  covering  his  instalment  payments.  This 
puts  the  transaction  into  a  much  more  definite,  irrevocable  form, 
and  also  where  the  amounts  are  large  enough  to  justify  notes, 
assists  the  seller,  as  we  shall  see  presently,  in  making  his  financial 
arrangements. 

§  159.    Working  Capital  Requirements  of  Instalment  Sales 

Coming  now  to  the  financial  problem  of  carrying  on  an 
instalment  business,  let  us  take  the  hypothetical  case  of  a  product 
which  sells  at  a  retail  price  of  $100.  We  will  say  that  the  cost 
to  the  manufacturer  or  retailer  is  $60,  the  selling  expense  is  $20, 
and  the  overhead  charges,  including  collection  expense  and  loss, 
are  $10,  leaving  a  net  profit  on  each  article  of  $10.  We  will 
assume  that  50  of  the  articles  are  sold  during  the  first  month  of 
operation;  100  the  second  month;  150  the  third  month;  200  the 
fourth  month;  and  thereafter  200  each  month;  and  that  instal- 
ment payments  are  made  at  the  rate  of  $10  per  month.  In  order 
to  simplify  the  problem,  we  will  make  the  arbitrary  assumption 
that  the  whole  $90  outgo,  including  collection  expense  and  loss, 
is  incurred  at  the  time  each  sale  is  made.  Under  these  assumed 
conditions,  how  much  working  capital  will  be  required  to 
"swing"  the  stated  volume  of  business?  During  the  first  month 
the  outgo  would  be  50  times  $90,  or  $4,500,  and  the  cash  receipts 
would  be  50  times  $10,  or  $500,  leaving  a  cash  deficiency  of 
$4,000.     During  the  second  month  the  outgo  would  be  100  times 


712 


CORPORATE  FINANCE 


[Bk.  n- 


$90,  or  $9,000,  while  the  receipts  would  be  $500  covering  sales 
made  during  the  first  month,  plus  $1,000  for  sales  during  the 
second  month,  making  a  total  of  $1 ,500 ;  leaving  a  cash  deficiency 
of  $7,500.  Putting  these  and  succeeding  calculations  into  tabu- 
lar form,  they  would  be  as  follows : 


First 

Second 

Third 

Fourth 

Fifth 

Sixth 

Seventh 

Eighth 

Ninth 

Tenth 

Eleventh 

Twelfth 

*Excess  Receipts. 


Outgo 

month $  4,500 

9,000 


i•ic^:l•■:fi 


13.500 
18,000 
18,000 
18,000 
18,000 
18,000 
18,000 
18,000 
18,000 
1 8,000 


Receipts 

$      500 

1,500 

3,000 

5.000 

7,000 

9,000 

11,000 

13,000 

15,000 

17,000 

18,500 

19,500 


Cash 
Deficiency 
for  Month 
$  4,000 
7.500 
10,500 
13,000 
11,000 
9,000 
7,000 
5,000 
3,000 
1,000 
500* 
1,500* 


Accumu- 
lating 
Deficiency 

$  4,000 
11,500 
22,000 
3S,ooo 
46,000 
55.000 
62,000 
67,000 
70,000 
71,000 
70,500 
69,000 


It  is  clear  from  the  above  table  that,  in  case  the  instalment 
seller  intends  to  carry  the  whole  burden  of  financing  on  his  own 
shoulders,  he  must  be  prepared  with  a  working  capital  amounting 
at  a  maximum  to  $71,000.  Unless  his  business  afterwards 
increases  more  rapidly  than  his  cash  receipts,  he  will  be  able 
later  to  draw  large  profits  in  cash  which  are  the  accumulated 
results  of  sales  that  he  has  made  during  the  preceding  months. 

§  160.    Financing  Instahnent  Sales 

The  case  above  given  is  necessarily  crude,  for  within  the 
space  limits  that  can  be  assigned  to  the  subject  in  this  volume 
it  would  be  impossible  to  enter  into  all  the  intricacies  of  the  cal- 
culations that  would  be  required  in  any  actual  case.  The 
figures  presented,  however,  serve  to  emphasize  one  principle 
which  must  be  borne  in  mind  in  connection  with  all  instalment 
financing : 


Ch.  i6]  WORKING  CAPITAL  REQUIREMENTS  713 

During  a  period  of  rapidly  increasing  business  the  cash 
receipts  cannot  keep  pace  with  the  volume  of  sales  and  the  outgo. 
Accordingly  cash  receipts  pile  up  much  more  slowly  than  sales; 
and  the  first  stage  in  building  up  an  instalment  business,  there- 
fore, is  a  stage  of  heavy  investment  and  of  patient  waiting.  No 
matter  what  profits  may  be  figured  on  the  volume  of  business 
that  is  being  done,  it  is  evident  that  the  realization  of  those 
profits  in  cash  will  necessarily  be  deferred  to  a  later  period,  and 
this  preliminary  state  may  last  for  several  years. 

The  question  arising  in  connection  with  every  instalment 
business,  therefore,  is:  What  can  be  done  to  shift  some  of 
the  financial  burden  of  building  up  the  business  from  its  own 
shoulders  to  the  shoulders  of  its  bankers  or  of  other  financial 
agencies? 

Ordinarily  this  may  be  done  in  one  of  three  ways : 

.  ,  ,  J.  By  securing  a  large  line  of  credit  from  the  bank  simply 
on  the  strength  of  its  general  showing  of  profits  and 
its  accumulating  assets,  consisting  of  instalment  ac- 
counts receivable.  , , 

2.  By  securing,  as  indicated  above,  notes  from  its  purchasers 

which  may  be  discounted. 

3.  By  making  arrangements,  not  with  a  bank,  but  with  a 

financing  company,  which  will  either  purchase  the 
instalment  accounts  or  notes  receivable,  or  will  make 
advances  against  these  accounts  or  notes  when  put  up 
as  collateral.  ^ 

This  last  method  brings  us  to  the  subject  of  converting  assets 
into  cash,  which  is  treated  in  the  next  section. 

§  161.    Liquidity  of  Assets 

A  distinction  is  to  be  made  between  cash  and  other  quick 
assets ;  under  the  latter  classification  are  to  be  included  account? 
and  notes  receivable  that  mature  within  a  few  days,  and  mer- 
chandise which  is  already  sold  or  is  readily  salable  for  cash.    The 


714  CORPORATE  FINANCE  [Bk.  II- 

only  asset  that  is  acceptable  in  settling  bills  is  cash,  but  other 
assets  that  are  really  "quick"  may  be  counted  as  almost  equiva- 
lent to  cash. 

Those  current  assets  which  are  convertible  into  cash  only  after 
a  considerable  lapse  of  time  or  after  considerable  effort,  belong  in 
a  different  category.  It  is  dangerous  to  count  on  them  as  if 
they  were  cash,  for  numerous  contingencies  may  interfere  with 
their  being  converted  into  ready  cash  at  the  time  that  has  been 
anticipated.  Many  a  merchant  has  found  himself  suddenly 
faced  with  bankruptcy  because  he  counted  merchandise  on  his 
shelves  as  if  it  were  already  sold  and  later  found  it  to  be  un- 
salable; or  because  he  looked  upon  accounts  receivable  on  his 
books  as  if  they  were  already  collected  and  later  found  that  some 
of  his  important  customers  were  themselves  embarrassed  or  were 
"slow  pay."  It  is  because  these  contingencies  exist,  that  it  is 
necessary  in  the  prudent  management  of  most  business  concerns 
to  maintain  current  assets  at  an  aggregate  figure  considerably 
exceeding  current  liabilities.  In  manufacturing  concerns,  as  we 
have  seen,  the  current  assets  are  usually  regarded  as  normal  if 
they  are  in  the  proportion  of  125%  to  133%  of  the  current  lia- 
bilities. 

The  more  readily  the  current  assets  of  a  corporation  are  con- 
vertible into  cash,  the  less  need  be  the  proportion  of  current 
assets  to  current  liabilities,  or,  to  state  the  same  thing  in  other 
terms,  the  less  need  be  the  working  capital  of  the  concern.  It 
is  clear  that  if  working  assets  consist  exclusively  of  cash,  all  the 
requirements  of  safety  would  be  met  if  these  assets  were  equal 
to  the  current  liabilities.  In  other  words,  a  concern  with  per- 
fectly liquid  working  assets,  needs  but  little  working  capital. 
The  nearer  a  company  approaches  to  this  condition,  the  smaller 
is  its  requirement  of  working  capital;  consequently,  it  follows 
that  any  measures  which  can  be  taken  to  increase  the  liquidity 
of  such  assets  as  inventories  and  accounts  receivable  will  make 
possible  a  corresponding  saving  in  the  sum  that  must  be  pro- 
vided for  working  capital. 


Ch.  i6]  WORKING  CAPITAL  REQUIREMENTS  715 

There  is  no  method  of  increasing  the  liquidity  of  stocks  of 
merchandise  except  care  in  manufacturing  or  in  purchasing  only 
stocks  that  are  readily  salable.  No  one  outside  the  business 
itself  can  be  of  much  assistance  in  securing  this  result.  Accounts 
receivable,  however,  constitute  an  asset  that  can  be  transferred, 
and  inasmuch  as  most  of  these  accounts  are  automatically  at 
some  later  date  converted  into  cash,  they  furnish  an  excellent 
collateral  for  preliminary  advances  of  cash — a  use  of  accounts 
receivable  that  is  frowned  upon  by  the  banks. 

In  this  general  connection  the  following  table  showing  the 
amount  of  cash  and  securities  as  compared  with  its  total  working 
capital  carried  by  the  American  Car  and  Foundry  Company,  is 
of  interest.!  This  company  is  highly  successful,  has  been  paying 
dividends  for  many  years  and,  since  1919,  at  the  rate  of  12%. 

.  (. 
Working  Cash  on 

Capital  Hand 

1921 , $37,544,509  $11,474,429 

1920 1'jf.'CVi'-I.     39,698,017  10,034,399 

1919 -■.•..     37,114,377  16,843,587 

1918 32,674,478  7,146,496  ■     • 

1917 26,559,182  6,017,220 

1916 20,597,809  4,443,959 

191S 18,911,543  3,659,856 

1914 18,830,607  4i25i.577 

§  162.    Finance  Corporations 

Within  recent  years  a  large  business  has  been  built  up  by 
financing  corporations  which  make  it  their  business  to  purchase 
at  a  discount  instalment  accounts  receivable  and  commercial 
accounts  receivable,  thus  enabling  concerns  which  own  such 
accounts  to  convert  them  wholly  or  partially  into  cash  before 
they  have  come  to  maturity. 

In  European  practice,  financing  corporations  of  this  type 
are  unknown  and  unnecessary,  for  most  sales  of  merchandise 
are  represented  by  accepted  drafts  (more  commonly  known  as 

>  Wall  street  Journal,  Feb.  27,  1922. 


7l6  CORPORATE  FINANCE  [Bk.  II- 

"trade  acceptances")  which  the  selling  firm  may  discount  at  its 
own  bank  or  may  sell  in  the  open  market.  In  the  United  States, 
however,  while  the  trade  acceptance  is  gradually  working  its 
way  into  favor,  the  custom  still  prevails  among  its  banks  of 
granting  "lines  of  credit."  These  lines  of  credit  are  based  in 
large  part  on  the  showing  of  a  satisfactory  proportion  of  working 
assets  to  current  liabilities,  and  the  banks  do  not  favor  any 
method  of  anticipating  the  normal  conversion  of  current  assets 
into  cash  or  of  pledging  any  of  the  current  assets.  It  has,  in 
fact,  grown  to  be  an  accepted  principle,  which  many  bankers 
perhaps  fail  to  apply  with  sufficient  discretion,  that  all  current 
assets  must  be  kept  free  and  unencumbered. 

In  spite  of  this  opposition  on  the  part  of  the  banks,  the 
financing  corporations  have  rapidly  increased  the  volume  and 
raised  the  character  of  their  dealings.  Moreover,  certain  banks 
and  trust  companies  have  gradually  come  to  carry  on  a  limited 
amount  of  business  of  the  same  type. 

There  are  two  distinct  fields  of  operation  for  these  financing 
corporations,  and  they  are  readily  divisible  into  two  correspond- 
ing groups:  the  first  group  confines  itself  almost  entirely  to 
making  advances  against  instalment  accounts  receivable,  and 
the  second  group  into  making  advances  against  commercial 
accounts  receivable.  The  instalment  accounts  handled  are 
mainly  those  which  arise  in  connection  with  the  sale  of  agricul- 
tural machinery,  automobiles,  pianos,  and  other  musical  instru- 
ments. On  such  accounts,  if  the  general  conditions  are  good, 
these  corporations  will  advance  from  60%  to  65%. 

On  commercial  accounts  these  companies  usually  loan  up  to 
about  75%  or  80%  of  the  face  value  of  the  paper  which  they 
accept  as  collateral.  Sometimes  a  fixed  line  of  credit  is  granted 
to  a  client,  against  which  a  corresponding  amount  of  collateral  is 
constantly  maintained  (paid  or  bad  accounts  being  continually 
replaced  by  fresh  ones),  and  sometimes  a  separate  loan  is  made 
against  each  given  block  of  collateral,  each  loan  being  regarded 
as  a  new  and  distinct  transaction. 


Ch.  i6j  WORKING  CAPITAL  REQUIREMENTS  717 

§  163.     Seasonal  Requirements  .     . 

Many  concerns  work  under  the  handicap  of  extreme  varia- 
tions in  the  amount  or  the  character  of  their  business  according 
to  the  season.  This  is  true,  for  example,  in  the  automobile 
business,  where  the  great  bulk  of  sales  are  made  in  the  spring 
and  early  summer  of  each  year.  Manufacturers  of  rubber  goods, 
especially  rubber  shoes,  find  their  sales  concentrated  at  certain 
seasons;  the  same  thing  is  true  of  manufacturers  of  agricultural 
implements,  of  sporting  goods,  and  of  many  other  products. 
On  the  other  hand,  manufacturers  of  textiles,  of  beet  sugar,  and 
of  other  products  made  from  raw  materials  gathered  from  the 
soil,  are  under  the  necessity  of  buying  heavily  at  certain  seasons 
of  the  year  in  order  to  secure  the  benefit  of  minimum  prices. 

In  all  such  fines  of  industry  where  seasonal  fluctuations  in 

purchases  or  sales  are  experienced,  either  large  stocks  of  finished 

products  must  be  accumulated  during  the  remainder  of  the  year 

in  order  to  meet  the  requirements  of  the  busy  season,  or  large 

stocks  of  raw  materials  must  be  purchased  at  a  given  season,  and 

gradually  used  up  during  the  remainder  of  the  year.     In    either 

case  it  is  clear  that  much  larger  sums  of  money  must  be  tied  up 

in  working  assets  during  certain  periods   than  during  other 

periods  of  the  year.     This  is  a  situation  that  involves  unusual 

difficulties  and  greatly  affects  the  amount  of  working  capital 

that  is  required. 

5di  ? 
§  164.     Provision  for  Meeting  Seasonal  Requirements 

The  usual  method  of  meeting  these  seasonal  demands  on 
working  capital  is  to  secure  a  gradually  increasing  amount  of 
bank  loans  as  finished  products  are  accumulated,  which  are 
rapidly  paid  off  during  the  sales  season;  or  if  the  other  situation 
prevails,  a  large  loan  is  effected  during  the  buying  season  which  is 
gradually  paid  off  during  the  remainder  of  the  year.  Dependence 
upon  bank  loans  exclusively,  however,  is  unsafe,  as  many  companies 
have  discovered.  Sometimes  such  loans  cannot  be  secured  when 
needed ;  at  other  times  anticipated  renewals  have  been  refused. 


7l8  CORPORATE  FINANCE  [Bk.  II- 

Textile  manufacturing  companies  and  other  lines  of  business 
where  similar  heavy  purchases  must  be  made  at  certain  seasons, 
have  been  peculiarly  subject  to  failure  because  of  their  inability, 
owing  to  some  unforeseen  contingency,  to  meet  the  obligations 
held  by  their  banks.  Some  years  ago,  when  the  so-called  "Sugar 
Trust"  desired  to  obtain  control  of  an  important  beet  sugar 
refinery,  it  is  alleged  to  have  obtained  this  control  by  secretly 
buying  up  all  the  short-time  notes  given  by  the  refinery  during 
its  purchasing  season  and  then  demanding  prompt  payment  of 
these  notes  instead  of  granting  the  customary  partial  renewals. 
As  a  result  the  prosperous  refinery  suddenly  found  itself  con- 
fronted with  the  prospect  of  bankruptcy  and  was  forced  to  sur- 
render. 

Although  it  would  not  ordinarily  be  economical  for  companies 
engaged  in  seasonal  industries  to  keep  themselves  supplied  with 
the  amount  of  working  capital  required  at  the  maximum  period 
of  each  year,  it  is  highly  desirable  and  prudent  that  they  should 
carry  a  much  larger  working  capital  than  would  be  sufficient  for 
the  off  seasons.  This  is  a  part  of  their  normal  expense  of  doing 
business.  Such  companies  sometimes  find  it  advantageous  to 
invest  their  surplus  cash  reserves  during  the  off  seasons  in  se- 
curities which  can  either  be  readily  converted  into  cash,  or  may 
be  used  as  collateral  for  loans.  »" 

§  165.    Month-by-Month  Calculations 

It  was  remarked  at  the  beginning  of  this  chapter  that  it 
would  be  impracticable  to  draw  up  any  invariable  formula  for 
calculating  the  amount  of  working  capital  required  in  any  given 
concern.  We  must  content  ourselves  with  the  general  statement 
that  working  capital  requirements  vary  roughly  in  proportion 
to  the  cost  and  quantity  of  raw  materials  required,  the  cost  of 
labor,  the  overhead,  the  volume  of  business,  the  length  of  period 
of  manufacture,  the  average  length  of  credit  extended  to  cus- 
tomers, and  the  extent  of  seasonal  variations  in  volume  of  busi- 
ness, and  that  they  vary  roughly  in  inverse  proportion  to  the 


Ch.  i6]  WORKING  CAPITAL  REQUIREMENTS  719 

rapidity  of  turnover,  length  of  credit  obtained  in  purchases  of 
goods,  and  the  facilities  available  for  converting  current  assets 
into  cash.     These  are  the  factors  to  be  taken  into  account. 

Inasmuch  as  the  customary  unit  of  time  used  in  reckoning 
most  commercial  operations  is  the  month,  it  is  worth  while,  in 
all  close  thinking  and  figuring  as  to  working  capital  require- 
ments, to  make  estimates  on  a  month-to-month  basis.  An  esti- 
mate of  this  nature  relating  to  a  hypothetical  case  of  a  house 
doing  an  instalment  business  has  already  been  given  and  will 
serve  as  an  illustration  of  the  method  that  should  be  followed  in 
making  up  such  estimates.  If  all  the  factors  that  have  just  been 
named  are  known,  and  assuming  in  addition  that  the  various 
costs  of  manufacture  or  of  purchase,  selling,  overhead  adminis- 
tration, and  the  like  are  known,  there  will  be  no  difficulty  in 
approximating  the  cash  outgo  and  cash  receipts  of  each  month. 
This  will  show  the  working  capital  requirements  month  by 
month.  By  adding  a  liberal  margin  to  cover  faulty  estimates 
and  contingencies,  the  approximate  amount  of  working  capital 
required,  even  for  a  new  corporation,  can  be  estimated.  In  the 
case  of  an  established  corporation,  which  has  behind  it  years  of 
experience  and  of  records,  the  information  that  is  desired  can  be 
worked  out  with  much  accuracy. 


CHAPTER  XVII 
THE  FINANCIAL  PLAN 

§  i66.    Adaptation  of  Securities  to  Market 

In  previous  chapters  the  principal  forms  of  security  issues — 
common  and  ordinary  shares,  preferred  shares,  income  bonds, 
debentures,  collateral  trust  bonds,  mortgage  bonds,  and  the 
like — have  been  described.  The  point  has  been  emphasized 
that,  while  there  are  favored  and  popular  forms  of  security 
issues,  there  are  no  invariable  forms.  Some  kind  of  a  security 
issue  can  be  found  that  will  suit  both  the  taste  and  the  pocket- 
book  of  anyone  who  has  capital  at  his  disposal.  The  financial 
manager  of  a  business  enterprise  Avill  naturally  make  such 
adaptations  of  the  securities  he  has  to  offer  as  will  best  fit  them 
for  the  market  he  is  trying  to  reach.  If  his  prospective  pur- 
chasers are  people  of  small  income,  he  may  find  it  best  to  issue 
shares  of  a  par  value  of  $5  or  $10,  instead  of  the  conventional 
$100.  On  the  other  hand,  if  he  is  getting  out  a  note  issue  ex- 
clusively for  sale  to  some  of  the  big  institutions,  he  will  perhaps 
give  his  notes  a  par  value  of  $10,000  or  even  $100,000.  He  will 
also  pay  reasonable  attention  to  passing  fashions  or  popular 
interests.  In  one  year  convertible  bonds  are  much  talked  about 
and  easily  sold.  In  another  year  the  popular  interest  is  centered 
largely  on  industrial  preferred  shares.  In  another  year  there  is, 
it  may  be,  an  unreasoning  aversion  to  collateral  trust  bonds. 
Any  successful  seller  of  securities  will  carefully  study  these 
fashions  and  whims  on  the  part  of  the  investing  public. 

In  choosing  forms  of  securities,  unfamiliar  financial  devices 
are  usually  to  be  avoided  unless  perhaps  they  are  brought  for- 
ward by  some  individual  or  corporation  with  great  prestige. 
The  financial  conditions  at  the  time  the  security  is  brought  out 

720 


Ch.  17I  THE  FINANCIAL  PLAN  721 

must  also  be  carefully  considered.  Thus  during  the  period 
of  the  Great  War  short-term  securities  were  issued  in  great 
quantities,  partly  because  there  was  a  public  preference  for  such 
notes  and  partly  also  because  it  was  hoped  that  interest  rates 
would  fall  and  thus  make  the  conditions  more  favorable  for 
long-term  issues.  The  wisdom  or  unwisdom  of  this  course  need 
not  be  considered  here.  The  point  to  be  made  is  that  the  large 
corporations  have  been  consciously  endeavoring  to  adjust  their 
s^(?\irity  issues  to  current  conditipns  in  the  security  market. 

§  167.    Results  of  an  Ill-judged  Issue 

A  striking  example  of  very  poor  judgment  in  trying  to  make 
this  adjustment  is  found  in  the  history  of  the  ill-fated  Cordage 
combination.  In  December  of  1892  the  common  stock  of  the 
combination  was  selling  at  $142  a  share  and  the  standing  and 
reputation  of  the  company  was  high.  In  January  a  stock  divi- 
dend of  100%  was  declared,  increasing  the  common  stock  from 
$10,000,000  to  $20,000,000.  In  April,  1893,  the  company  had 
an  inventory  consisting  of  between  $5,000,000  and  $6,000,000 
of  binder  twine,  against  which  it  had  borrowed  upward  of  $5,000,- 
000  from  New  York  and  Boston  banks  in  the  form  of  demand 
loans  and  short-term  paper. 

While  it  was  in  this  difficult  condition  the  crisis  of  1893 
became  more  and  more  threatening  and  some  of  the  bankers 
notified  the  company  that  the  loans  must  be  taken  up  at  least 
in  part  on  maturity.  On  Friday,  April  28,  1893,  the  shares  of 
the  National  Cordage  Company  were  seUing  at  excellent  prices, 
the  preferred  at  103^  and  the  common  at  61,  and  the  credit 
of  the  company  was  high.  The  following  morning  at  a  special 
meeting  of  the  board,  it  was  decided  to  take  care  of  the  demands 
of  the  banks  by  an  immediate  offer  to  the  common  shareholders 
of  $2,500,000  of  new  preferred  shares  at  par.  This  was  equiva- 
lent to  giving  the  common  shareholders  a  privileged  subscription 
of  some  slight  value.  Under  ordinary  conditions  there  would 
have  been  little  doubt  as  to  its  success.     But  the  conditions  were 


722  CORPORATE  FINANCE  [Bk.  II- 

not  ordinary.  The  action  of  the  board  was  interpreted  in  the 
light  of  the  general  feeling  of  suspicion  and  uncertainty  as  to  the 
soundness  of  all  corporations;  a  bear  party  attacked  the  Na- 
tional Cordage  Company's  shares  and  within  the  day  the  market 
price  of  the  preferred  stock  fell  to  less  than  par  and  that  of  the 
common  to  less  than  50;  two  days  later  the  preferred  had  gone 
down  to  83  and  the  common  to  36. 

Under  such  conditions  it  was,  of  course,  out  of  the  question 
to  make  a  success  of  the  preferred  stock  issue.  The  next  day  the 
common  stock  fell  to  $18.75,  the  banks  became  alarmed  and 
demanded  immediate  and  full  repayment,  and  the  company  sud- 
denly collapsed.  It  was  one  of  the  most  surprising  and  spec- 
tacular insolvencies  to  be  found  in  the  financial  history  of  the 
country.  Undoubtedly  the  National  Cordage  Company  was 
in  unsound  financial  condition  at  this  time,  but  the  immediate 
cause  of  its  collapse  was  the  imprudence  of  the  directorate  in 
failing  to  give  due  consideration  to  the  general  market  condi-' 
tions.i 

Every  possible  measure  should  be  taken  to  meet  the  conven- 
ience of  prospective  purchasers  in  putting  out  security  issues; 
for  instance,  large  corporations  which  enjoy  an  international 
market  frequently  make  interest  payable  at  the  principal  cities 
of  the  various  countries  in  which  the  bonds  are  likely  to  be  sold. 
There  are  a  number  of  bonds  issued  in  this  country  the  interest 
on  which  may  be  collected  in  Paris,  London,  Berlin,  or  New  York. 
On  the  other  hand,  the  interest  and  also  the  principal  of  most  of 
the  recent  external  loans  of  the  governments  of  Europe  are 
payable  in  this  country  and  in  its  currency.  '  ^ 

§  168.    Adaptation  of  Securities  to  Corporate  Conditions 

Up  to  the  present  point  we  have  considered  only  the  relations 
between  security  issues  and  the  needs  or  desires  of  the  prospec- 
tive purchaser  of  these  issues.  It  is,  of  course,  clear  that  there 
must  be  a  correspondence  also  between  the  security  issues  and 

1    Dewing  on  Corp.  Prom,  and  Reorg.,  p.  112  et  seq. 


Ch.  17I  THE  FINANCIAL  PLAN  723 

the  financial  condition  of  the  corporation.  The  mere  fact  that 
a  security  of  a  given  type  is  thought  to  be  easily  salable  is  not 
always  the  final  reason  for  issuing  just  that  security.  The  cor- 
poration's interests  may  best  be  served  by  some  other  type  of 
security,  and  it  may  be  necessary — in  fact,  generally  is  necessary 
— to  make  a  compromise. 

From  the  corporation's  standpoint,  the  outstanding  securities 
should  be  in  correct  relation  both  to  the  assets  of  the  corporation 
and  to  its  earnings.  If  this  correct  relation — or  an  approxima- 
tion to  it — is  not  secured,  then  one  of  two  undesirable  results 
must  follow:  either  the  capital  required  is  secured  upon  terms 
that  are  more  or  less  onerous  and  wasteful,  or,  on  the  other  hand, 
the  corporation  is  burdened  with  claims  which  it  may  not  be 
able  to  meet  and  which  therefore  endanger  its  continued  exist- 
ence. The  first-named  fault  is  probably  both  less  frequent  and 
less  to  be  condemned  than  the  second  fault. 

§  169.    Adjustment  between  Common  Stock  and  Prior  Obligations 

There  are  some  corporations,  which  have  actually  caused 
unnecessary  sacrifices  to  their  stockholders  by  reason  of  a  blind 
adherence  to  the  policy  of  putting  out  only  common  stock.  If 
a  public  utility  company,  for  example,  were  to  attempt  to  finance 
itself  solely  by  the  sale  of  common  stock,  the  chances  are  that 
there  would  be  very  little  money  for  anyone  interested.  The 
profits  on  such  enterprises  are  comparatively  limited,  and  the 
financing  must  be  watched  with  the  closest  attention  in  order  to 
preserve  reasonably  good  earnings  for  the  benefit  of  the  common 
shares.  This  can  be  made  clearer  by  a  hypothetical  case  than 
by  any  example  which  is  at  hand,  for  practically  all  public  utility 
companies  do  raise  the  greater  portion  of  their  capital  through 
issuing  obligations  rather  than  through  issuing  shares.  Let  us 
suppose  that  a  public  utility  corporation  requires  $10,000,000 
capital,  and  that  its  net  earnings  amount  to  $700,000,  or  7% 
on  the  invested  capital.  Clearly  this  would  not  in  itself  be  an 
attractive  return  to  prospective  purchasers  of  the  common  stock. 


724  CORPORATE  FINANCE  [Bk.  II- 

Let  us  further  assume,  however,  that  $6,000,000  of  the  required 
capital  is  secured  by  bond  issues  at  an  average  cost  to  the  cor- 
poration of  6%;  that  $2,000,000  is  obtained  through  preferred 
stock  or  junior  bond  issues  at  an  average  cost  to  the  corporation 
of  8%;  and  that  $2,000,000  is  obtained  by  the  sale  of  common 
stock.  In  that  case  the  annual  profits  would  be  distributed  as 
follows: 

Bonds,  $6,000,000  at  6% $360,000 

Preferred  stock,  $2,000,000  at  8% 160,000 

Common  stock,  $2,000,000  with  earnings  of  9% 180,000 

Total  earnings $700,000 

As  a  matter  of  fact,  it  is  customary  to  provide  all  the  cost  of 
the  tangible  property  of  public  service  enterprises  by  issuing 
bonds  up  to  about  75%  of  the  cost,  and  preferred  stock  or  junior 
bonds  up  to  about  25%.  The  common  stock  in  this  case  repre- 
sents intangible  assets  or  earning  power  and  is  retained  by  the 
promoters  of  the  enterprise  as  their  profits.  If  this  rule  were 
followed  in  the  case  just  cited,  the  results  would  be  as  follows : 

57>S00i000  bonds  at  6% $450,000 

*  t  $2,500,000  junior  bonds  at  8% 200,000 

Available  as  earnings  on  common  stock. 50,000 

Total $700,000 

§  170.     Relation  between  Income  and  Security  Issues  * 

It  would  be  useless  to  give  illustrations  at  this  point  of  cor- 
porations which  have  transgressed  the  limits  of  prudence  in  sell- 
ing their  obligations  to  the  public,  for  such  cases  are  dealt  with 
in  the  later  chapters,  where  financial  embarrassments,  insol- 
vencies, and  reorganizations  are  discussed.  It  is  obvious,  on  the 
face  of  it,  that  a  corporation,  like  an  individual,  may  abuse  its 
credit.  The  rule  of  safety  in  the  issuance  of  funded  obligations 
requires  that  the  corporate  income  shall  at  its  minimum  not  only 
cover  the  fixed  charges,  including  both  interest  payments  and 
sinking  fund  payments  if  any,  but  leave  a  safe  margin  beyond 


Ch.  17]  THE  FINANCIAL  PLAN  725 

tliis.  The  rule  of  prudence,  when  securities  such  as  income  bonds 
are  issued  which  carry  a  contingent  UabiUty,  is  that  the  cor- 
porate income  over  and  above  all  fixed  charges  must  be  ample 
under  all  conditions  that  can  reasonably  be  anticipated,  to  cover 
these  contingent  charges.  The  rule  of  good  faith  in  connection 
with  the  issuance  and  sale  of  common  stock  requires  that  the 
anticipated  income,  based  upon  the  probabilities,  should  be 
ample  to  provide  in  addition  to  all  fixed  and  contingent  charges 
a  reasonable  and  increasing  return  on  the  common  shares.  We 
may  state  this  relation  as  follows : 

1.  Assured  net  income  should  be  more  than  enough  to  meet 
'  '^"    ■"        all  fixed  charges  on  funded  obligations,  including  inter- 
est and  sinking  fund  payments.  '°^?^  i''  inuuiU 

2.  Additional  income  anticipated  beyond  rfeasdnalile  doubt, 

should  be  more  than  enough  to  cover  any  contingent 
charges. 

3.  Additional  probable  income  should  be  more  than  enough 

to  provide  a  satisfactory  yield  on  common  shares. 

■  It  is  true,  of  course,  that  unforeseen  occurrences  frequently 
wreck  even  the  soundest  and  most  careful  estimates,  and  that 
the  organizers  and  financial  managers  of  corporations  are  not 
always  entitled  to  censure  because  their  plans  miscarry.  They 
are  clearly  entitled  to  censure,  however,  if  they  do  not  make 
their  estimate  of  future  income  with  reasonable  foresight  and 
conservatism,  and  if,  after  having  procured  sound  estimates,  they 
fail  to  observe  the  relations  above  referred  to  between  earnings 
and  security  issues. 

§  171.    Relation  between  Assets  and  Security  Issues 

The  assets  of  every  enterprise  fall  into  three  natural  divisions : 

1.  Fixed  tangible  assets,  which  represent  a  permanent  in- 

vestment essential  to  the  conduct  of  the  business. 

2.  Current  assets,  which  consist  of  cash  and  of  such  property 

as  can  readily  be  converted iut^  ca^, ,, , ,,  .,^.  .  ,    , 


726  CORPORATE  FINANCE  [Bk.  II- 

3.  Intangible  assets,  which,  as  previously  defined,  are  the 
capitalization  of  the  earning  power  which  cannot  be 
attributed  to  the  other  assets.  t 

There  is  a  relation  between  these  classes  of  assets  and  the 
security  issues  of  a  corporation,  which  may  be  stated  in  the  fol- 
lowing form : 

The  actual  value  of  fixed  assets  (not  merely  the  book 
value)  should  exceed  by  at  least  25%  to  50%  the  bonded 
obligations  outstanding. 

The  actual  value  of  the  fixed  assets,  plus  the  value  of  net 
current  assets  (after  deduction  of  current  liabilities) 
should  at  least  equal,  and  generally  considerably  exceed, 
the  outstanding  preferred  shares,  income  bonds,  or  other 
contingent  obligations. 

The  actual  value  of  tangible  assets,  plus  that  of  intangible 
assets,  should  equal  or  preferably  exceed,  the  combined 
value  of  fixed  obligations,  contingent  obligations  or 
shares,  and  common  shares  outstanding. 

§  172.    Common  Stock  to  Represent  Intangible  Assets 

Quite  a  large  number  of  industrial  corporations  have  followed 
the  principle  of  issuing  bonds  and  preferred  shares  up  to  the  full 
net  value  of  their  tangible  assets,  and  then  issuing  common  stock 
up  to  the  value  of  their  intangible  assets.  Cluett,  Peabody  and 
Company,  the  well-known  manufacturers  of  collars  and  shirts, 
carry  an  account  called  "Good-will,  Patent  Rights,  Trade- 
Names,  etc.,"  of  $18,000,000,  against  which  the  corporation  had 
outstanding  up  to  1920,  $18,000,000  of  common  stock.  In  1920 
this  €ommon  stock  was  increased  to  $18,275,000.  The  F.  W. 
Woolworth  Company  has  good-will  $50,000,000,  and  common 
stock  now  $65,000,000,  but  up  to  1920,  exactly  $50,000,000. 
The  George  A.  Fuller  Company,  later  consolidated  with  the 
United  States  Realty  and  Improvement  Company,  at  the  time 
of  its  incorporation  presented  a  balance  sheet  showing  net  quick 


Ch.  17]  THE  FINANCIAL  PLAN  ^727 

assets  of  approximately  $5,000,000,  and  "Tools,  Machinery,  and 
Good-Will"  of  $10,000,000;  against  this,  $5,000,000  of  preferred 
and  $10,000,000  of  common  stock  were  issued. 

In  most  cases  the  correlation  between  the  different  forms  of 
securities  and  the  three  classes  of  assets  is  not  so  direct  and 
readily  visible.  But  there  is,  or  should  be,  some  measure  of 
relation.  The  possibilities  in  this  direction  have,  though, 
been  somewhat  interfered  with  in  late  years  by  the  provision 
of  the  Federal  Excess  Profits  Tax  Law,  limiting  the  valuation  of 
intangibles  to  "25  per  centum  of  the  par  value  of  the  total  stock 
or  shares  of  the  corporation  outstanding  at  the  beginning  of  the 
taxable  year."2 

§  173.     Special  Forms  of  Securities 

As  has  been  previously  stated,  there  are  many  forms  of 
securities  issued.  The  more  important  types  have  been  de- 
scribed in  previous  chapters,  but  a  few  examples  may  be  cited 
here  of  instances  in  which  unusual  changes  were  made  in  order 
to  adapt  the  security  to  peculiarities  in  the  assets  or  in  the  mar- 
ket conditions.  English  practice  runs  very  strongly  toward  the 
the  issuance  of  perpetual  or  irredeemable  debentures,  the  idea 
being  that  all  the  debtor  cares  for  is  to  have  his  interest  paid 
regularly,  thus  giving  him  a  security  which  is  readily  marketable. 
Even  the  large  brewing  companies  in  England,  which  can  hardly 
be  thought  to  have  a  business  that  is  beyond  all  human  vicissi- 
tudes, have  nevertheless  issued  and  sold  a  large  number  of  these 
perpetual  debentures.  In  this  country  perpetual  bonds  are 
almost  unknown,  though  there  are  a  few  issues,  such  as  the 
Lehigh  Valley  Railroad's  Consolidated  "Annuity"  bonds,  which 
have  no  redemption  date. 

In  the  United  States  participating  bonds  are  occasionally 
brought  out  when  it  is  desirable  to  make  an  issue  unusually 
attractive,  as  in  the  case  of  the  6%  Debenture  Gold  bonds  of  the 
Beneficial  Loan  Society  of  New  York,  where  each  purchaser 


'  Excess  Profits  Tax  Law,  Sec.  326a,  Subdiv.  $. 


728  CORPORATE  FINANCE  [Bk.  II- 

receiyes  a  profit-sharing  certificate  which  entitles  him  to  a  share 
in  the  profits  of  the  society  on  a  prescribed  basis  as  long  as  his 
bond  is  outstanding.  Of  a  similar  nature  are  the  7%  Par- 
ticipating First  Mortgage  Guaranteed  10-Year  Gold  bonds  of  the 
Eastern  Limestone  Corporation  of  New  Jersey,  where  each  year 
20%  of  the  net  earnings  of  the  company,  after  deducting  sinking 
fund  requirements,  are  to  be  distributed  to  the  holders  of  these 
bonds. 

Other  devices  of  a  somewhat  similar  nature  to  make  securities 
attractive  are  not  uncommon,  as  where  a  land  company  makes 
its  bonds  or  stock  redeemable  in  land  at  the  option  of  the  holder. 
Recently  a  Florida  company,  organized  to  prospect  for  oil  on  its 
13,000  acres  of  land,  offered  "certificates"  for  sale  which  in  case 
the  company  did  not  strike  oil  might  be  exchanged  for  *' citrus- 
growing"  land.  An  even  more  peculiar  security  was  brought 
out  by  a  large  distilling  company — before  the  days  of  national 
prohibition — consisting  of  a  preferred  stock  issue  which  was  to 
be  redeemed  by  the  corporation  and  was  secured  by  a  first  lien 
on  all  the  whiskey  stored  in  bond.  The  holder  of  a  share  of 
preferred  stock  could,  however,  if  he  chose,  take  a  barrel  of 
whiskey  in  payment,  of  his  claim^  Even  this  ingenious  arrange- 
ment, it  is  understood,  did  not  bring  about  the  success  of  the 
issuei'>'i»i'.i!i  0''^" 

§  174.     Haphazard  Financing 

There  is  very  little  real  planning  in  the  financial  development 
of  most  corporations.  The  easy  and  obvious  thing  to  do  is  to 
meet  each  financial  difficulty  or  problem  as  it  comes  along,  in  the 
hope  that  there  will  be  no  further  problems.  Frequently  the 
result  is  to  create  a  maze  of  conflicting  claimis,  and  to  impose 
obligations  upon  the  corporation  which  seriously  interfere  with 
the  normal  growth  of  its  credit  and  lead  to  loss  or  even  to  in- 
solvency. 

Many  of  the  financial  troubles  which  come  to  concerns  that 
are  fundamentally  sound  and  prosperpus  are  wholly  unnecessary. 


Ch.  17]  THE  FINANCIAL  PLAN  729 

They  could  be  avoided  by  a  moderate  amount  of  foresight  and 
careful  planning.  A  typical  instance  is  that  of  a  knitting  mill  in 
an  eastern  state  which  is  capitalized  at  $900,000,  $600,000  com- 
mon and  $300,000  7%  cumulative  preferred  stock.  The  quick 
assets  are  $450,000  in  excess  of  its  quick  liabilities,  and  the  com- 
pany has  a  surplus  of  $500,000.  This  corporation,  like  most 
textile  concerns,  borrows  heavily  from  the  banks.  It  seldom 
has  loans  of  less  than  $600,000  outstanding,  and  frequently  they 
rise  to  $900,000;  the  loans  are  obtained  at  an  average  rate  of 
6%.  The  question  that  has  been  raised  and  is  now  under  con- 
sideration, is  whether  it  would  be  desirable  to  put  out  an  addi- 
tional $300,000  of  8%  preferred  stock  at  par,  thus  cutting  down 
the  bank  borrowing. 

W:  iicnii  girl  lo  ^vho^qeoni  .vjaimq 

§175.     A  Financial  Plan  rrfaj^firuim  iov 

To  this  question  there  is  apparently  but  one'  sound  answer. 
When  bank  loans  of  this  concern  reach  their  maximum  of  $900,- 
000,  these  loans  are  equivalent  to  the  whole  capital  stock,  and 
the  margin  of  quick  assets  is  too  small  for  safety.  A  failure  to 
dispose  of  the  products  of  the  mill  on  the  usual  terms  and  at  the 
usual  time  might  suddenly  bring  on  bankruptcy  as  in  the  case 
of  the  National  Cordage  Company  already  cited.  Because  of 
its  extensive  and  growing  business,  the  corporation  is  evidently 
driving  towards  a  possible  financial  position  of  serious  danger! 
Probably  the  preferred  stock  is  the  best  form  of  security  that 
could  be  issued,  and  granting  that  this  can  be  sold,  the  advisa- 
bility of  the  issue  can  hardly  be  questioned.  The  proceeds 
would  reduce  the  bank  borrowings  to  a  reasonably  safe  amount. 
The  preferred  dividends  would,  it  is  true,  also  reduce  the  earn- 
ings on  the  common  stock  by  approximately  $6,000  per  year, 
but  this  is  a  small  item  compared  with  the  gain  in  safety. 

It  may  be  asked  why  the  problem  is  not  solved  by  placing  a 
mortgage  upon  the  mill  and  thus  borrowing  on  better  terms  than 
through  the  issue  of  preferred  shares.  The  answer  is  that,  in  the 
textile  industry  it  is  a  well-recognized  principle  that  mill  prop- 


730  CORPORATE  FINANCE  [Bk.  II- 

erty  should  not  be  mortgaged.  Cotton  mills  borrow  from  the 
banks  so  heavily  that  any  permanent  loan  outranking  the 
banker's  lien  would  be  a  distinct  handicap. 

§  176.    Incorporating  a  Partnership  ^ 

Many  puzzling  problems  arise  in  connection  with  the  custom 
which  has  become  common  in  recent  years,  of  giving  up  the 
partnership  form  of  organization  in  established  business  enter- 
prises and  substituting  for  it  the  corporate  form  of  organization. 
During  the  life  of  the  partnership  numerous  personal  agreements 
have  usually  been  entered  into  which  at  first  sight  seem  difficult 
either  to  continue  or  replace  under  the  corporate  form.  More- 
over, one  essential  feature  of  the  partnership  form  is  that  every 
partner,  irrespective  of  his  financial  interest,  shall  have  an  equal 
voice  in  the  management  of  the  enterprise.  If  there  is  wide 
discrepancy  between  the  financial  interests  of  the  partners,  it  is 
difficult  to  continue  this  arrangement  under  the  corporate  form. 
The  following  is  a  concrete  example  which  will  make  clear  some 
of  these  difficulties: 

Three  partners.  A,  B,  and  C,  conduct  a  jobbing  business 
established  60  years  ago  by  A's  father.  A,  having  inherited  his 
father's  estate, is  the  principal  owner  and  the  head  of  the  concern; 
B,  who  began  30  years  ago  as  a  clerk,  is  in  charge  of  the  produc- 
tion and  a  large  share  of  the  selling;  C,  who  entered  as  a  book- 
keeper 20  years  ago,  is  in  charge  of  the  financing,  office  manage- 
ment, and  credits.  The  capital  of  the  firm  is  $325,000,  of  which 
A  owns  $275,000,  B  $35,000,  and  C  $15,000;  interest  at  6%  is 
paid  each  partner  on  the  amount  of  his  investment;  each  partner 
draws  a  salary  of  $7,200  per  annum,  and  the  profits  are  divided 
as  follows:  A  50%;  B  40%,  and  C  10%.  The  annual  sales 
are  about  $750,000,  and  the  net  profits  $25,000.  An  important 
reason  for  turning  the  partnership  into  a  corporation  is  to  provide 
a  safe  and  simple  method  of  allowing  department  heads  and  some 


*  For  a  fiill  discussion  of  this  subject  see  Book  I,  Ch.  LIX,  "Incorporating  a  Partnership." 


Ch.  17]  THE  FINANCIAL  PLAN  731 

of  the  salesmen  to  gain  an  interest  in  the  business.  This  could 
be  done  under  the  corporate  form  by  permitting  these  subordin- 
ates to  buy  stock. 

It  is  at  once  evident,  in  considering  this  case,  that  its  diffi- 
culty arises  out  of  the  fact  that  profits  are  divided  without  any 
fixed  relation  either  to  investment  of  capital  or  to  the  value  of 
services.  Six  per  cent  is  hardly  a  sufficient  rate  of  return  on  the 
capital  employed  in  a  business  of  this  character,  so  that  it  is  no 
doubt  intended  to  give  some  special  allowance  to  A  in  the  division 
of  profits,  that  will  constitute  an  increased  return  on  his  capital. 
However,  this  cannot  be  the  controlling  interest  since  B,  with  a 
comparatively  small  investment,  receives  40%  of  the  profits. 
The  problem  is  then  to  preserve  these  various  rights  and  claims 
under  the  corporate  form.  ,  [ 

§  177.    Adjustmg  the  Partnership  Interests 

It  would  be  possible  to  issue  6%  bonds  of  the  proposed  cor- 
poration to  A,B,  and  C  to  represent  their  respective  investments, 
but  inasmuch  as  this  is  a  jobbing  business,  it  would  be  preferable 
to  issue  preferred  stock  rather  than  bonds.  We  will  start,  then, 
by  providing  for  the  issuance  of  $325,cxx>  of  6%  cumulative  pre- 
ferred stock;  $275,000  to  A,  $35,000  to  B,  and  $15,000  to  C. 
The  best  method  of  determining  the  total  amount  of  common 
stock  to  issue  is  to  capitalize  the  remaining  $25,000  of  profit  at 
some  reasonable  percentage,  say  8%,  making  the  common  issue 
$312,500.  If  we  assume  that  the  distribution  of  profits  to  the 
three  partners  is  meant  to  represent  their  permanent  contribu- 
tions to  the  upbuilding  of  the  business,  this  $312,500  of  common 
stock  should  be  divided  among  them,  50%  to  A,  40%  to  B,  and 
10%  to  C.  Possibly,  though,  this  division  of  profits  in  the 
partnership  is  based  on  a  difference  in  the  abilities  of  the  three 
men  in  directing  the  affairs  of  the  business;  if  that  were  the 
case,  these  discrepancies  should  be  adjusted  by  corresponding 
changes  in  the  salaries  of  the  three  men,  which  in  turn  would 
involve  a  different  distribution  of  the  common  stock. 


73  i  CORPORATE  FINANCE  [Bk.  II  - 

§  178.    Financial  Plan  for  a  Railroad 

Another  problem  of  especial  interest  in  illustrating  some  of 
the  principles  discussed,  arose  some  years  ago  in  connection  with 
the  financing  of  a  short  railroad  in  one  of  the  southern  states. 
The  whole  project  involved  an  investment,  including  terminals, 
of  about  $4,183,000.  The  probable  gross  earnings  after  two 
years  from  date  of  opening  the  road  to  operations,  were  calcu- 
ated  at  $2,018,000;  operating  expenses  were  estimated  at 
approximately  65%,  say  $1,300,000,  and  taxes  and  insurance  at 
$80,000,  making  the  total  expense,  $1,380,000,  and  leaving  a 
net  revenue  of  $638,000  from  which  to  meet  fixed  charges  and 
provide  a  surplus.  It  is  estimated,  also,  that  there  would  be  a 
deficit  close  to  $100,000  during  the  first  2  years  of  operation. 
Equipment  was  expected  to  cost  $1,650,000.  The  total  capital 
required  was  as  follows: 

Cost  of  construction ' $4,183,000 

Cost  of  equipment 1,650,000 

" "       Loss  in  first  two  years  of  operation 100,000 

■''■       Working  capital ^.. 500,000 

>Ih}0<1  ffrdt 

Total $6,433,000 

-aiq  •)■/'.  >):;nfijj< 

A  certain  amount  of  capital  required  for  the  earlier  stages  of 
construction  would  necessarily  be  tied  up  without  any  income  to 
pay  the  interest  on  it,  until  the  road  is  put  in  operation.  To 
take  care  of  this  expense  it  would  be  well  to  form  a  construction 
company  to  build  the  road  and  furnish  all  other  necessary  prop- 
erty and  cash.  The  construction  company  should  be  prepared 
to  hand  over  to  the  railroad  company  $600,000  in  cash,  that  sum 
being  required  to  provide  working  capital  and  to  cover  the  loss 
on  the  first  two  years  of  operation.  The  construction  company 
should  also  pay  interest,  taxes,  insurance,  etc.,  up  to  the  time 
the  property  is  handed  over  to  the  railroad  company.  In 
exchange  for  the  railroad  and  the  cash,  the  railroad  company 
would  then  turn  over  all  its  securities  to  the  construction  com- 
pany, from  the  sale  of  which  the  construction  company  would 


Ch.  17]  THE  FINANCIAL  PLAN  733 

derive  its  profit.     The  promoters  of  the  railroad  would  nat- 
urally be  the  organizers  of  the  construction  company. 
biuofi  :,  ^  nommQiJiili 

§  179.    Capitalization  of  Railroad  Company 

On  the  basis  of  normal  earnings  of  $638,000,  the  corporation 
might  be  capitalized  as  follows : 

«i  iirbns :  ;«(d  oS  X  Cash  Fixed  and 

Nominal        Receipts  to    Contingent 
Value  Corporation        Charges 

5H%  first  mortgage  bonds  on  all  pro- 
perty, exclusive  of  equipment,   to  be  fiJ^WItir. 
disposed  of  at  90  with  a  bonus  of  two 
shares  of  common  stock  to  each  $1,000 
bond $4,000,000        $3,600,000         $220,000 

6%  lo-year  serial  equipment  notes 1,500,000  1,500,000  90,000 

Annual  payment  during  first  10  years  of    )J(Ii'ABG  gninifimtn  dlij  t 
operation  to  retire  above  notes '.'. . ..';". . .  '       '..■.."''       150,000 

8%  cumulative  stock  to  be  disposed  of  at 
90,  with  a  bonus  of  one  share  of  com- 
mon to  each  five  shares  of  preferred ..  .       1,500,000  1,350,000  120,000 

$7,000,000        $6,450,000         $580,000 

This  leaves  a  balance  of  $58,000  a  year  available  for  contin- 
gencies out  of  the  income  of  the  first  ten  years.  <5t<x)|i.«  oi 

The  common  stock  required  for  bonuses  to  purchasers  of  the 
first  mortgage  bonds  and  of  the  preferred  stock,  is  $1,100,000. 
The  promoters  of  the  enterprise  will  want  some  pay  for  their 
services,  and  will  probably  want  to  retain  control  of  the  company. 
They  should  therefore  issue  approximately  $4,000,000  of  com- 
mon stock  to  the  construction  company.  Under  the  above  esti- 
mates $2,900,000  of  stock  would  be  left  for  themselves.  '^ 

For  the  first  ten  years — unless  the  earnings  should  largely 
increase — the  common  stock  could  not  expect  to  receive  any 
dividends.  It  will  be  noticed  that  $150,000  worth  of  serial 
notes  is  to  be  retired  each  year,  and  that  the  interest  on  that 
amount  each  year  should  be  added  to  the  balance  available  for 
contingencies.  At  the  end  of  ten  years,  not  only  will  there  be 
no  interest  to  pay  on  the  notes  but  the  annual  payments  on  the 


734  CORPORATE  FINANCE  [Bk.  II- 

principal  will  cease.  Thereafter  $298,000,  less  any  reserve  or 
payments  for  contingencies,  may  be  disbursed  as  dividends  on 
the  common  stock.  If  all  this  amount  were  available  it  would 
mean  almost  7^%  earnings  on  the  common  stock. 

It  will  be  noted  that  in  the  above  arrangement,  first  mortgage 
bonds  are  issued  to  an  amount  approximately  equal  to  the  actual 
cost  of  the  property  mortgaged.  This  may  seem  to  be,  and  is  in 
fact,  somewhat  reckless  financing;  yet  it  is  a  common  practice 
in  railroad  construction  and  it  must  be  assumed  that  the  project 
itself  is  worth  something;  that  is,  the  rails,  buildings,  and  real 
estate,  which  are  the  chief  items  in  cost,  are  worth  more  after 
they  are  laid  down  and  the  railroad  is  ready  for  operation,  than 
their  actual  first  cost.  The  preferred  stock  is  more  than  equiva- 
lent to  the  remaining  balance  of  all  the  tangible  assets  and  is 
partly  offset  by  good-will.  The  proposed  common  stock  issue 
of  $4,000,000  is  offset  wholly  by  good-will  or  prospective  earning 
power.  The  amount  of  each  class  of  security  that  may  safely 
be  issued  has  been  determined  with  reference  to  the  earnings 
rather  than  with  reference  to  the  assets.  It  is  assumed  that  there 
is  little  likelihood  of  failure  to  meet  the  fixed  charges  amounting 
to  $460,000. 

§  180.    Financing  an  Advertising  Agency 

At  the  other  end  of  the  scale  from  a  railroad  company  is  an 
enterprise,  such  as  an  advertising  agency,  which  renders  a  service 
that  is  largely  of  a  personal  nature  analogous  to  the  service 
rendered  by  a  lawyer,  physician,  or  consulting  engineer.  It  is 
true,  of  course,  that  many  of  the  functions  of  an  advertising 
agency  are  of  a  more  or  less  clerical  nature ;  but  the  more  impor- 
tant functions  are  advisory  and  cannot  be  performed  properly 
except  by  well-qualified,  high-priced  men.  The  time  and 
energy  of  the  principals  are  limited,  and  if  an  attempt  is  made  to 
spread  their  efforts  over  too  many  undertakings,  the  result  is 
apt  to  be  unsatisfactory  both  to  their  clients  and  to  themselves. 
Under  these  conditions  the  growth  of  an  advertising  agency,  if 


Ck.  17]  THE  FINANCIAL  PLAN  73  <i 

it  is  a  healthy,  permanent  growth,  is  necessarily  a  rather  slow 
process.  Also  it  is  difficult — and  usually  impossible- — to  finance 
such  an  undertaking  by  the  sale  of  its  securities  to  outside 
parties. 

It  would  seem,  therefore,  in  considering  the  financial  problems 
of  an  established  agency,  that  a  reasonably  rapid  growth  ought 
to  be  financed  directly  out  of  the  profits  of  the  agency.  It  is 
not  necessary  to  maintain  a  great  working  capital  in  proportion 
to  the  volume  of  business  handled,  for  an  advertising  agency 
usually  pays  its  bills  on  the  same  terms  that  its  own  bills  to 
clients  are  paid  by  them.  For  example,  if  an  advertising  agency 
gets  a  discount  of  2%  for  cash  in  10  days,  it  should  give  the  same 
discount  to  its  clients  and  thus  secure  the  cash  from  them  with 
which  to  meet  the  bUl. 

In  one  instance,  however,  an  advertising  agency  was  assisting 
some  of  its  clients  to  carry  on  large  advertising  campaigns  by 
granting  them  extra  time  for  the  payment  of  their  accounts, 
while  the  advertising  agency  was  paying  its  own  bills  on  the 
minute.  The  result  was  that  it  became  necessary  to  add  $75,000 
to  $100,000  to  the  working  capital  of  the  agency.  The  agency 
had  been  in  existence  for  many  years,  was  highly  regarded,  and 
was  making  satisfactory  profits,  and  it  was  in  as  favorable  posi- 
tion as  possible  for  the  sale  of  securities.  The  best  that  could  be 
done,  however,  was  a  sale  of  preferred  stock  to  some  of  the  per- 
sonal friends  and  acquaintances  of  the  president  of  the  agency, 
and,  in  order  to  make  the  stock  attractive,  it  was  found  necessary 
to  give  it  a  participating  feature,  which  would  make  the  possible 
net  earnings  run  as  high  as  25%.  Under  these  conditions  the 
stock  was  sold.  It  is,  however,  a  difficult  problem  to  raise 
cash  by  sales  of  securities  for  an  enterprise  in  which  personality 
plays  so  prominent  a  part. 

§  181.     Simplicity  Desirable 

The  successful  financial  plan  is  not,  as  a  rule,  one  that  is  highly 
involved  and  full  of  unusual  and  supposedly  ingenious  expedients. 


73#  CORPORATE  FINANCE  [Bk.  H- 

It  is  more  likely  to  be  simple  and  to  look  beyond  the  needs  of  the 
moment.  The  chief  financial  virtue  is  foresight.  Hit-or-miss 
financing  is  almost  certain  to  involve  either  waste  or  danger. 

We  see  this  exemplified  over  and  over  again  in  examining  the 
tangled  affairs  of  insolvent  corporations  which  are  in  process  of 
reorganization.  One  of  the  noteworthy  advantages  of  most 
reorganizations  is  the  greater  simplicity  secured  in  the  reorgan- 
ized company  by  the  refunding  of  small  and  isolated  issues  into 
a  few  large  issues  with  well-defined  claims, 
r)  It  is  usually  best,  also,  in  financing,  to  work  along  con- 
ventional lines.  Originality  is  only  too  apt  to  arouse  distrust. 
There  is  almost  an  established  routine  in  organizing  public 
utility  corporations,  which  is  about  as  follows:  First  mortgage 
6%  bonds  are  issued  up  to  75%  or  80%  of  the  cost  of  construction 
or,  if  the  company  is  a  consolidation,  of  the  value  of  the  com- 
bined fixed  assets.  These  bonds  sell  to  bankers  at  95  to  100. 
Preferred  shares  carrying  a  7%  or  8%  cumulative  dividend  are 
then  issued  for  the  balance  of  the  tangible  assets  plus  a  reasonable 
amount  of  good-will.  It  is  expected  that  these  preferred  shares 
will  be  able  to  keep  up  their  dividends.  They  are  usually  taken 
by  bankers  at  about  95.  Common  stock  is  then  issued  to  such 
an  amount  that  the  remaining  earnings,  after  the  period  of 
development  is  over,  will  be  sufficient  to  pay  at  least  5%  or  6%. 
This  would  be  considered  a  conservative  method  of  capitaliza- 
tion, and  in  fact  it  would  be  difficult  to  suggest  any  material 
improvement. 


If  JiTj  liXAKmrl  STfiMnHOO 


CHAPTER  XVIII 
COMBINATIONS 


tifiJi 


H^n<  J   i'.j'.]r.  >-';ii;!''.   :  iVJ  id  J 


§182.    Types  of  Industrial  Combination 

Among  the  fields  for  promotive  activities,  probably  the  one 
that  has  attracted  the  most  public  attention  is  the  formation  of 
combinations  of  previously  existing  companies.  The  small  com-? 
pany  is  usually  of  little  importance  but  of  much  independence. 
As  it  grows,  however,  it  is  almost  sure  to  come  into  closer  and 
closer  relations  with  the  concerns  from  which  it  buys  and  those 
to  whom  it  sells,  and  may  even  establish  some  financial  connec- 
tion with  them.  It  is  likely,  also,  to  come  into  increasingly  bitter 
competition  with  rival  concerns,  which  competition  may  either 
seriously  cut  its  profits  or  greatly  Hmit  the  field  of  its  operations. 
Thus,  there  exists  an  almost  universal  tendency  toward  combina- 
tion along  one  or  both  of  the  following  lines : 

Tf/  'I.  What  may  be  called  "vertical  combination,"  which  means 
!  )M  the  establishment  of  joint  control  over  two  or  more 

concerns  that  have  buying  or  selling  relations. 
i     2.  What  may  be  referred  to  as  "horizontal  combination," 
..•hfui'i-    which  means  the  establishment  of  joint  control  over 

two  or  more  competitive  concerns. 

Vertical  combination  is  especially  common  between  those 
who  produce  or  deal  in  raw  materials,  which  may  be  wholly  or 
partially  monopolized,  and  the  manufacturers  of  these  materials. 
It  is  also  common,  on  the  other  hand,  between  manufacturers 
who  do  not  sell  direct  to  the  final  consumers  of  their  products  and 
the  middlemen  who  intervene. 

The  United  States  Steel  Corporation  is  a  notable  example  of 
a  complete  vertical  combination,  since  it  includes  great  iron- 

737 


73^  CORPORATE  FINANCE  [Bk.  II- 

mining  companies,  ships  and  railroads  for  the  transfer  of  ore, 
blast  furnaces,  mills  of  all  kinds  for  the  production  of  finished 
iron  and  steel  in  every  form,  and  selling  agencies  for  its  disposal. 
Here  is  a  complete  integrated  organization  which  carries  on  the 
whole  process  of  mining,  manufacturing,  and  selling.  The 
United  States  Steel  Corporation  in  some  of  its  aspects  also  is  a 
horizontal  combination.  Examples  of  combinations  between 
competing  concerns  are  not  difficult  to  find,  and  will  readily 

occur  to  every  reader. 

:li  j 

§  183.    Tendency  towards  Combination  y^ 

The  large  combinations,  with  their  hundreds  of  millions  of 
dollars  of  capital,  so  common  from  1897  to  1903,  and  now  occa- 
sionally formed,  have  naturally  attracted  most  attention.  It  is 
not  always  reaUzed  that  the  combination  movement  is  still  going 
on  among  comparatively  small  concerns,  and  that  the  aggregate 
importance  of  these  smaller  combinations  is  probably  even 
greater  than  the  aggregate  importance  of  the  huge  combinations 
that  have  their  securities  listed  on  the  stock  exchanges.  The 
idea  of  taking  over  an  interest  in  another  concern,  or  the  idea  of 
forming  a  new  corporation  which  shall  hold  control  of  two  or 
more  other  concerns,  is  now  entirely  familiar  and  is  being  applied 
in  hundreds  of  cases.  In  a  great  many  of  the  smaller  cities,  manu- 
facturers who  have  been  operating  on  a  comparatively  small 
scale  have  in  recent  years  combined  their  facilities.  The  remark- 
able growth  of  business  associations  made  up  of  competitive 
manufacturers  or  traders  has  been  a  factor  of  importance  in 
facilitating  this  movement  toward  small  combinations. 

§  184.    Promotion  of  Combinations 

If  the  combination  is  purely  a  case  of  one  concern  purchasing 
a  controlling  interest  in  one  or  more  other  concerns,  there  is  no 
distinct  process  of  promotion.  In  cases,  however,  where  a  new 
corporation  is  formed  to  take  over  two  or  more  previously  inde- 
pendent corporations,  promotion  is  an  essential  feature  of  the 


Ch.  i8)  COMBINATIONS  739 

arrangement.  Some  person,  or  group  of  persons,  must  conceive 
the  combination,  must  carry  on  investigations,  work  out  a  finan- 
cial plan,  assemble  their  proposition,  see  to  its  preliminary  financ- 
ing, and  finally  dispose  of  the  securities  put  out  by  the  new 
corporation.! 

§  185.    Fields  for  Combinations 

We  have  spoken  above  chiefly  of  combinations  among  manu- 
facturing concerns;  and  this  is  probably  the  field  in  which  the 
tendency  has  in  recent  years  been  strongest.  However,  it  should- 
not  be  forgotten  that  there  are  other  fields  for  combination. 
Among  the  trading  companies  there  have  been  a  great  many 
mergers  or  alliances  of  department  stores  and  of  groups  or 
"chains"  of  small  retail  stores.  Sometimes  these  chains  of  stores 
have  grown  up  in  a  very  loose  association,  held  together  really  by 
the  personaUty  of  one  or  two  men  who  are  interested  in  each  of 
the  separate  stores  or  plants.  This  loose  association,  it  may  be 
remarked,  is  especially  common  in  the  trade  pubhcation  field, 
where  one  man  will  often  possess  a  controlHng  interest  in  a  num- 
ber of  trade  papers,  each  one  of  which  has  its  own  separate  cor- 
poration and  organization. 

An  example  of  a  somewhat  similar  arrangement  in  the  retail 
store  field  is  that  of  the  J.  C.  Penney  Company.  There  is  prac- 
tically a  partner  in  each  one  of  the  197  stores  which  constitute 
the  "chain,"  as  the  managers  of  these  stores  are  also  stockholders 
and  participate  in  the  profits  of  the  stores  they  manage.  The 
undertaking  has  been  very  successful. 

The  movement  toward  combination  has  been  strong  among 
companies  in  the  theatrical  and  moving  picture  field,  resulting 
in  Loews,  Incorporated,  owning  or  affiliated  with  40  other  amuse- 
ment companies,  and  owning  a  stock  interest  in  almost  30  more; 
the  Orpheum  Circuit,  Incorporated,  controlHng  45  vaudeville 
theaters;  and  Famous  Players-Lasky  Corporation,  a  moving  pic- 


■  For   investigations    and   accounting   requirements    of    combinations,    see    Book    III, 
Part  V,  "Corporate  Combinations." 


74©  CORPORATE  FINANCE  [Bk.  II- 

ture  combination,  owning  in  whole  or  in  part  147  moving  picture 
companies. 

Combinations  among  banks  are  also  fairly  common.  Thus 
the  merger  of  the  Seaboard  National  Bank  and  the  Mercantile 
Trust  Company,  both  of  New  York  City,  was  announced,  Janu- 
ary 23,  1922,  the  new  bank  which  will  retain  the  name  of  the  Sea- 
board National  Bank  having  total  resources  of  over  $80,000,000. 
Again,  but  a  few  weeks  later — March  7,  1922 — the  New  York 

riweS  announces:  ,     .;::;■;,_      •        ;i,    t.!,:,     ,-:;;>;i;        >'ii:iiij  'it 

The  Mechanics  and  Metals  National  Bank  yesteraay  announced 
•'''that  it  had  acquired  a  controlling  interest  in  the  Lincoln  Trust 
/!'    Company  and  would  continue  to  operate  the  branches  of  that  insti- 
ll >    tution  as  adjuncts  to  the  bigger  institution.     This  is  the  third  large       ; 
,,.j  ^  institution  which  has  been  taken  over  by  the  Mechanics  and  Metals 
,    Bank  within  the  last  eight  years.    In  1914  it  took  over  the  Fourth      j 
National  Bank,  and  in  June,  1920,  it  took  over  the  Produce  Ex- 
change National  Bank,  thereby  establishing  nine  branches. 
'..(.I  it 

.i)j  Such  combinations  are  apt  to  be  successful  because  they  pro- 
duce stronger  banks  with  a  more  diversified  clientele,  less  likely 
to  be  swamped  by  local  disturbances. 

Another  field  in  which  there  has  been  a  great  deal  of  com- 
bination is  among  pubUc  utilities — including  gas  and  electric 
light  and  power  companies,  street  railways,  water  works,  irriga- 
tion works,  and  the  like.  Combinations  in  the  public  utility  field 
are  of  a  slightly  different  type  from  those  in  the  manufacturing 
field.  Usually  they  include  a  considerable  number  of  local  com- 
panies, each  one  operating  in  its  own  community,  which  may  be 
far  distant  from  any  other  of  the  combined  companies.  In  fact 
it  is  regarded  as  a  point  of  strength  if  the  various  companies  in 
a  public  utility  combination  are  not  affected  by  the  same  geo- 
graphical or  economic  conditions,  thus  minimizing  the  danger 
that  all  of  them  may  be  seriously  depressed  at  the  same  time. 
While  a  combination  of  this  type  may  be  classed  as  "horizontal," 
it  is  evidently  made  up,  not  of  competing  enterprises,  but  of  en- 
terprises which  may  profitably  co-operate  in  such  activities  as 


Ch.  i8I  COMBINATIONS  741 

the  purchase  of  raw  materials,  securing  high-grade  engineering 
talent,  comparing  experiences,  and  the  like.  The  great  advan- 
tage, however,  which  the  public  utility  combination  has  to  offer, 
is  the  fact  that  it  can  float  bond  and  stock  issues  on  a  large  scale 
and  give  them  a  national  market,  whereas  the  local  public  utility 
company  experiences  difficulty  in  selling  its  securities  outside  its 
local  market.  As  a  result,  "about  78.5%  of  the  total  gas,  electric 
light,  and  traction  capital  of  operating  public  utilities  is  now 
owned  by  holding  companies.  The  average  electric  light  com- 
pany has  about  $342,000  of  securities  outstanding.  The  under- 
taking is  too  small  to  finance  itself  efficiently  when  it  has  to  in- 
crease its  capital  investment  about  20%  per  annum ;  that  is  why 
the  holding  company  is  efficient  as  a  financial  medium .  "2  A  single 
Company,  Cities  Service  Company,  owns  or  controls  over  100 
subsidiary  companies — 28  of  them  oil  companies — with  a  com- 
bined investment,  January  10,  192 1,  of  over  $600,000,000. 

Among  recent  noteworthy  combinations  in  other  lines  are  the 
General  Motors  Corporation,  almost  rivaling  the  United  States 
Steel  Corporation  in  size ;  the  AHied  Chemical  and  Dye  Corpora- 
tion, a  combination  of  the  most  powerful  chemical  manufactur- 
ers of  the  country,  with  a  capital  stock  of  over  $50,000,000,  and 
a  surplus,  December  31,  1920,  of  over  $126,000,000;  and  the  Sin- 
clair Consolidated  Oil  Corporation,  with  a  capital  stock  of  almost 
$200,000,000. 

§  186.    Basis  of  Combination — National  Starch  ' 

The  first  consolidation  in  the  starch  industry  was  the  National 
Starch  Manufacturing  Company  in  1890.  In  this  case  the  pro- 
moter, after  making  his  preliminary  investigation  and  forming 
his  financial  plan,  secured  options  on  20  starch  manufacturing 
plants.  All  the  options  stipulated  that  the  vendors  should  re- 
ceive 25%  of  the  value  of  their  mills  in  cash;  2,1^/i^o  in  bonds; 


'  W.  H.  Gardner,  in  'New  York  Annalist,  June,  1915. 

'  The  data  in  this  chapter  as  to  the  starch  combinations  are  based  upon  the  accounts 
given  in  Dewing's  Corp.  Prom,  and  Reorg. 


742  CORPORATE  FINANCE  [Bk.  n- 

22%%  ini  first  preferred  stock;  and  i8^%  in  second  preferred 
stock.  In  addition,  each  manufacturer  was  to  receive  a  common 
stock  bonus  of  27>^%.  The  working  assets  of  each  independent 
concern  were  taken  over  and  paid  for  in  cash. 

It  was  part  of  this  general  plan  that  the  promoter  himself, 
through  the  Cumberland  Investment  and  Security  Company,  of 
which  he  was  president,  should  furnish  $1,545,750  cash,  for  which 
he  received  an  equal  amount  in  bonds  and  preferred  stock  and 
100%  bonus  of  common  stock.  Assuming  that  the  promoters 
were  able  to  market  these  securities  at  the  prices  prevaiKng  dur- 
ing the  first  two  years  following  the  promotion,  their  compensa- 
tion amounted  to  $722,677. 

It  is  evident  that  in  this  instance,  although  the  promoter  was 
acting  on  his  own  responsibiHty,  there  was  a  common  basis  of 
valuation  and  terms  of  payment  for  the  plants  which  were  turned 
into  the  combination.  When  securities  are  exchanged,  it  is,  in 
fact,  necessary  that  there  should  be  soine  such  common  agree- 
ment— or  at  least  an  informal  understanding — for  otherwise  there 
is  no  method  of  judging  the  probable  value  of  the  securities  re. 
ceived  in  payment  for  the  plants.  . 

§  187.    Basis  of  Combination — United  Starch 

In  1899  another  promoter  planned  to  organize  a  second  starch 
combination,  and  a  meeting  was  held  for  the  purpose  of  deciding 
upon  the  basis  of  combination.  The  notes  of  this  meeting  have 
been  preserved,  and  are  extremely  interesting  as  showing  the  first 
stages  in  the  process  of  organizing  a  combination. 

Memorandum  of  Meeting  held  in  the  office  of  Charles  R. 
Flint,  June  30,  at  10  a.m. 

Present:  Messrs.  Flint,  Auerbach,  T.  P.  Kingsford,  Higgins, 
Duryea,  Morton,  and  Allen. 

It  is  agreed  to  organize  the  United  States  Starch  Company  with 
a  capital  of  $2,500,000  preferred  6%  cumulative  stock  and  $3,500,- 
000  common  stock.  And  that  the  former  shall  be  held  in  trust  by 
the  United  States  Mortgage  and  Trust  Company,  and  issued  later 
through  bankers  to  be  provided  by  Mr.  Flint.     The  common  stock 


Ch.  i8]  COMBINATIONS  743 

shall  also  be  held  in  trust  for  the  owners  for  such  a  time  as  they 
may  elect. 

It  is  agreed  and  understood  that  the  vendors  shaU  receive 
$95o,ocx)  in  cash,  $1,550,000  preferred  stock,  and  $3,000,000  in 
common  stock,  for  their  plants  and  inventories,  to  be  provided  for 
as  follows: 

First,  a  loan  shall  be  made  by  the  United  States  Mortgage  and 

Trust  Company  for  $950,000  for  nine  months,  same  to  be  paid  from 

the  proceeds  of  the  sale  of  an  equal  amount  of  preferred  stock  to  be 

issued  at  such  time  as  in  the  judgment  of  the  Directors  may  be 

,.  proper.     The  proceeds  of  this  loan  to  be  used  as  follows: 

To  pay  Kingsford $400,000 

Morton 175,000                     j 

Graves 350,000 

"     "    Duryea Vl^ji^h . .  25,000                   'f 


Total $950,000 

Second,  in  addition  to  the  cash  paid  as  above,  preferred  stock 
shall  be  assigned  to  the  vendors  as  follows: 

Kingsford $1,100,000  on  plant  and  inventory 

Morton 125,000  "  plant 

Duryea 100,000  "  inventory 

7S,ooo  "  plant 

Graves 100,000  "  inventory 

50,000  "  plant 


Total $1,550,000 

"• '  which  shall  be  held  in  trust  by  the  United  States  Mortgage  and 

Trust  Company  for  account  of  the  owners  until  the  time  of  issue. 

$3,000,000  of  common  stock  is  to  be  issued  to  the  vendors  in 

part  payment  of  real  and  personal  property  turned  over  to  the  new 

company,  as  follows: 

Kingsford , $2,422,500 

Morton ...,..,...  .,^.\.  ...^, ^.....„  ,  255.000  ,-. 

TA.  „  „       xiodHfiidixtoJ  iffttti*:^  »  lol  nnlH  l&rjTiiinri 
Duryea 322,500 


Total $3,000,000 

Included  in  the  property  tiu-ned  over  by  the  vendors,  it  is  es- 
timated that  there  wiU  be  about  $750,000  of  quick  assets,  consisting 
of  grain,  package  materials,  and  starch,  manufactured  and  in 
process 


^  CORPORATE  FINANCE  [Bk.  II- 

$Soo,ocx)  in  common  stock  shall  be  paid  to  cover  the  entire  costs 
of  promoting  the  company,  including  the  charter,  the  organization, 
the  commission  paid  in  stock  for  securing  the  loan,  the  fee  of  the 
bankers  who  issue  the  preferred. 

Common  stock  to  vendors $3,000,000 

Common  stock  to  promoters 500,000 

Total $3,500,000 

§  188.     Consolidations 

Sometimes  two  or  more  formerly  independent  corporations 
are  not  joined  under  one  control  by  an  exchange  of  securities, 
but  are  actually  "consolidated"  or  "merged."  The  tvi^o  w^ords 
just  quoted  are  sometimes  used  in  a  popular  sense  as  almost 
equivalent  to  "combined,"  but  are  here  used  in  their  legal  sense. 
A  "consolidation"  or  "merger,"  technically  speaking,  consists  of 
the  complete  union  of  one  corporation  with  another  corporation, 
so  that  the  charters,  corporate  powers,  and  security  issues  are  all 
combined,  making  only  one  corporation  in  place  of  the  two  which 
previously  existed.  This  is  entirely  different,  it  will  be  seen,  from 
the  usual  plan  of  keeping  ahve  all  the  corporations  that  enter  the 
combination  and  simply  acquiring  voting  control  over  those 
corporations.  One  of  the  largest  and  most  important  consolida- 
tions that  has  ever  taken  place  in  the  United  States  was  that  of 
the  New  York  Central  and  Lake  Shore  and  Michigan  Central 
Railroad  Company  in  1914.  The  prime  purpose  in  this  case,  it 
was  stated,  was  to  make  possible  a  more  extensive  mortgage  and 
larger  bond  issues  than  could  be  brought  out  by  either  of  the 
corporations  separately. 

§  189.     Financial  Plan  for  a  Small  Combination 

The  following  brief  review  of  the  facts  as  to  a  small  combina- 
tion of  manufacturing  plants  located  in  a  western  city  illustrates 
the  principles  of  financial  organization  as  applied  to  combinations. 

The  Western  Machinery  Company  was  organized  for  the 
purpose  of  manufacturing  certain  patented  specialties.    Its  capi- 


Ch.  i8]  COMBINATIONS  745 

tal  stock  was  $150,000,  and  first  mortgage  bonds  were  issued  to 
the  extent  of  $25,000;  $100,000  of  the  capital  stock  was  given  in 
payment  for  patents,  and  $50,000  was  given  to  a  promoter  for 
his  services  in  disposing  of  the  bonds  at  par.  The  $25,000  re- 
ceived for  the  bonds  represented  the  total  cash  actually  invested. 

It  was  quickly  found  that  the  business  could  not  prosper  with 
the  few  specialties  it  controlled,  and  other  specialties  intended 
for  the  same  general  market  were  added.  As  a  result,  practically 
all  of  the  profits  which  were  earned  from  year  to  year  were  spent 
in  securing  new  patents  and  in  their  development.  This  con- 
tinued for  some  five  or  six  years,  when  at  last  a  satisfactory  out- 
put was  made.  Then,  however,  a  depression  in  the  following 
year  almost  wiped  out  the  business  of  the  company  and  cut  down 
the  profits  practically  to  zero.  Since  then  there  has  been  a  re- 
covery and  net  profits  are  now  running  at  the  rate  of  approxi- 
mately $20,000  per  annum.  The  character  of  the  business  has 
changed  considerably  since  its  inception,  but  it  may  be  regarded 
as  established  on  a  reasonably  sound  basis.  The  company,  how- 
ever, is  considerably  handicapped  by  its  location  which  is  unfav- 
orable for  the  business  in  which  it  is  now  engaged. 

A  few  miles  distant  from  the  city  in  which  the  Western 
Machinery  Company  operates  is  a  related,  but  not  competitive 
business,  owned  outright  by  a  gentleman  whom  we  will  call 
James  Smith.  He  has  a  small  plant  worth  perhaps  $60,000, 
which  is  earning  net  profits  of  about  $6,500. 

There  is  also  in  the  immediate  neighborhood  the  plant  of  a 
manufacturing  company  which  became  bankrupt  some  years 
ago.  The  plant  has  been  closed  for  over  three  years.  The  build- 
ings and  other  assets,  even  in  their  present  depreciated  condition, 
are  estimated  to  have  a  value  of  well  over  $100,000,  but  could  be 
bought  for  a  much  smaller  consideration. 

§  190.    The  Proposed  Plan 

It  is  now  proposed  to  combine  these  three  plants  under  the 
name  and  charter  of  the  first-named  company.    It  is  believed 


746  CORPORATE  FINANCE  [Bk.  II- 

that  the  management  which  has  developed  this  business  in  the 
face  of  unfavorable  conditions  can  at  least  go  ahead  with  the 
successful  operation  of  the  plant  owned  by  James  Smith  and  can 
reorganize  and  successfully  conduct  the  abandoned  business  of 
the  company  which  formerly  owned  the  third  plant.  James 
Smith  is  willing  to  remain  with  the  new  organization  for  a  short 
time  and  then  retire,  so  there  are  no  personal  antipathies  or 
jealousies  to  be  overcome.  It  is  proposed  to  recapitalize  the 
Western  Machinery  Company  as  follows: 

Issued  at 
Authorized  Time  of 

Issue  Combination 

6%  First  Mortgage  Bonds $500,000  $150,000 

6%  Cumulative  Preferred  Stock 250,000  180,000 

Common  Stock 250,000  250,000 

It  is  proposed  to  distribute  the  securities  of  the  reorganized 
company  as  follows: 

Preferred         Common 
Bonds  Stock  Stock 

Western  Machinery  Company $  30,000         $100,000         $250,000 

James  Smith 20,000 

Owners  of  abandoned  plant 20,000  40,000 

To  be  sold  to  the  public 100,000  20,000 

Total $150,000         $180,000         $250,000 

It  is  anticipated  that  the  bonds,  with  a  20%  bonus  of  pre- 
ferred stock,  can  be  sold  to  an  underwriting  syndicate  at  par. 
The  syndicate  will  probably  be  able  to\iispose  of  the  bonds  alone 
at  par,  leaving  its  selling  expenses  and  profits  to  be  covered  by 
the  bonus  of  preferred.  Thus  the  company  will  realize  $100,000 
in  cash. 

It  is  further  provided  in  the  financial  plan  that  James  Smith 
shall  receive  in  addition  to  his  $20,000  preferred,  $30,000  in  cash, 
thus  leaving  $70,000  in  cash  for  the  rehabilitation  of  the  aban- 
doned plant  and  for  working  capital. 

It  is  further  provided  that  when  earnings  on  the  preferred 
stock  amount  to  as  much  as  12%,  then  the  70%  of  preferred  re- 


Ch.  i8]  COMBINATIONS  747 

maining  unissued  at  the  time  of  organization  shall  be  distributed 
as  a  bonus  in  agreed  proportion  among  the  owners  of  the  three 
plants  entering  into  the  combination. 

It  is  estimated  that  the  net  profits  of  the  combination  should 
average  at  least  $60,000,  or  approximately  three  times  the  inter- 
est and  preferred  dividend  payments,  at  the  outset.  The  three 
lines  of  business  fit  together  well  and  the  combination  of  the  dif- 
ferent businesses  will  provide  excellent  facilities  for  manufactur- 
ing and  shipping.  This  will  much  improve  the  efficiency  of  the 
two  going  plants  and  will  make  possible  the  profitable  operation 
of  the  abandoned  plant. 

§  191.     Criticism  of  Financial  Plan 

In  an  independent  analysis  and  criticism  of  the  foregoing  plan, 
it  was  pointed  out  that  the  earnings  of  the  proposed  combination 
appear  to  be  loosely  estimated  and  that  a  much  more  thorough 
investigation  of  probable  markets  for  the  products  of  the  com- 
bination, of  the  selling  expenses,  and  of  the  actual  expenditures 
required  to  build  up  an  efficient  working  organization  in  the 
abandoned  plant,  would  be  demanded  by  a  conservative  investor 
before  putting  any  of  his  money  into  the  proposition.  Unless  it 
can  be  demonstrated,  not  merely  as  a  supposition,  but  as  a  rea- 
sonable certainty,  that  the  earnings  will  average  $60,000  or  more, 
there  will  be  no  real  advantage  to  the  Western  Machinery  Com- 
pany in  carrying  through  this  combination.  After  all,  the  plant 
which  that  company  possesses  is  the  only  one  that  is  now  earning 
a  considerable  volume  of  profits,  and  this  plant  will  presumably 
be  the  chief  contributor  to  the  profits  of  the  combination. 

Also,  while  it  is  no  doubt  true,  as  stated  in  the  plan,  that  the 
Western  Machinery  Company  could  make  use  of  enlarged  facili- 
ties advantageously,  the  question  to  consider  here  is  whether  a 
small  bond  or  preferred  stock  issue,  based  upon  the  assets  of  the 
company,  would  not  provide  facilities  for  enlarging  its  operations 
and  earning  more  profits  with  less  risk  than  would  be  the  case  if 
the  combination  were  formed.     Under  the  proposed  plan,  the 


74^  CORPORATE  FINANCE  [Bk.  II- 

Western  Machinery  Company  assumes  nearly  the  whole  burden 
of  risk,  must  contribute  its  own  profits  to  the  payment  pi  interest 
and  dividends,  and  must  rely  on  its  ability  to  develop  new  busi-, 
ness  for  the  other  two  plants  before  the  combination  can  give  a 
satisfactory  return  to  the  present  owners  of  the  Western  Machin- 
ery Company.  To  state  the  case  in  slightly  different  terms,  the 
most  successful  of  the  three  companies  entering  into  this  plan 
will  be  giving  up  the  practical  certainty  of  continued  satisfactory 
profits,  for  the  uncertainty  of  developing  a  new  enterprise. 

It  may  be  stated  in  general  terms,  that  the  wisdom  of  comr^ 
bining  a  going,  successful  concern  with  an  unsuccessful  concern 
may  almost  always  be  questioned.  If  the  successful  concern  de- 
sires to  acquire  the  assets  of  the  unsuccessful  concern,  that  may 
best  be  done  by  raising  cash  upon  its  own  credit  and  purchasing 
those  assets  outright.  The  situation  is  entirely  different  from  the 
one  which  exists  when  two  or  more  going  and  successful  corpora- 
tions are  combined  on  the  basis  of  their  earning  powers.  /  . 

On  the  strength  of  this  criticism,  the  plan  was  abandoned .<^^ 

§  192.     The  Rock  Island  Manipulation 

It  sometimes  happens  that  the  promoters  of  a  combination 
have  in  mind,  not  so  much  the  immediate  cash  profits  from  a 
combination  as  the  control  of  properties.  If  two  or  more  compa- 
nies are  already  capitalized  at  a  high  figure,  it  may  be  difficult 
to  put  through  an  exchange  of  securities  that  will  realize  much 
profit;  yet  possibly  control  may  be  secured  with  a  very  small 
expenditure  of  cash. 

One  of  the  most  remarkable  illustrations  of  this  type  of  com- 
bination is  afforded  by  the  history  of  the  old  Rock  Island  Com- 
pany, which  in  191 5  went  into  a  receiver's  hands.  The  original 
company  was  the  Chicago,  Rock  Island  and  Pacific  Railway 
Company  of  Illinois,  which  up  to  1901  had  outstanding  capital 
shares  amounting  to  $50,000,000.    In  1901  a  controlling  interest 


'As  the  facts  cited  in  this  section  are  not  matters  of  public  record,  the  names  and  some  of 
the  identifying  details  are  altered. 


Ch.  i85  COMBINATIONS  749 

was  acquired  through  the  open  market  by  a  group  which  came 
to  be  known  as  the  "Rock  Island  Crowd,"  made  up  of  W.  H. 
Moore,  Daniel  G.  Reid,  William  B.  Leeds,  James  H.  Moore,  and 
some  minor  participants.  With  the  exception  of  Mr.  Leeds,  none 
of  these  men  had  had  any  special  experience  or  interest  in  rail- 
road affairs.  Their  activities  in  Rock  Island  were  almost  wholly 
in  connection  with  its  finances. 

In  June,  1901,  within  three  months  after  they  had  secured 
control,  the  capital  stock  was  increased  from  $50,000,000  to 
$60,000,000,  the  new  shares  being  sold  to  the  public  at  par.  In 
1902  the  authorized  capital  stock  was  again  increased  to  $75,- 
000,000  and  the  new  shares  sold  at  par.  This  $25,000,000  was 
used  to  construct  and  buy  small  lines  or  ''feeders"  for  the  railroad. 

Shortly  afterwards  a  new  corporation,  the  Chicago,  Rock 
Island  and  Pacific  Railroad  Company  of  Iowa,  was  organized 
with  an  authorized  capital  stock  of  $125,000,000,  and  an  author- 
ized issue  of  collateral  trust  bonds  of  $75,000,000.  The  collateral 
trust  bonds  were  exchanged,  dollar  for  dollar,  for  the  outstanding 
capital  shares  of  the  Chicago,  Rock  Island,  and  Pacific  Railway, 
Company  of  IlUnois.  )  v/ia  k  bf\iz  .h^iainhih 

At  about  the  same  time  another  new  corporation,  the  Rock 
Island  Company  of  New  Jersey,  was  incorporated  and  at  once 
issued  $96,000,000  of  common  and  $54,000,000  of  preferred 
shares.  This  $150,000,000  of  stock  was  exchanged  for  the  capital 
shares  of  the  Chicago,  Rock  Island  and  Pacific  Railroad  Company 
of  Iowa.  A  peculiarity  of  the  Rock  Island  Company  of  New 
Jersey  was  the  fact  that  the  preferred  stock  elected  a  majority  of 
the  board  of  directors.  Hence,  control  of  slightly  over  $27,- 
000,000  of  the  $54,000,000  outstanding  preferred  stock  would 
give  control  of  the  corporation.  Inasmuch  as  the  preferred  stock 
sold  below  par  in  the  open  market,  the  actual  cash  investment 
required  was  $16,000,000  to  $17,000,000.  As  the  stock  was  good 
banking  collateral,  a  large  part  of  this  could  be  borrowed. 

As  is  evident,  the  new  Rock  Island  Company  controlled  the 
Chicago,  Rock  Island  and  Pacific  Railroad  Company  of  Iowa, 


750  CORPORATE  FINANCE  [Bk.  II- 

which  in  turn  controlled  the  Chicago,  Rock  Island  and  Pacific 
Company  of  Illinois,  the  operating  corporation.  In  other  words, 
the  relatively  small  cash  investment  of  not  over  $17,000,000  was 
sufficient  to  control  a  corporation  whose  outstanding  stock  had 
a  book  value  of  over  $75,000,000. 

The  Chicago,  Rock  Island  and  Pacific  Railway  Company  of 
Illinois  resumed  operations  after  the  termination  of  the  receiver- 
ship in  191 7,  under  its  original  charter. 

§  193.    Requirements  for  a  Successful  Combination  \^ 

It  may  be  remarked,  in  closing  this  chapter,  that  the  history 
of  the  large  industrial  and  railroad  combinations  does  not  sup- 
port the  opinion  formerly  prevalent  that  combinations  neces- 
sarily achieve  economies  and  improvements  in  operation.  On 
the  contrary,  the  general  impression  which  today  prevails  among 
conservative  bankers  and  investors  is  that  most  combinations 
are  more  or  less  failures,  due  largely  to  the  recklessness  and  in- 
efficiency of  their  management.  It  is  clear  that  when  the  execu- 
tive organizations  of  a  number  of  different  plants  are  suddenly 
disrupted,  and  a  new  executive  organization  takes  over  the  man- 
agement of  all  these  plants,  there  are  pressing  and  difficult  prob- 
lems of  organization  to  be  solved.  The  controlling  spirits  of  the 
new  management  must  indeed  be  able,  thoroughly  trained,  and 
resourceful,  if  they  are  to  retain  the  good  features  of  the  former 
managements  and  also  add  the  other  good  features  which  their 
larger  capital  enables  them  to  command.  It  is  but  seldom  that 
they  are  adequate  to  the  task. 

Sometimes  a  combination  is  formed  under  auspices  so  favor- 
able and  with  so  much  harmony  that  a  majority  of  the  executive 
talent  engaged  in  the  former  independent  concerns  remains  with 
the  combination.  Then,  if  the  leader  of  the  combination  proves 
to  be  a  man  of  unusual  breadth  and  of  commanding  abilities,  he 
may  be  able  quickly  to  build  up  a  new  and  efficient  organization. 
Ordinarily,  however,  it  happens  that  the  executive  officers  of  the 
former  independent  plants,  who  are  perhaps  not  large  sharehold- 


Ch.  i8]  COMBINATIONS  751 

ers  in  those  plants,  are  not  satisfied  to  accept  subordinate  posi- 
tions in  the  combination.  They  prefer  to  go  into  other  lines  of 
business  or  even  to  start  competing  concerns  of  their  own.  The 
malting  combination  and  the  various  starch  combinations  afford 
excellent  examples  of  such  a  result.  They  were  formed  to  limit 
and  forestall  competition;  their  chief  result  was  to  increase  the 
amount  and  intensity  of  competition. 

On  the  other  hand,  this  difficulty  is  not  so  likely  to  arise  when 
a  combination  grows  gradually,  absorbing  one  or  two  plants  at  a 
time.  In  that  case  the  executive  organization  may  also  expand 
accordingly  and  the  concern  will  be  built  on  a  safe  basis. 

It  may  further  be  said  that  when  the  principles  of  business 
organization  are  better  understood  and  more  effectively  applied, 
the  greatest  obstacle  to  the  success  of  combinations  will  tend  to 
disappear. 


10 


Part  IV— Securing   Capital 


CHAPTER  XIX 
PROMOTION— PREPARATORY  WORK 

§  194.    Three  Steps  in  Promotion  Wiih-  ^"> 

After  the  financial  plan  for  a  new  undertaking  has  been 
agreed  upon,  the  next  step  is  to  put  it  into  operation.  If  the 
only  persons  to  be  identified  with  the  new  enterprise  are  those 
who  have  talked  it  over  among  themselves  and  have  come  to  a 
decision  as  to  the  plan,  there  can  hardly  be  said  to  be  a  separate 
process  of  persuading  them  to  accept  the  plan  and  to  purchase 
the  securities  of  the  new  enterprise.  But  when  the  launching 
of  an  enterprise  necessitates  the  seeking  of  capital  outside  the 
original  circle,  then  there  is  a  distinct  stage  of  shaping  the 
proposition  into  salable  form  and  of  raising  the  required  capital 
through  the  sale  of  th  corporate  securities — a  process  known  as 
**  promotion." 

As  to  the  legitimacy  and  usefulness  of  the  promotion  of 
sound  and  beneficial  enterprises,  there  can  be  no  real  question. 
The  promoter  finds  an  opportunity  and  turns  it  into  a  reality. 
His  work  has  been  in  part  discredited  because  the  term  "  pro- 
motion" has  been  misapplied  to  many  swindling  efforts  to  sell 
worthless  stock.  In  its  proper  meaning,  however,  it  should  be 
a  term  of  honor.  The  promoter  is  the  organizer  who  brings 
together  capital  and  an  enterprise  in  which  this  capital  can  be 
usefully  and  profitably  employed. 

If  promotion  is  carried  on  properly,  it  is  divisible  into  three 
distinct  stages: 

753 


754  jCORPORATE  finance'  [Bk.  II- 

1.  The  thorough  investigation  of  the  new  enterprise  in  all 
its  phases.  Sometimes  the  promoter  is  so  familiar  with  the 
enterprise  that  this  stage  may  be  almost  ignored ;  more  fre- 
quently, he  possesses  merely  a  general  knowledge  of  similar 
enterprises,  which  knowledge  enables  him  readily  to  grasp  the 
particular  enterprise  before  him.  It  is  dangerous,  however, 
to  make  any  assumptions  without  full  and  accurate  verification. 

2.  The  "assembling"  of  the  enterprise,  that  is  to  say,  the 
forming  of  the  financial  plan,  the  securing  of  options,  the  char- 
tering of  the  new  corporation,  and  the  other  final  preparations 
for  selling  securities.  > 

3.  The  financing  of  the  new  enterprise;  that  is,  the  actual 
sale  of  its  securities  to  secure  capital  to  establish  the  business. 

§195.    Necessity  of  Investigation  1  -:'i! 

When  any  one  of  the  thousand  and  one  possibilities  of  the  '" 

'^'    business  world  is  brought  forward  for  financing  no  matter  by  whom  'b 

V    or  in  what  stage  of  its  progress  of  development,  the  first  and  most  j 

.)i,  important  question  is:  "Will  it  pay?"    The  question  can  only  be  ,j 

.      answered  by  investigation.    This  investigation,  then,  is  obviously 

of  the  most  vital  importance  to  everyone  interested,   whether 

owner,  promoter,  operator,  or  investor.     Upon  its  thoroughness,  * 

intelligent  direction,  and  accuracy  depend  the  safety  of  the  investment —  ' '  I 

^  1 '    if  an  investment  is  made — and  to  a  very  large  degree  the  whole  future  of  \  i 

the  enterprise.  " .  noiiomoiq ' ' 

§  196.    For  Whom  Investigation  Is  Important  ,  .       ^  * 

In  this  matter  of  investigation  there  is,  when  an  enterprise  is  to 

be  financed,  a  paralleling  of  interests  of  both  owner  or  promoter  and 

"'    '  the  prospective  investor.     The  owner  or  promoter  is  desirous  of 

capitalizing  his  enterprise  at  the  highest  legitimate  figure  and  tne  ■  f 
prospective  investor  wants  to  "come  in"  at  the  lowest  possible  7 
figure,  and  in  these  respects  their  interests  are  opposed.  But  in 
each  case,  before  the  financial  aspect  of  the  undertaking  can  be 
intelligently  considered,  both  parties  require  the  same  basic  in- 
formation. No  matter  what  the  enterprise  to  be  financed — the 
development  of  a  mine,  the  exploitation  of  an  invention,  the  com- 


•  Prom  I  Financing  an  Enterprise,  by  H.  R.  Conyngton,  pp.  8i,  82. 


Ch.  19J  PROMOTION— PREPARATORY  WORK  755 

bination  of  existing  industries,  or  some  other  form  of  commercial 
activity,  the  owners  or  promoters  cannot  determine  the  value  of 
what  they  have  to  offer  untU  a  very  thorough  investigation  has 
given  a  basis  of  estimation,  or  in  the  case  of  a  going  concern  or  a      . 
combination  of  going  concerns,  until  appraisals  have  been  made 

Jg'J!  and  balance  sheets  and  profit  and  loss  statements  have  been  worked 
out  and  so  compared  and  combined  as  to  supply  the  desired  in- 
formation.    On  the  other  hand,  the .  investor  cannot  gauge  the 
.  .  worth  or  the  safety  of  the  investment  offered  until  he  has  in  some 
way  secured  access  to  the  same  data.     Both  are  vitally  interested 

^"^"  ■  in  the  intrinsic  worth  of  the  enterprise  and  consequently  in  the 
adequacy  and  accuracy  of  the  preliminary  investigation, 

§  197.     Inadequate  Investigation 

Most  promoters,  however,  have  to  do,  not  with  entirely 
new  enterprises,  but  with  readjustments  or  combinations  of 
old  enterprises;  consequently,  some  of  the  processes  of  in- 
vestigation may  be  eliminated.  The  common  tendency,  however, 
is  to  slur  over  all  of  it,  and  the  common  result  is  that  calcula- 
tions of  prospective  earnings,  of  the  amount  of  capital  re- 
quired, and  the  like,  are  frequently  far  removed  from  the 
truth.     This  is  just  where  slipshod  methods  do  most  harm. 

A  curious  case  of  disaster  resulting  from  unanticipated 
conditions  is  that  of  the  Canadian  Sardine  Company  which 
some  years  ago  put  up  a  half-million  dollar  plant  at  St.  Johns, 
New  Brunswick.  This  plant  was  thoroughly  modern  and 
efficient  and  was  expected  to  yield  large  profits.  Unfortunately, 
for  two  or  three  years  after  the  completion  of  the  plant  the 
sardines  did  not  run.  It  was  impossible  to  carry  on  the  busi- 
ness, and  the  company  went  into  bankruptcy.  Shortly  there- 
after, the  sardines  returned  to  the  Newfoundland  fishing  banks 
and  ran  as  usual  but  it  was  too  late.  This  is  a  striking,  but  by 
no  means  extreme  instance  of  establishing  a  business  and  in- 
vesting a  large  sum  of  money  upon  an  uncertainty.  In  this 
particular  case  it  may  not  have  been  possible  to  determine 
in  advance  the  approaching  conditions  which  led  to  disaster. 
In  most  cases,  however,  the  uncertai^jtieSj  can  by|Cja,ref\U,  pre- 


f$6  CORPORATE  FINANCE  [Bk.  II- 

liminary  investigation  be  avoided  entirely,  or  at  least  greatly 
minimized. 

§  198.    Scope  of  Investigation 

We  cannot  here  enter  into  a  discussion  of  the  technical 
points  and  subjects  which  are  covered  in  the  investigations 
of  many  different  projects,  for  their  range  is  infinite.  A  well- 
known  engineering  firm  has  had  under  investigation  within 
the  last  two  years  such  various  undertakings  as  an  irrigation 
project  in  Brazil,  a  steam  railroad  in  the  Philippines,  a  street 
railway  in  South  Africa,  and  hundreds  of  proposals  within  the 
United  States.  Every  one  of  these  propositions  that  seems 
worth  while  is  reported  upon  at  great  length  by  trained  engineers 
and  investigators.  The  stock  of  information  which  is  contained 
in  the  reports  filed  with  the  head  office  of  this  firm  is  varied 
and  enormous.  It  includes  many  studies  of  sociological  and 
political  conditions,  as  well  as  of  more  technical  considerations 
of  construction  and  engineering.  '  Each  one  of  the  more  elaborate 
reports  is  illustrated  with  photographs  pasted  on  the  type- 
written pages.  Often  a  report  will  run  from  50,000  to  200,000 
words  and  yet  will  contain  only  essential  information  boiled 
down  to  as  brief  a  space  as  safety  will  permit.  '^ 

The  questions  to  be  considered  in  such  an  investigation 
are  well  stated  in  a  paper  on  "Initial  Financing  of  an  Enter- 
prise" by  E.  K.  Chapman,  president  of  the  Hudson  Trust 
Company  of  New  York  City.  According  to  Mr.  Chapman,  in 
promoting  a  manufacturing  corporation  which  is  taking  over 
either  tangible  property  or  patent  rights,  copyrights,  good-will, 
and  the  like,  there  are  eight  points  which  should  at  the  outset 
receive  careful  consideration: 

1.  The  validity  of  the  patents,  copyrights,  and  other  titles 
and  rights,  or  the  soundness  of  the  claim  of  good-will. 

2.  Strength  and  dangers  of  present  and  potential  competition. 

3.  Likelihood  of  securing  for  the  new  company  the  proper 
grade  of  managerial  talent. 


Ch.  iqI  promotion— preparatory  WORK  757 

4.  Sufficiency  of  capital  and  dependable  resources.  This 
should  be  enough,  not  merely  to  get  along  if  everything  goes 
well,  but  to  include  the  expenses  and  losses  of  the  early  experi- 
mental stage,  and  to  provide  a  safe  margin  for  emergencies. 
It  is  generally  not  desirable  to  apply  for  money  a  second  time 
to  the  people  who  subscribed  the  original  amount  of  capital 
stock. 

5.  The  par  value  of  the  capital  shares,  which  should  be 
low  if  the  appeal  is  to  be  made  to  small  investors,  and  not  less 
than  $100  if  the  appeal  is  to  be  made  to  large  investors.       ! 

6.  The  contract  between  the  corporation  and  the  promoter. 
The  promoter  should  be  reimbursed  in  cash  for  his  actual  cash 
expenditures,  but  the  compensation  for  his  services  should  be 
in  the  form  of  shares  in  the  corporation. 

7.  Necessity  of  investing  a  large  sum  of  capital  in  con- 
structing a  plant  for  manufacturing  the  proposed  product. 
Ordinarily  it  is  less  risky  to  start  by  having  the  product  manu- 
factured under  contract  by  outsiders  or  by  assembling  the 
parts  which  have  been  purchased  or  manufactured  under 
contract. 

8.  Probability  of  securing  capital  from  men  with  experience 
in  similar  lines  of  business  or  with  special  information. 

It  is  well  for  a  banker,  or  investor,  or  anyone  else  who 
has  to  do  with  financing  new  enterprises,  to  have  some  such 
list  as  Mr.  Chapman's  before  him  in  order  to  make  sure  he  is 
not  overlooking  some  essential  point  of  any  suggested  enter- 
prise,, 

§  199.    Preliminary  Analysis 

The  preliminary  analysis  and  review  of  the  underlying 
conditions  of  an  enterprise  to  be  financed  has  been  best  stan- 
dardized, perhaps,  in  public  utility  fields.  A  great  number  of 
projects  of  this  nature  have  been  presented  during  recent  years, 
and  bankers  have  worked  out  and  come  to  accept  certain  well- 
defined  standards.     Their  preliminary  estimates  of  earnings. 


758  CORPORATE  FINANCE  [Bk.  II- 

for  instance,  are  based  upon  approximately  the  following  prob- 
able yearly  receipts,  from  each  person  in  the  territory  covered 
by  the  public  utility .2 

Electric  light  and  power  companies $3.00  to  $6.00  per  capita 

Gas  companies 2.00  "    6.00 

Electric  street  railways  in  small  cities ... .      4.00  "     5.00 
Electric  street  railways  in  large  cities ...  .      7.00  "  10.00      " 
Interurban  railways 6.00  "  10.00 

§  200.     Preliminary  Survey  of  an  Electric  Railway 

The  New    York  Annalist^  describes  the  preliminary  survey 
of  an  electrical  railway  project  as  follows: 

There  are  25  or  30  banking  houses  in  New  York  City  that  spe- 
cialize in  financing  electrical  railways.    Each  of  them  is  supposed  .i^j 
to  receive  500  to  1,000  proposals  for  building  new  lines  or  purchas- 
ing and  rehabilitating  old  lines  each  year. 

In  judging  these  new  projects,  the  bankers  take  into  considera- 
tion, first  of  all,  the  political  attitude  of  the  state  or  city  in  regard 
to  public  utilities.  They  have  on  file  tabulated  data  with  regard  to 
the  political  record  and  activities  of  each  state.  They  consider, 
next,  the  United  States  census  figures  of  population  and  statistics, 
which  indicate  the  rate  of  growth  of  population.  ^.. 

Next,  the  promoter  is  asked  to  pay  the  expenses  and  fees  of  an 
expert  engineer  designated  by  the  banking  house,  who  makes  a 
preliminary  survey  of  the  proposed  line.  He  tabulates  the  number 
of  cuts  and  fills  and  arrives  at  an  approximate  estimate  of  the  cost 
of  construction.  He  also  inquires  closely  into  the  cost  of  rights  of 
way  and  of  terminals.  His  advance  estimates  of  cost  of  construc- 
tion and  opyeration  are  generally  expected  to  come  within  5%  of  the 
actual  figures. 

This  preliminary  rep)ort  is  then  checked  against  the  previous      ^^ 
experience  of  the  house.     They  add  to  the  cost  of  construction  the 
carrying  charges  on  the  investment  before  it  begins  to  make  any      ^ 
return.     They  may  get  bids  on  the  construction  of  power  plants. 
This  ofiice  analysis  and  checking  is  expected  to  result  in  very     ^.^ 
accurate  estimates  of  gross  earnings  and  of  outgo.  , 

Some  bankers  decline  to  take  up  any  such  propositions  unless 
advance  estimates  show  net  interest  earnings  equal  to  two  and  one- 
half  times  the  interest  charges  on  the  bonds  that  wiU  be  necessary. 

2  From  Prom,  and  Org.  of  Pub.  Serv,  Corp..  by  L.  R.  Nash,  of  Stone  and  Webster. 
'July  20,  1914. 


Ch.  19]  PROMOTION— PREPARATORY  WORK  759 

Each  mile  of  track  should  earn  a  minimum  of  $5,000,  which  is  a 
generally  accepted  figure  for  interurban  roads. 

If  the  operating  cost  is  60%,  this  leaves  net  earnings  of  $2,000 
If  the  construction  cost  is  $25,000,  all  provided  by  bonds  at  5%, 
the  interest  charges  per  mile  are  $1,250,  leaving  $750  per  mile  to 
provide  for  depreciation,  unexpected  losses,  and  accidents. 

A  population  per  mile  in  a  strip  two  miles  wide  on  each  side  of 
the  road  of  one  thousand  is  considered  a  safe  minimum.  The  inter- 
urban railroad  which  exists  mostly  on  paper  is  not  in  large  favor,  as 
it  is  believed  that  most  of  the  choice  locations  have  been  occupied. 

§  201.    Preliminary  Analysis  of  a  Railroad 

A  proposal  of  some  complexity  came  from  a  southern  state 
in  which  it  was  planned  to  build  a  railroad  of  some  30  miles 
through  three  prosperous  villages  so  as  to  open  up  a  rich  agri- 
cultural and  lumber  country  to  Port  "D"  and  the  sea.  Some 
information  was  furnished  by  the  intending  promoter,  but  the 
information  submitted  by  him  was  so  incomplete  that  a  list  of 
definite  questions  was  drawn  up  in  order  to  secure  the  data 
that  would  be  at  once  required  by  any  banker  or  capitalist 
looking  into  the  proposition.    These  questions  are  given  below: 

1.  How  much  traffic  is  now  hauled  by  existing  transporta- 
tion agencies  in  this  region? 

2.  How  much  standing  lumber  will  be  made  available  for 
shipment  by  this  new  road? 

3.  What  are  the  important  markets  for  this  lumber? 

4.  At  what  price  can  it  probably  be  sold  in  these  markets? 

5.  What,  approximately,  will  be  the  cost  of  cutting  and  of 
hauling  lumber  to  railroad  and  loading  on  cars? 

(Answers  to  the  above  questions  will  give  a  basis  for  figuring 
the  possible  rates  on  lumber  from  the  point  of  loading  to  the 
markets.) 

6.  Just  how  much  rail  and  water  traffic  through  "D"  is 
in  sight? 

7.  What  advantages  as  a  port  for  rail  and  water  traffic 
will  Port  "D"  have  over  competing  ports? 

8.  What  inducements  can  be  offered  which  will  lead  to  the 


76q  corporate  finance  [Bk.  ii- 

diversion  of  traffic  now  moving  through  competing  ports  to 
the  route  through  Port  "D"? 

9.  At  what  rates  does  traffic  now  move  through  competing 
ports  to  and  from  the  markets  which  the  promoter  hopes  to 
reach  by  his  proposed  route? 

10.  What  is  the  attitude  of  connecting  rail  and  water  lines? 
Will  they  be  inclined  to  assist  in  the  development  of  Port  "D" 
or  will  they  find  it  to  their  interest  rather  to  discourage  the 
growth  of  this  port?  (This  is  perhaps  the  most  important 
question  of  all,  for  a  short  railroad,  such  as  the  promoter  has 
in  view,  could  scarcely  exist,  let  alone  thrive,  unless  it  has  the 
cordial  co-operation  of  connecting  lines.) 

11.  Assuming  that  connecting  lines  are  friendly,  what  rate 
per  ton-mile  can  the  proposed  railroad  probably  secure  on 
through  traffic? 

12.  What  will  be  the  exact  cost  of  securing  the  right  of 
way  and  constructing  the  proposed  road? 

13.  What  will  be  the  cost  of  providing  docks  and  other 
terminal  facilities  at  Port  "D"? 

14.  Do  the  above  estimates  contemplate  providing  a  well- 
built,  modern  road,  or  rather  a  temporary  construction  which 
will  have  to  be  replaced  later? 

15.  What  will  be  the  cost  of  equipment  and  of  necessary 
supplies  of  all  kinds? 

16.  Will  it  be  possible  to  secure  local  subsidies  or  other 
assistance? 

17.  Does  the  promoter  have  banking  connections  on  which 
he  can  rely  for  assistance  in  floating  the  securities  of  the  proposed 
road? 

18.  Does  the  promoter  know  any  capitalists  who  may  be 
willing — ^provided  satisfactory  answers  to  all  the  above  ques- 
tions are  given — to  buy  the  stock  issues  of  the  proposed  road? 

19.  Is  the  promoter  able  and  willing  to  incur  the  expense 
that  will  be  necessary  to  secure  correct,  dependable  answers 
to  all  the  above  questions? 


Ch.  19I  PROMOTION-PREPARATORY  WORK  761 

The  process  of  securing  answers  to  the  questions  above 
listed  would  in  each  case  probably  bring  to  light  many  addi- 
tional questions  requiring  investigation.  Just  what  these 
questions  may  be,  could  not  very  well  be  determined  in  ad- 
vance, inasmuch  as  they  would  result  in  part  from  the  local 
conditions  under  which  the  project  is  to  be  established.  By 
working  out  a  list  of  questions  such  as  this,  in  their  logical 
sequence  and  by  getting  the  most  complete  and  trustworthy 
answers  possible,  the  promoter  may  be  certain  that  he  is  leaving 
nothing  of  great  importance  uncovered.  To  be  sure,  there  may 
be  unfortunate  slips  and  omissions  even  in  the  most  thorough 
investigations,  but  they  will  generally  be  found  to  be  due  to 
peculiarities  of  the  business  or  of  the  locality  in  which  it  is 
carried  on  which  escape  the  eyes  of  a  stranger.  For  this  reason 
it  is  always  very  desirable  that  the  investigator  should  associate 
himself  as  closely  as  possible  with  men  who  are  thoroughly 
familiar,  by  long  experience,  with  the  peculiarities  of  the  project 
and  the  locality. 

§  202.    Investigating  a  Combination 

,  Among  the  questions  that  should  be  fully  and  clearly  an- 
swered before  any  combination  of  going  concerns  is  attempted, 
are  the  following:  ,,, 

1.  What  is  the  financial  history  of  each  concern  that  is  to  be 
considered  as  a  possible  member  of  the  combination?  How  long 
has  it  been  in  existence?  Is  its  organization  stable?  Are  its 
earnings  increasing  or  decreasing?  Are  adequate  depreciation 
and  other  reserves  deducted  before  estimating  profits?  Is  the 
plant  and  physical  property  in  good  condition? 

2.  Who  are  the  men  engaged  in  this  industry  who  have 
shown  the  most  enterprise  and  good  judgment?  Will  they  join 
in  the  proposed  combination  and  work  together  on  harmonious 
terms?  Will  it  be  necessary  to  give  positions  to  incompetents 
or  to  make  unfair  concessions  in  order  to  influence  men  who  are 
essential  to  the  combination?  .-     ,,...., 


762  CORPORATE  FINANCE  [Bk.  H- 

3.  What,  if  any,  advantages  as  a  money  maker  will  the 
proposed  combination  have  over  the  separate,  independent 
concerns?-  Will  the  combination  be  in  violation  of  any  laws? 
Will  it  be  necessary  to  raise  prices  or  otherwise  incur  any  un- 
popularity in  order  to  secure  larger  profits?  Is  it  possible  to 
introduce  more  efficient  methods  into  the  management  of  the 
various  plants  without  arousing  undue  hostility  at  the  beginning? 

4.  Assuming  that  the  combination  is  agreed  to,  what  should 
be  the  financial  plan  of  the  proposed  combination?  Upon  what 
basis  can  its  securities  be  exchanged  for  the  securities  of  the 
independent  concerns?  On  what  basis  can  other  securities  be 
underwritten  and  sold  to  the  public?  How  much  fresh  capital 
will  the  combination  need?  Will  there  remain  a  block  of  securities 
sufficient  to  compensate  all  who  took  part  in  the  promotion, 
for  their  respective  risks  and  expenditures? 

The  questions  above  suggested  are  by  no  means  exhaustive, 
but  merely  indicate  the  lines  which  the  promoter  will  follow  in 
his  own  preliminary  investigation.  If  the  promoter  is  himself 
engaged  in  the  industry  in  which  the  combination  is  to  be  formed, 
he  will  probably  be  familiar  at  first  hand  with  the  answers  to 
most  of  the  questions  listed  above.  Nevertheless  it  is  unsafe 
for  him  to  depend  altogether  on  his  personal  knowledge,  which 
will  probably  be  inexact.  The  promoter  must  in  any  case  pro- . 
ceed  with  much  discretion  and  even  with  secrecy  in  gathering  the 
preliminary  information  that  he  needs;  otherwise  he  is  likely 
either  to  arouse  suspicion,  which  would  interfere  with  his  later 
plans,  or  to  stir  up  premature  discussion  and  arguments  that 
might  lead  to  personal  differences  or  might  even  favor  the  pro- 
motion of  rival  plans.  f<I 

§  203.    Assembling  the  Proposition 

After  the  promoter  of  a  combination,  or  his  immediate 
associates  if  there  is  a  group  of  promoters,  have  gathered  all  the 
preliminary  information  available,  it  will  be  possible  to  form  a 
tentative  plan  indicating  about  what  capitalization  the  proposed 


Ch.  19]  PROMOTION— PREPARATORY  WORK  763 

company  should  possess,  and  what  terms  should  be  offered  to 
the  concerns  that  are  to  be  included.  It  is  usually  safe  to  assume 
that  this  tentative  plan  will  be  greatly  modified  during  the  prog- 
ress of  negotiations. 

If  the  promoters  and  the  financiers  working  with  them  are 
well  supplied  with  cash,  their  promotion  problem  may  be  much 
simplified.  In  the  organization  of  the  Mount  Vernon- Woodberry 
Cotton  Duck  Company,  the  promoters  acquired  14  mills  by 
making  a  separate  bargain  with  each  manufacturer  and  paying 
to  him  an  agreed  price  in  cash.  The  price  fixed  with  one  manu- 
facturer was  not  known  to  the  others.  In  working  under  this 
method  the  promoters  were,  of  course,  assuming  a  large  personal 
risk  which  it  is  frequently  impossible  for  the  organizer  of  a  large 
combination  to  take  upon  himself. 

The  next  most  secure  plan  is  to  persuade  each  concern 
that  is  to  be  taken  into  the  combination,  to  grant  an  option  for 
a  limited  period  at  a  fixed  price.  After  the  promoter  has 
secured  enough  of  these  options  to  assure  the  realization  of  the 
project,  he  is  then  in  position  to  form  a  definite  proposition 
and  take  it  up  with  bankers  for  the  purpose  of  securing  finan- 
cial backing.  The  methods  of  securing  options  may  differ 
in  each  case,  and  then  a  separate  bargain  will  in  each  case  be 
driven.  When  the  United  States  Shipbuilding  Company  was 
undertaken.  Colonel  John  J.  McCook  and  John  W.  Young,  the 
promoters,  first  of  all  persuaded  Lewis  Nixon  to  give  an  option 
on  his  Crescent  Ship  Yard  and  the  adjoining  property,  with  the 
understanding  that  Mr.  Nixon  should  consent  to  act  as  general 
manager  of  the  proposed  consolidation. 

Sometimes  the  process  of  "assembling"  is  completed  when 
the  promoter  has  obtained  a  control  over  some  one  plant  or 
some  one  portion  of  the  contemplated  project  which  is  regarded 
as  essential.  This  control  puts  him  in  a  position  of  strategic 
advantage.  There  can  be  no  general  rule  as  to  assembling; 
the  most  that  can  be  said  is  that  the  promoter  must  put  himself 
and  keep  himself  in  a  position  of  mastery  over  the  situation. 


764  CORPORATE  FINANCE  [Bk.  H- 

If  he  does  not  do  so,  he  cannot  expect,  and  as  a  matter  of  fact 
he  has  no  right  to  expect,  any  large  compensation  for  his  ser- 
vices. He  is  playing  his  game  on  the  implied  understanding 
that  in  case  he  obtains  a  position  of  advantage  he  will  expect 
a  large  return  for  his  services,  which  must  in  fairness  be  balanced 
by  the  understanding  that  in  case  he  finds  himself  at  a  disad- 
vantage he  will  get  very  little  return. 


CHAPTER  XX 

(i 

PROMOTION— METHODS  OF  FINANCING 

nj;  .,ft  vd  \: 

§  204.    Preliminary  Financing 

As  soon  as  a  promoter  starts  to  develop  a  new  proposi- 
tion, he  begins  to  establish — if  he  has  not  previously  done  so — 
the  banking  connections  that  will  be  of  greatest  use  in  con- 
nection with  the  enterprise.  These  connections  should  be  with 
banks  that  are  already  familiar,  through  their  own  experience, 
either  with  the  line  of  business  or  with  the  field  of  operations 
of  the  business  in  which  the  promoter  is  working.  To  be  specific, 
if  the  project  is  to  establish  an  interurban  railroad  near  Dallas, 
Texas,  the  promoter  will  look  for  his  financial  connections  either 
among  the  New  York,  Boston,  Chicago,  and  St.  Louis  banking 
houses  that  are  accustomed  to  investigating  and  floating  inter- 
urban properties,  or  among  the  Dallas  bankers  who  thoroughly 
know  the  local  situation  and  can  perhaps  assist  in  raising  funds 
from  local  people. 

The  active  co-operation  of  interested  bankers  is  quite  essential 
to  the  success  of  most  promotions.  The  first  stage  of  the 
financing  in  which  the  banker  plays  his  part  may  be  reached 
when  the  purchase  of  options  or  the  outright  purchase  of  property 
is  under  consideration.  The  bankers  interested  may,  at  this 
point,  create  a  syndicate  which  will  advance  money  to  the  pro- 
moter for  the  purchase  of  options  on  the  property,  with  the  agree- 
ment that  repayment  is  to  be  made  as  soon  as  the  promotion  is 
successfully  floated.  If  the  expenditure  at  this  stage  is  for 
options  only  and  the  promoter's  personal  means  do  not  allow  him 
to  go  ahead  unassisted,  he  will  very  likely  attempt  to  organize 
a  small  syndicate  among  personal  acquaintances  who  are  willing 
to  share  with  him  equally  the  risks  and  the  profits  of  the  pro- 

76s 


766  CORPORATE  FINANCE  [Bk.  II- 

motlon.  Ordinarily  the  bankers  would  not  step  in  unless  out- 
right purchase  on  a  large  scale  was  called  for. 

The  next  stage  at  which  bankers'  co-operation  may  be  called 
for  is  during  the  period  of  development,  when  the  promotion 
involves  a  great  deal  of  construction;  or  the  period  of  waiting, 
when  the  promotion  is  a  combination  that  cannot  at  once  be 
financed  by  the  sale  of  securities  to  the  public.  Let  us  take  an 
assumed  example  for  the  sake  of  clearness.  A  new  manufacturing 
company  is  to  put  up  a  plant  costing  $1,000,000,  and  provide 
machinery  and  equipment  amounting  to  $500,000.  Let  us  as- 
sume that  the  product  is  of  such  nature  that  there  can  be  no 
question  as  to  its  marketability.  It  may  sometimes  be  desirable 
and  possible  to  raise  the  full  amount  of  required  capital — 
$1,500,000  in  this  case — at  the  outset,  and  expend  it  gradually 
in  the  construction  of  the  plant;  but  in  other  cases  this  plan  will 
be  found  impracticable  and  the  question  will  arise  as  to  how  to 
secure  the  funds  with  which  to  keep  construction  going  while 
at  the  same  time  taking  care  of  the  sale  of  securities. 

The  customary  plan  is  to  place  a  mortgage  on  the  property 
acquired,  and  to  issue  bonds  to  the  extent  of  the  mortgage. 
These  bonds,  however,  will  not  be  salable  until  the  property  has 
actually  been  developed.  The  difficulty  may  best  be  met  by 
depositing  them  with  bankers  as  security  for  short-term  loans 
and  using  these  loans  for  construction.  The  banker  receives 
the  bonds  as  collateral,  which  will  eventually  be  salable,  and  in 
case  the  whole  proposition  is  sound,  he  may  consider  himself 
at  least  fairly  well  protected.  Usually  the  arrangement  is  that 
the  bonds  shall  be  delivered  as  construction  goes  on,  so  that  the 
banker  may  never  have  on  hand  bonds  representing  property 
that  exists  as  yet  only  on  paper. 

The  analogous  difficulty  in  case  a  combination  is  formed, 
the  securities  of  which  are  not  at  once  salable,  is  met  in  the 
same  way.  The  securities  are  posted  as  collateral  for  bank 
loans  and  the  loans  are  later  paid  off  as  the  securities  are  dis- 
posed of. 


Ch.  20]  PROMOTION— METHODS  OF  FINANCING  767 

By  means  of  this  preliminary  financing,  an  enterprise  can 
be  financed,  even  though  the  promoter  and  his  immediate 
friends  have  limited  funds,  up  to  the  point  when  the  sale  of 
securities  to  the  public  brings  in  the  required  amount  of  capital. 

§  205.    Plan  to  Raise  Capital  for  a  Factory  ^ 

The  following  interesting  and  successful  plan  of  raising  money 
for  cotton  mills  is  described  by  Daniel  Augustus  Tompkins, 
"ABuilderof  theNew  South."  The  same  method  of  raisingmoney 
could  be  utilized  with  equal  success  in  many  other  directions. 

There  are  in  successful  operation  in  the  southeast  a  number  of 
cotton  factories  built  by  money  raised  on  the  instalment  plan  as  the 
payments  are  made  in  a  building  and  loan  association.  The  writer 
had  observed  that  in  many  towns  there  was  a  strong  desire  among 
the  people  to  buUd  and  operate  a  cotton  factory,  but  they  conceived 
it  impossible  to  raise  the  capital  at  home  because,  as  a  rule,  few 
people  in  towns  or  small  cities  have  much  unemployed  capital.  It 
was  further  observed  that  in  almost  if  not  quite  every  one  of  these 
instances  one  or  more  building  and  loan  associations  were  in  opera- 
tion with  accumulated  cash  in  excess  of  what  was  considered  pos- 
sible to  raise  for  the  construction  of  a  cotton  factory.  The  con- 
clusion was  therefore  reached  that  if  a  plan  could  be  formulated  by 
which  a  company  could  be  organized  whose  capital  stock  was  made 
payable  in  the  shape  of  regular  weekly  or  monthly  saving,  then  any 
ordinary  community  could  raise  the  money  to  build  a  factory. 

Following  out  this  line  of  thought  it  was  found  that  with  shares 
of  one  hundred  dollars  par  value  they  could  be  paid  in  full  as  follows: 

1.  At  the  rate  of  one  dollar  per  week  per  share  the  par  value 

would  be  reached  in  a  little  less  than  two  years. 

2.  At  the  rate  of  fifty  cents  per  week  the  time  would  be  a  little 

less  than  four  years. 

3.  At  the  rate  of  twenty-five  cents  per  week  the  time  would  be 

a  little  less  than  eight  years.  All  of  these  plans  of  pay- 
ments have  been  tried  at  Charlotte,  North  Carolina,  and 
in  every  case  the  result  has  been  successful.  .  .  . 

On  the  basis  of  subscriptions  aggregating  one  hundred  thousand 


'  By  permission  of  Doubleday,  Page  &  Co.,  from  "A  Builder  of  the  New  South,  Daniel 
Augustus  Tompkins,"  by  George  Tayloe  Winston. 


768  CORPORATE  FINANCE  [Bk.  II- 

dollars  there  would  be  paid  the  company  each  year  about  twenty- 
five  thousand  dollars.  With  this  amount  of  money  the  buildings 
could  be  constructed  and  paid  for  in  the  first  year.  Within  the 
second  year,  one- third  of  the  machinery  could  be  purchased  and  put 
in  operation.  In  three  years  from  the  time  of  organization  it  would 
be  usually  possible  to  have  the  entire  plant  in  operation  with  some 
debt,  which  could  be  paid  off  as  the  instalments  were  paid  in  the 
last  year.  .  .  . 

It  goes  without  saying  that  the  quickest  time  in  which  the 
capital  can  be  accumulated  is  the  best.  If  subscriptions  can  be 
procured  on  a  basis  of  two  dollars  a  week  per  share,  thus  making 
the  capital  payable  in  about  a  year,  this  would  be  the  next  best 
thing  to  having  the  money  subscribed  subject  to  call  as  it  might 
be  needed.  Next  to  the  rate  of  $2.00  per  week  the  one  dollar  per 
week  would  be  desirable.  Then  follows  fifty  cents  a  week  and 
twenty-five  cents  per  week. 

The  last-named  rate,  while  it  has  been  proven  practicable  in  the 
case  of  a  few  mUls,  is  undesirable  if  the  subscriptions  can  possibly 
be  got  to  fifty  cents  per  week  or  more. 

The  plan  of  fifty  cents  per  week  has  been  the  most  popular  one, 
and  it  has  in  all  cases  worked  well,  the  result  having  been  dividend- 
paying  manufacturing  plants. 

The  completion  of  a  miU  may  always  be  hastened  beyond  what 
could  be  done  with  ordinary  income  by  borrowing  money  to  com- 
plete the  mill  at  once  and  then  paying  this  money  back  as  it  is  paid 
into  the  treasury  in  instalments  by  the  stockholders.  Wherever 
this  has  been  done  the  mUl  company  has  commonly  made  notes 
which  have  been  made  secure  by  indorsement  of  the  directors.  For 
this  reason  it  is  desirable  to  have  a  board  of  directors  whose  re- 
sponsibility is  well  known. 

Some  of  the  mUls  have  been  built,  however,  simply  by  investing 
the  money  as  it  came  from  the  members;  and  while  this  is  some- 
what slow,  yet  when  the  miU  is  finished  and  in  operation,  it  is 
usually  so  much  property  ahead  for  the  stockholders  for  it  fre- 
quently represents  money  that  would  not  have  been  accumulated 
at  all,  except  for  the  obligation  of  the  stockholders  to  get  together 
and  save  so  much  money  each  week  or  month.  .  .  . 

The  preliminary  preparation  for  the  organization  of  such  a 
company  in  the  way  of  preparing  the  right  kind  of  charter,  by-laws 
and  subscription  list,  should  be  left  to  the  engineer  selected  to  make 
plans  and  guide  the  company  in  the  conduct  of  its  affairs. 


Ch.  20]  PROMOTION— METHODS  OF  FINANCING  •  769 

It  is  very  important  for  a  company  of  inexperienced  people  to 
select  a  good  engineer  and  then  rely  upon  his  knowledge,  skill,  and 
judgment.  Any  attempt  to  build  a  mill  without  good  counsel  will 
be  troublesome.  Advice  picked  up  here  and  there,  free  of  charge, 
is  worth  just  what  it  costs,  viz.,  nothing.  A  good  engineer  wiU 
charge  a  good  fair  price,  and  will  handle  the  matter  just  as  a  good  . ) 
lawyer  would  a  law-suit  or  as  a  physician  would  handle  a  case  of  -r 
sickness.  There  are  numbers  of  good  engineers  in  the  country 
whose  records  for  successful  work  become  a  guarantee  for  the 
success  of  whatever  they  undertake.  ... 

In  one  or  two  cases  another  feature  has  been  introduced,  viz., 
subscribers  give  notes  for  the  amount  of  their  subscriptions.  By 
this  plan  the  company  has  the  notes  to  use  for  collateral  in  case  of 
borrowing  money;  and  if  the  notes  are  made  interest-bearing  then 
the  burden  of  interest  falls  on  the  subscribers  and  not  on  the  , 
treasury  of  the  company.  .  .  . 

The  factories  built  with  capital  raised  on  the  above  plan  have 
all  been  successful,  and  are  now  doing  well. 

§  206.    Necessity  for  Adequate  Financing 

One  of  the  most  common  errors — and  also  one  of  the  most 
dangerous — in  organizing  a  new  corporation  is  to  start  it  off  with 
insufficient  capital  to  carry  it  through  to  success.  The  result 
is  that  the  new  corporation  perhaps  makes  a  fine  start,  gives 
promise  of  yielding  large  profits,  and  then  suddenly  threatens  to 
collapse  because  the  supply  of  cash  has  been  exhausted.  Credit 
is  not  readily  available  for  most  new  corporations.  The  or- 
ganizers turn  hopefully  to  the  natural  recourse  of  selling  more 
stock,  and  usually  find  themselves  confronted  by  a  blind  wall  of 
skepticism.  It  is  a  curious  fact  that  an  entirely  new  project, 
which  exists  only  as  an  idea  and  has  not  yet  been  troubled  by 
any  of  the  harsh  vicissitudes  of  business  existence,  appeals 
strongly  to  the  imagination  and  is  generally  able  to  command 
capital  with  comparative  ease;  whereas  exactly  the  same  project 
six  months  or  a  year  later,  when  substantial  progress  has  been 
made  and  its  profitableness  has  been  in  part  demonstrated,  is 
no  longer  appealing  and  raises  new  capital  with  difficulty.  The 
reason  is  no  doubt  to  be  found  in  the  fact  that  the  owner  of  the 


770  •  CORPORATE  FINANCE  [Bk.  II- 

capital  in  the  second  case  looks  at  the  project  at  close  range, 
sees  it  in  its  prosaic  realization  and  can  hardly  conceive  it  as  a 
great  money  maker.  In  the  first  place  his  imagination  was  left 
untrammeled.  Promoters  are  insistent,  therefore,  on  one  piece 
of  advice  in  which  they  all  agree :  in  organizing  a  new  enterprise, 
raise  at  the  outset  all  the  capital  required  to  bring  it  to  success. 
One  difficulty  that  often  comes  up  at  this  point  is  that  of 
estimating  the  amount  of  cash  capital  required.  The  strong 
tendency  is  to  underestimate.  Even  where  a  new  proposition 
is  of  quite  a  definite  character,  that  is  to  say,  where  it  involves 
buying  a  given  property  or  properties  at  an  agreed  price,  turning 
out  a  stable  product  for  an  assured  market  and  selling  it  at  a  price 
known  in  advance — even  under  such  conditions  underestimates 
are  frequent.  They  most  commonly  arise  from  two  oversights : 
first,  the  neglect  to  provide  sufficient  working  capital; 2  second, 
overlooking  the  incorporation  and  selling  expenses  to  start  the 
corporation  and  dispose  of  its  capital  stock.  Selling  expense 
of  capital  stock  may  run  as  high  as  25%  or  30%,  or  even  more. 

§  207.    Effect  of  Inadequate  Funds 

The  following  is  a  typical  experience  in  organizing  a  small 
corporation  with  insufiicient  financial  backing : 

About  two  years  ago  I  was  induced  to  purchase  stock  in  the 
Johnson  Manufacturing  Company,  which  owned  the  patents  and 
intended  to  manufacture  and  sell  an  office  equipment  device.  Only 
one  other  person  was  interested  and  he  took  an  equal  amount  of 
stock  and  was  to  be  the  active  man  at  $150  per  month.  It  was 
nearly  six  months  before  we  were  able  to  get  our  dies  constructed 
and  sufficient  stock  on  hand  to  go  after  business,  and  this  work  took 
a  lot  more  money  than  we  anticipated.  We  also  had  trouble  with 
our  finish  and  replaced  a  lot  of  our  devices  which  we  had  placed  in 
the  first  few  months.  Manufacturing  difficulties  were  finally  over- 
come and  we  have  had  no  other  complaints  on  that  score.  Our 
difficulty  now  is  to  market  the  product.  Sales  for  the  year  have 
been  only  about  2,500  units. 


s  See  Chs.  XV  and  XVI,  "Working  Capital  Requirements." 


Ch.  20]  PROMOTION— METHODS  OF  FINANCING  771 

Up  to  this  time  about  $20,000  has  gone  into  the  business  and  as 
yet  we  are  hardly  making  expenses  on  average  monthly  sales  of 
$1,000.  It  has  come  to  the  point  now  where  we  must  find  a  more 
profitable  method  of  merchandising,  sell  out,  or  liquidate.  We 
woidd  prefer  to  sell  out,  but  we  have  nothing  very  encouraging  to 
offer  a  purchaser,  so  it  resolves  itself  into  one  of  the  other  two.  A 
first-class  merchandising  man,  in  whom  both  of  us  feel  confidence, 
could  be  secured  if  we  were  in  position  to  put  in  another  $10,000  so 
as  to  make  sure  that  the  business  runs  for  another  year.  Personally. 
I  am  convinced  that  with  the  right  plan  of  sale,  the  whole  project 
would  be  a  tremendous  money  maker,  but  ve  haven't  the  cash  our- 
selves, don't  know  where  to  turn  for  it,  and  haven't  much  of  a 
record  to  fall  back  upon. 

§  208.    Causes  of  Failure 

The  stories  of  loss  in  establishing  enterprises  that  are  known 
to  be  in  themselves  sound  and  profitable,  are  so  numerous 
that  probably  every  reader  can  pick  one  or  more  out  of  his  own 
experience  or  observation.  It  will  take  very  little  analysis  of 
each  one  of  these  cases  to  demonstrate  that  the  loss  has  been  due 
to  carelessness  in  one  or  more  of  the  following  features : 

1.  In  not  ascertaining  all  the  available  facts  in  advance 

of  investment. 

2.  In  neglecting  to  clinch  the  legal  rights  of  the  organizer 

by  means  of  contracts,  options,  or  the  outright  pur- 
chase of  some  of  the  essential  property. 

3.  In  failing  to  establish  close  relations  with  financial  houses 

which  would  be  of  assistance  in  carrying  the  enter- 
prise through  the  construction  stage  and  up  to  the  point 
where  securities  could  be  sold  as  the  issues  of  an  estab- 
lished concern. 

4.  In   making   insufficient   estimates   of    capital   require- 

ments, including  not  only  fixed  capital  but  also  working 
capital  and  the  necessary  expenses  of  selling  securities. 

All  these  errors  with  a  little  judgment  and  foresight  are 
easily  avoidable. 


CHAPTER  XXI 

THE  PROMOTER 

§  209.    Professional  Promoters 

The  word  "promoter"  has  come  to  be  associated  with  Colonel 
Sellers  and  J.  Rufus  Wallingford,  and  consequently  is  commonly 
regarded  as  a  term  of  reproach  rather  than  of  praise.  Yet  when 
it  is  used  in  its  proper  sense,  it  indicates  a  man  of  exceptional 
energy  and  foresight  who  is  able  to  conceive  a  new  enterprise  and 
to  set  it  on  its  feet.  He  belongs  to  the  class  of  men  who  make 
for  progress. 

One  unfavorable  connotation  for  the  word  comes  out  of  the 
expression,  "professional  promoter."'  Each  one  of  the  two 
words  in  the  expression  is  innocent  in  itself,  but  where  they  are 
combined  they  seem  to  imply  an  individual  who  is  making  his 
money  by  his  wits  either  at  the  expense  of  the  enterprise  he  is 
supposed  to  finance,  or  of  the  dupes  whose  money  goes  into 
these  enterprises.  There  is  undoubtedly  some  truth  in  this 
implication,  for  a  certain  group  of  semi-criminals  who  call  them- 
selves brokers  and  promoters  make  it  their  business  to  prey 
upon  struggling  enterprises  and  defraud  them  while  they  pretend 
to  assist. 

Yet  there  are  some  men  of  excellent  standing  to  whom  the 
term  "professional  promoter,"  if  used  in  its  correct  sense,  could 
properly  be  applied.  Of  this  type  are  such  men  as  Charles  M. 
Warner,  who  took  part  in  promotions  so  widely  separated  as 
the  American  Malting  Company,  the  Corn  Products  Refining 
Company,  the  Bay  State  Cotton  Corporation,  the  International 
Cotton  Mills  Corporation,  and  the  National  Asphalt  Company. 
To  the  same  class  belong  many  of  the  most  prominent  financiers 
of  the  day,  who  have  assisted  with  more  or  less  directness  in  all 

772 


Ch.  2i]  THE  PROMOTER  773 

the  great  promotions  and  combinations  of  the  past  twenty  years. 
The  professional  promoter  is  not,  however,  of  so  much 
importance  to  the  business  world  as  what  may  be  termed  the 
occasional  promoters  who  make  up  in  the  number  of  enterprises 
promoted  for  the  smaller  average  capitalization  of  each.  These 
promoters  come  mainly  from  the  following  classes: 

Local  lawyers  and  bankers 
Engineering  firms 
Business  executives 

§  210.    Local  Lawyers  and  Bankers 

There  is  little  to  be  said,  if  we  are  to  speak  in  general  terms, 
of  the  activities  of  local  lawyers  and  bankers  as  promoters. 
It  is  enough  to  call  attention  to  the  fact  that  ordinarily  they  are 
natural  leaders  in  organizing  new  local  enterprises.  If  some 
western  country  town  is  establishing  a  new  creamery  or  a  new 
cannery;  if  in  some  eastern  city  there  is  opportunity  for  a  com- 
bination of  small  local  manufacturing  concerns;  if  a  man  of  in- 
ventive talent  gets  up  a  new  device  and  begins  to  talk  among 
his  friends  as  to  the  possibilities  of  developing  it — in  any  one 
of  these  cases  the  opportunity  usually  comes  straight  to  the 
lawyer  or  banker  who  is  in  position  to  give  it  some  of  his  time  and 
and  thought  and  perhaps  to  carry  it  through  to  success.  The 
nimiber  of  such  cases  of  local  promotions  on  a  small  scale  is  sur- 
prising and  accounts  for  a  considerable  proportion  of  the  annual 
crop  of  new  enterprises. 

§  211.    Engineering  Firms  as  Promoters 

It  is  well  known  that  a  few  large  engineering  firms  of  high 
standing  have  organized  and  financed  and  now  manage  thousands 
of  street  railway  and  other  public  utility  corporations,  especially 
in  the  smaller  cities  and  towns.  Among  the  most  important 
of  these  firms  may  be  mentioned  Stone  and  Webster,  J.  G.  White 
Engineering  Corporation,  H.  M.  Byllesby  and  Company,  and 


774  CORPORATE  FINANCE  [Bk.  II- 

Henry  L.  Doherty  and  Company.  All  of  these  firms,  it  is  stated, 
have  more  or  less  drifted  into  their  present  promotion  activities. 
The  business  of  each  firm  was  primarily  to  carry  on  professional 
engineering  work.  As  they  grew  in  size  and  the  expense  of 
maintaining  a  large  staff  of  high-priced  experts  became  a  greater 
and  greater  burden,  it  was  found  necessary  to  go  beyond  merely 
seeking  profitable  work  for  these  men  and  to  embark  upon  the 
policy  of  creating  work  for  them.  This  could  be  done  only  by 
actively  organizing  and  financing  new  corporations  with  which 
the  firm  then  made  contracts  for  engineering  service.  Promotion 
at  the  beginning,  then,  was  a  side  issue;  but  it  has  grown  and 
grown  until  one,  at  least,  of  these  firms  is  regarded  as  much  more 
distinctly  a  financial  house  than  an  engineering  firm. 

We  might  include  with  this  group  some  of  the  large  manu- 
facturing companies  which  are  actively  engaged  in  financing 
new  enterprises  with  a  view  to  obtaining  their  orders  for  ma- 
chinery and  other  equipment.  Among  the  concerns  that  have 
followed  this  policy  with  the  greatest  enterprise  and  success  are 
the  Westinghouse  Electric  and  Manufacturing  Company,  and 
the  General  Electric  Company,  which  through  subsidiary  cor- 
porations disposed  of  the  securities  of  a  great  number  of  enter- 
prises which  they  desired  developed. 

All  such  concerns,  after  their  ability  to  sell  securities  once 
becomes  known,  are  deluged  with  a  constant  stream  of  applica- 
tions for  assistance  in  developing  new  enterprises.  Any  of  these 
which  appear  to  be  worth  while  are  investigated  along  the  lines 
suggested  in  the  preceding  chapter.  In  case  the  investigation 
yields  a  favorable  report  and  it  is  decided  to  take  hold  of  the  new 
enterprise,  they  proceed  to  capitalize  and  incorporate  it  in 
accordance  with  the  principles  previously  discussed.  The  pro- 
cedure thereafter  differs.  -Some  of  the  firms  work  in  close  con- 
nection with  banking  hou^s  which  underwrite  the  securities 
of  their  corporations  and  proceed  to  sell  them  to  the  general 
public.  Other  firms  have  their  own  departments  or  subsidiary 
corporations  for  the  sale  of  securities,  thus  carrying  through  the 


Ch.  2i]  THE  PROMOTER  775 

whole  enterprise  from  its  inception  through  the  investigation, 
the  flotation,  the  construction  of  the  plant  or  property,  and  even 
beyond  this,  through  the  initial  stages  of  its  management. 

§  212.    Business  Executives  as  Promoters  ,v 

In  forming  combinations  among  competing  manufacturing 
plants,  it  is  not  at  all  unusual  to  find  the  initiative  taken  by  the 
manufacturers  themselves.  Sometimes  they  get  together  and, 
through  a  committee  or  through  informal  discussion,  agree  upon 
some  plan  of  combination  which  shall  take  in  all  the  previously 
competing  plants.  This  was  done  in  the  case  of  the  leather, 
cordage,  asphalt,  and  glucose  combinations.  In  a  case  of  this 
kind  it  is  hardly  correct  to  speak  of  a  "promoter."  There  is 
really  not  much  need  for  his  services,  inasmuch  as  the  manufac- 
turers manage  the  matter  themselves. 

Another  situation  exists  in  some  industries  where  there  is 
keen  competition  and  possibly  some  ill-feeling,  but  where  one 
plant  or  one  individual  stands  out  as  a  recognized  leader,  either 
through  size,  enterprise,  personality,  or  other  cause.  If  a  com- 
bination is  to  be  formed  in  an  industry  where  this  situation 
prevails,  it  may  be  easily  possible  for  the  leading  firm  or  in- 
dividual to  become  the  promoter.  This  was  true  in  the  case  of 
the  salt,  malting,  and  bicycle  combinations.  It  constitutes  a 
somewhat  exceptional  case  when  a  business  executive  or  a  group 
of  executives  in  one  concern  actually  promote  a  combination 
with  their  rivals.  The  case  is  exceptional  for  the  reason  that  no 
man  readily  subordinates  himself  to  a  former  competitor  or  is 
easily  reconciled  to  entering  a  combination  in  which  his  com- 
petitor, starting  from  the  same  level  as  himself,  takes  a  leading 
part,  including  a  large  block  of  promoter's  profits.  It  is  far 
easier  for  a  man  from  the  outside  to  carry  through  such  a  com- 
bination. '^■'  '-^'^f^'^ 

The  customary  case  of  the  business  executive  acting  as  a 
promoter  arises  in  the  formation  of  entirely  new  enterprises. 
The  man  who  takes  the  lead  in  such  an  undertaking  is  commonly 


776  CORPORATE  FINANCE  [Bk.  li- 

the same  man  who  expects  to  manage  it  after  it  is  organized. 
In  many  respects  this  is  the  correct  arrangement.  When  the 
promoter  forms  a  combination  and  then  ceases  his  active  con- 
nection with  it,  he  is  usually  influenced  wholly  by  his  desire  to 
sell  stock  and  float  the  new  enterprise,  and  not  at  all  by  con- 
sideration of  the  future  requirements  of  the  enterprise.  When  the 
future  manager  of  the  enterprise  himself  promotes  it,  this 
situation  does  not  exist.  There  is  though,  on  the  other  hand, 
the  corresponding  danger  that  if  he  is  not  skilled  in  such  matters 
the  promotion  manager  will  underestimate  the  financial  needs 
of  his  enterprise,  or  perhaps  while  securing  his  capital — if  he  is 
successful  in  getting  it — will  reduce  it  below  the  amount  really 
required  by  unnecessarily  crude  and  wasteful  promotion  methods. 
In  the  interests  of  men  of  this  type,  a  few  remarks  as  to  points 
they  should  watch  in  forming  their  financial  plan  will  not  be  out 
of  place. 

§  213.    Promotion  Requirements 

First  of  all,  it  is  necessary  that  sufficient  capital  should  be 
raised  or 'authorized ;  yet,  on  the  other  hand,  it  is  desirable, 
if  the  period  of  construction  and  development  is  to  be  lengthy, 
that  the  sale  of  securities  should  be  postponed  until  the  cor- 
poration is  actually  on  its  feet.  There  may  seem  to  be  at  first 
glance  no  gossibility  of  reconciling  these  two  conflicting  re- 
quirements. The  solution  of  this  problem  is  to  be  found  in 
such  connections  with  banking  houses  that  they  will  be  willing 
to  carry  through  the  preliminary  financing  and  underwrite  the 
sale  of  the  securities  of  the  completed  proposition.  This  is  one 
of  the  devices  universally  used  in  large  enterprises,  but  seldom 
in  small  ones.  There  is  no  reason,  however,  why  it  is  not  almost 
equally  well  adapted  to  the  small  concern,  which  through  the 
local  bankers  should  be  able  to  secure  accommodation  on  the 
strength  of  its  own  securities  as  collateral  and  may  later  sell 
those  securities  and  repay  the  bank  loan. 

A  second  point  to  notice  is  that  the  promoter  must  protect 


Ch.  2i]  THE  PROMOTER  777 

his  own  interests,  for  he  may  be  sure  that  no  one  else  will  do  this 
for  him.  If  he  is  acting  as  a  principal,  the  proper  method  of 
taking  care  of  himself  is  to  raise  all  the  capital  that  is  needed, 
on  as  good  terms  as  possible,  by  the  sale  of  bonds,  preferred 
shares,  and  common  shares,  retaining  for  himself  the  remaining 
equity  in  the  business.  This  is  the  place  where  many  business 
executives,  as  promoters,  fail  to  realize  the  full  returns  to  which 
they  are  entitled.  They  are  likely  to  put  in  their  own  money 
under  precisely  the  same  conditions  as  the  money  of  other 
people,  without  reserving  for  themselves  the  equitable  interest 
which  belongs  to  the  promoter  of  the  enterprise  and  which  any 
other  promoter  would  easily  obtain. 

§  214.    Protecting  the  Promoter 

When  the  promoter  is  not  acting  as  a  principal,  or  is  as- 
sociated with  others  in  the  promotion  or  is  perhaps  acting  for 
others,  and  especially  if  he  merely  plays  the  part  of  a  "connecting 
link,"  his  interests  must  be  protected  by  definite  contract. 

A  case  in  which,  according  to  his  own  story,  the  promoter 
failed  to  give  himself  proper  protection,  came  into  the  New  Jersey 
courts  some  years  ago.  It  appears  that  Harry  C.  Haskins  claims 
to  have  been  the  originator  of  the  scheme  to  unite  all  the  inde- 
pendent lead  companies  not  previously  included  in  the  National 
Lead  Company.  He  went  to  Thomas  F.  Ryan,  the  well-known 
financier,  and  enlisted  his  support.  Mr.  Haskins  charges  that 
after  Mr.  Ryan  and  his  friends  had  secured  from  him  all  the 
information  they  needed,  and  had  made  use  of  his  knowledge 
of  the  lead  business,  resulting  from  years  of  study,  they  froze 
him  out  of  the  deal,  and  that  while  Mr.  Ryan  made  enormous 
profits  as  the  promoter  of  the  consohdation,  he  himself  had 
received  nothing. 

Without  attempting  to  express  any  opinion  whatever  on 
the  merits  of  this  case,  it  is  plain  that  in  the  eyes  of  the  law 
Mr.  Haskins  could  have  little  standing.  He  had  no  property 
right  in  the  idea  of  forming  the  consolidation;  the  facts  and 


778  CORPORATE  FINANCE  [Bk.  II- 

figures  which  he  submitted  to  Mr.  Ryan  were  apparently  freely 
given.  He  may  have  had  a  verbal  understanding,  but,  if  so, 
it  can  be  best  described  as  an  agreement  to  make  an  agreement, 
fulfilment  of  which  cannot  of  course  be  compelled  in  equity  pro- 
ceedings. In  other  words,  the  original  promoter,  Mr.  Haskins, 
according  to  his  own  statement,  did  not  contractually  protect 
himself.  He  went  ahead  before  he  had  "assembled"  his  proposi- 
tion, i 

§  215.    Promotion  Difficulties 

Under  the  most  favorable  circumstances  the  promoter  does 
not  lead  an  easy  life.  In  investigating  whatever  proposition 
he  has  in  mind,  he  must  expend  both  money  and  time  freely 
and  it  is  quite  likely  that  his  efforts  will  be  fruitless;  he  must 
exercise  diplomacy  and  patience  in  securing  his  options  or  other- 
wise assembHng  his  proposition;  he  must  protect  himself  with 
the  greatest  care  and  forethought  if  he  is  to  reap  the  reward  of 
his  efforts;  he  must  approach  the  owners  of  capital  with  a 
proposition  which  he  believes  to  be  favorable  to  them,  and  yet 
must  be  prepared  for  rebuffs  and  suspicion.  These  are  the  cus- 
tomary difficulties  in  promoting  an  enterprise.  o:> 

The  above  difficulties  are  doubled  or  tripled  when  the  enter- 
prise is  a  combination  of  previously  independent  concerns. 
And  if  the  combination  includes  concerns  that  have  been  pre- 
viously competitive,  the  promoter  is,  first  of  all,  confronted 
with  the  necessity  of  conciUating  individuals  who  perhaps  for 
years  have  been  fighting  each  other  with  all  the  weapons  at  their 
command.  Furthermore,  the  business  interests  of  each  separate 
concern  going  into  the  combination  demand  that  it  should  make 
for  itself  the  largest  claims  that  it  can  reasonably  support  and 
should  look  with  much  suspicion  on  the  claims  that  are  advanced 
by  the  other  concerns.  Unless  the  promoter  is  a  man  of  much 
force  and  unusual  tact,  it  is  almost  inevitable  that  the  negotia- 
tions should  break  off  as  a  result  of  mutual  distrust.  This  has 
been  the  result  again  and  again,  even  though  every  person 


Ch.  2i]  THE  PROMOTER  779 

interested  may  have  fully  recognized  the  proposed  combination 
as  desirable  for  the  common  good  of  all. 

§  216.    Difficulty  of  Creating  a  New  Organization 

In  addition  to  the  questions  and  conflicts  that  arise  in  de- 
termining the  financial  terms,  the  creation  of  a  working  organi- 
zation for  the  combination  is  more  than  likely  in  itself  to  break 
up  all  negotiations.  If  the  promoter  is  a  true  diplomat,  he  will 
usually  try  to  postpone  consideration  of  management  personnel 
until  after  the  combination  as  a  whole  has  been  pretty  well 
decided  upon.  Nevertheless,  it  may  at  the  last  moment  wreck 
the  whole  project.  The  promoter  must  usually  make  up  his 
mind  between  one  of  two  courses:  either  he  must  bring  in  an 
outsider  of  high  standing  as  the  chief  officer  of  the  combination 
and  give  him  discretion  to  pick  the  best  men  he  can  find,  thus 
creating  an  efficient  working  organization;  or  he  must  ''play 
politics"  and  choose  the  officers  from  the  men  whose  influence 
he  requires  in  order  to .  form  the  combination.  If  he  chooses 
the  first  alternative,  he  must  make  his  appeal  most  strongly 
to  the  men  who  have  capital  invested  and  whose  business  sense 
will  lead  them  to  respect  the  necessity  and  justice  of  the  proposed 
course  of  attion,  even  though  it  may  involve  sacrifices  on  the 
part  of  some  individuals.  If  he  chooses  the  second  alternative, 
he  must  make  his  appeal  primarily  to  the  active  officers  of  the 
concerns  that  are  to  be  combined,  and  must  depend  upon  them 
to  help  him  in  influencing  the  owners  of  capital.  Unfortunately 
this  second  alternative  is  too  often  chosen,  and  is  probably  the 
direct  cause  of  the  breakdown  of  various  combinations  which 
should  have  proved  highly  successful. 

§  217.    The  Chances  of  Success 

The  probabilities  are  that  loss  and  failure  in  promotion  is 
the  ultimate  result  of  fully  one-half  of  the  serious  attempts  to 
start  new  enterprises.  There  are,  to  be  sure,  classes  of  enterprise 
in  which  failure  has  become  rare,  as  for  example  public  utility 


78o  CORPORATE  FINANCE  [Bk.  II- 

corporations.  The  standards  for  estimating  the  probable  income 
and  expenses  of  such  corporations  have  become  so  exact,  and  the 
estimating  is  now  so  carefully  and  scientifically  done,  that  there 
is  little  reason  to  fear  disaster. 

Other  enterprises,  particularly  those  engaged  in  manufac- 
turing industries  or  trading,  are  apt  to  be  shipwrecked  through 
lack  of  careful  calculation,  foresight,  and  provision  for  the 
future.  Yet  in  addition  to  these  probable  causes  of  disaster, 
there  are  innumerable  contingencies  which  cannot  be  foreseen. 
This  is  true  of  all  business  enterprises.  In  addition  to  the  seri- 
ous risk  that  the  new  enterprise  itself  may  prove  to  be  unsuc- 
cessful and  all  the  promoter's  profits,  as  far  as  represented  in 
common  stock,  may  be  wiped  out,  there  is  the  further  risk  to 
the  promoter  that  he  may  fail  to  carry  through  the  enterprise 
and  may  lose  all  his  own  expenditures  of  money,  time,  and  energy 
devoted  to  its  promotion. 

§  218.    Promotion  Profits 

Some  indication  has  already  been  given  of  the  customary 
method  by  which  the  promoter  takes  his  profits.  As  a  funda- 
mental principle  he  is  entitled  to  whatever  remains  of  the  capital- 
ized value  of  the  enterprise  after  it  has  been  financed.  To  make 
the  practice  entirely  clear,  let  us  take  a  simple  hypothetical 
case.  A  promoter  determines  that  a  given  manufacturing 
enterprise  will  reasonably  earn,  after  it  has  completed  a  two- 
year  period  of  development,  in  excess  of  $110,000  per  annum  net 
profits.  If  he  is  conservative,  he  will  perhaps  figure  on  creating 
securities  all  of  which  should  be  salable  at  par  on  the  following 
basis: 

Interest 
Capitalization  and  Dividend 

Requirements 

$   500,000  7%  first  mortgage  bonds $  3S.ooo 

250,000  9%  preferred  stock 22,500 

500,000  common  stock  yielding  10% 50,000 

$1,250,000  $107,500 


Ch.  2i]  THE  PROMOTER  781 

We  will  assume  that  the  corporation  actually  needs  $1,000,- 
000  cash,  and  that  the  expense  of  investigating,  securing  options, 
incorporating,  and  selling  securities  amounts  in  total  to  $150,000. 
Under  these  conditions,  the  promoter  would  probably  enter 
into  a  contract  to  turn  over  $1,000,000  in  cash,  or  possibly 
property  and  total  assets  for  which  he  would  actually  pay 
$1,000,000,  in  exchange  for  all  the  bonds,  preferred  stock,  and 
common  stock  of  the  corporation.  He  would  then  be  able  to 
sell  bonds,  preferred  stock,  and  $250,000  of  the  common  stock, 
and  would  retain  for  himself  $250,000,  against  which  should  be 
offset  his  expenses  of  $150,000.  In  other  words,  under  all  these 
estimates  his  net  profits  would  be  $100,000,  which  would  be 
realized  in  common  stock. 

The  principle  that  the  promoter  should  have  as  his  com- 
pensation a  portion  of  the  final  equity  in  the  corporation,  is 
well  established  in  what  may  be  termed  the  more  conservative 
promoting  circles.  Otherwise — in  case,  for  instance,  he  insists 
upon  receiving  bonds  or  preferred  stock — he  reveals  a  lack  of 
faith  in  the  success  of  the  enterprise  that  would  probably  be 
fatal  to  his  whole  promotion  scheme.  This  principle  of  common 
stock  for  the  promoter  obtains  quite  generally  in  the  United 
States.  In  English  practice  another  arrangement,  which  is  in 
some  respects  preferable,  has  been  common.  In  addition  to 
bonds,  preference  shares,  and  ordinary  shares,  the  organizers 
of  a  new  corporation  frequently  created  another  claim  on  the 
property,  ranking  after  ordinary  or  common  shares,  which  is 
represented  by  what  are  known  as  "founders'  "  shares.  The 
founders'  shares  ordinarily  are  entitled  to  dividends  only  after 
certain  dividends  have  been  paid  on  ordinary  shares,  after  which 
they  are  entitled  to  a  special  participation  in  additional  divi- 
dends.i 

A  favorite  arrangement  of  this  kind  is  to  give  the  ordinary 
shares,  say,  6%  as  their  preference  above  founders'  shares, 

"See  fl  54.  SS- 


782  CORPORATE  FINANCE  [Bk.  II- 

and  then  to  divide  any  additional  dividends  equally  between 
ordinary  shares  and  founders'  shares.  The  founders'  shares 
are  usually  issued  to  a  small  nominal  amount  with  a  small  par 
value  to  each  share,  often  only  one  shilling.  In  a  few  instances 
where  the  companies  have  been  phenomenally  successful,  the 
founders'  shares  have  become  extremely  valuable,  and  there  are 
even  cases  in  which  separate  corporations  have  been  formed 
in  order  to  hold  the  total  block  of  founders'  shares  and  to  sell 
interests  in  this  block.  The  advantage  of  this  English  practice 
is  that  it  defers  promoters'  profits  until  after  those  who  have 
contributed  cash  have  been  fully  protected. 

§  219.    Illustrative  Instances 

A  few  instances  from  corporate  practice  will  show  just  how 
promoters  have  secured  their  profits.2 

In  the  case  of  the  Mount  Vernon- Woodberry  Cotton  Duck 
Company,  the  promoters  had  remaining  in  their  hands  $6,- 
250,000  in  common  stock.  Figuring  its  market  value  at  $25, 
this  amounted  to  a  cash  profit  of  well  over  $1,500,000.  How- 
ever, Mr.  Parks,  the  chief  promoter,  was  in  no  situation  to  keep 
all  these  profits  for  himself;  they  were  divided  to  a  great  extent 
among  the  various  mill  owners  whose  personal  co-operation 
had  been  necessary. 

The  United  States  Realty  and  Construction  Company  was 
incorporated  in  1902  with  a  capitalization  of  $30,000,000  pre- 
ferred and  $36,000,000  common  stock.  The  five  promoters, 
among  whom  were  some  of  the  best  known  and  most  highly 
respected  citizens  of  New  York,  stated  publicly  that  they  would 
receive  a  profit  for  organizing  the  new  corporation  and  for  pro- 
curing the  necessary  working  capital.  The  announcement  was 
put  in  the  following  form: 

It  is  proper  to  state  that  we  expect  to  receive  for  the  responsi- 
bility and  risks  assumed  by  us  in  organizing  the  new  corporation, 


*  From  Dewing  on  Corp.  Prom.  &  Reorg. 


Ch.  2i]  '  THE  PROMOTER  783 

procuring  the  cash  capital,  and  for  the  expenses  incurred,  an  in- 
dividual profit  which  will  or  may  include  the  stock  of  the  new  cor- 
poration remaining  in  our  hands  after  carrying  through  the  trans- 
action. 

The  promoters'  profits  in  this  case  are  calculated  to  have 
amounted  to  about  $6,000,000  in  common  stock,  or  approxi- 
mately 10%  of  the  total  securities.  At  the  outset  the  market 
value  was  about  $1,800,000,  and  it  had  an  average  value  dur- 
ing the  first  year  of  $720,000. 

From  the  above  instances  it  is  clear  that  successful  promotion 
may  carry  with  it  very  large  profits.  There  are  at  times  exces- 
sive profits,  and  yet  on  the  other  hand  there  are  very  heavy 
expenses  and  very  great  risks  which  seem,  on  the  whole,  to  make 
promotion  profits  in  the  majority  of  cases  reasonable. 


CHAPTER  XXII 

PROMOTERS'  PROFITS^ 

§  220.    The  Work  of  the  Promoter 

A  promoter,  as  considered  here,  is  one  who  actively  engages 
in  the  financing  and  organization  of  an  enterprise  under  the 
corporate  form.  The  term  is  described  by  an  English  authority 
as  a  "short  and  convenient  way  for  designating  those  who  set 
in  action  the  machinery  by  which  the  Act  enables  them  to 
create  a  corporation."  Cook  briefly  classifies  the  promoter  as  a 
"person  who  brings  about  the  incorporation  and  organization 
of  a  corporation. "2 

Another  idea  enters  into  the  modern  every-day  business 
use  of  the  term.  The  promoter's  activity  and  interest  in  the 
affairs  of  the  enterprise  are  incited  by  the  expectation  of  special 
profits.  If  he  does  not  realize  or  expect  to  realize  special  profits 
out  of  the  undertaking,  he  is  not,  in  modern  parlance,  a  promoter, 
though  filling  every  requirement  of  the  legal  definition. 

In  the  organization  of  most  modern  corporations  the  promoter 
plays  an  active  and  very  important  part.  His  anticipated  special 
profits  from  these  efforts  are  usually  large  and  not  infrequently 
excessive.  As  stated  in  the  preceding  chapter,  among  the  more 
conservative  promotions  these  profits  are  taken  in  the  stock  of 
the  new  undertaking.  This,  however,  is  far  from  being  an 
invariable  rule.  On  the  contrary,  the  ordinary  promoter  is 
usually  very  anxious  to  secure  his  profits  at  the  earliest  possible 
moment  and  in  some  more  realizable  form  than  stock  in  his 
too  often  doubtful  enterprise.  To  accomplish  this  the  more 
easily  and  to  secure  larger  profits  than  would  otherwise  be 

1  Adapted  by  permission  from  Corp.  Org.  &  Mgt.,  by  T.  Conyngton. 
»  3  Cook  on  Corp.,  {  651. 

784 


Ch.  22]  PROMOTERS'  PROFITS  785 

possible,  he  sometimes  attempts  to  make  his  profit  a  secret 
profit. 

The  many  different  arrangements  whereby  the  promoter  en- 
deavors to  secure  his  special  profits  in  the  form  and  in  the  way 
he  prefers,  have  given  rise  to  a  class  of  cases  turning  solely  upon 
the  relations  existing  between  the  promoter,  his  associates,  and 
the  corporation.  The  ideal  of  the  law  in  regard  to  these  relations 
is  high.  It  is  to  be  regretted  that  the  ideals  and  methods  of 
promoters  are  usually  on  a  much  lower  level. 

§  221.    Promoter's  Relation  to  Corporation 

In  a  large  proportion  if  not  the  majority  of  cases,  the  pro- 
moter brings  about  the  organization  of  his  corporation  for  the 
express  purpose  of  souring  special  profits.  There  is  no  intrinsic 
iniquity  or  injustice  in  so  doing.  The  only  question  is  as  to  the 
propriety  and  legality  of  his  arrangements  for  collecting  these 
profits.  Too  frequently  the  methods  of  the  promoter  are  not 
only  of  doubtful  moral  status,  but  directly  in  conflict  with  the 
established  law. 

The  relation  of  the  promoter  both  to  the  corporation  and 
to  those  associated  with  him  in  its  organization  is  one  of  trust. 
He  is  guiding  the  affairs  of  the  incipient  corporation  and  is 
supposed  to  be  safeguarding  its  interests  as  he  would  his  own. 

This  doctrine  is  too  clearly  established  to  be  questioned. 
The  confidential  relations  of  the  promoter  being  admitted,  it 
follows,  then,  that  while  he  may  with  entire  propriety  profit 
by  his  connection  with  the  corporation,  such  profit  must  be  of 
such  a  nature  as  is  compatible  with  confidential  relations. 

§  222.    Illegal  Arrangements 

Corporations  can  be  formed  through  irresponsible  agents  with 
ease.  If  these  agents  can  vote  away  a  substantial  part  of  the 
capital  stock  for  property  of  comparatively  small  value,  and  still 
with  immunity  to  themselves  and  their  principals  receive  from  the 
uninformed  public,  cash  subscriptions  for  the  rest  of  the  capital 


786  CORPORATE  FINANCE  [Bk.  II- 

I  ,1     stock,  the  organization  and  management  of  corf>orations  might      ; 
readily  become  a  "system  of  frauds."  ' 

The  usual  mistake  the  promoter  makes  is  in  dealing  with  his 
corporation  as  he  would  with  a  stranger.  Unreasonable  or  even 
large  profits  are  difficult  of  attainment  if  the  party  from  whom 
they  are  to  be  drawn  is  informed  as  to  the  facts,  and  for  this 
reason,  as  stated,  the  promoter  wishing  to  sell  property  to  the 
corporation  he  has  organized,  or  caused  to  be  organized,  fre- 
quently conceals  or,  worse  still,  misrepresents  the  real  cost. 

When  the  promoter  occupies  this  position,  he  is  in  conflict 
with  the  law,  for  it  has  been  laid  down  clearly  and  unmistakably 
that  a  promoter  must  not  make  any  secret  profit  out  of  his 
corporation,  or  out  of  those  associated  with  himself  in  the 
formation  of  the  corporation. 

§  223.    A  Case  in  Point 

The  leading  case  on  this  subject  is  an  English  case,^  but  its 
doctrines  have  been  generally  followed  in  this  country.  One 
Erlanger  and  his  associates  formed  a  syndicate  to  purchase  an 
island  containing  phosphate  which  was  offered  to  them  for 
£55,000.  Through  agents  a  company  was  then  formed,  Erlanger 
naming  the  five  directors.  Of  these,  two  were  at  the  time  out 
of  the  country.  Of  the  three  remaining,  one  was  Erlanger's 
private  agent,  one  was  Lord  Mayor  of  London,  and  the  third 
was  a  Rear  Admiral  of  the  British  Navy.  These  two  latter 
were  not  interested  in  any  way  with  Erlanger  in  the  sale  of  the 
island  to  the  corporation,  were  not  informed  as  to  the  circum- 
stances and  did  not  make  any  inquiry,  but,  acting  with  the 
Erlanger  director,  accepted  Erlanger's  proposition  to  sell  the 
island  to  the  corporation  for  £80,000  in  cash  and  £30,000  in 
shares.  Stock  in  the  corporation  was  then  sold  until  some  400 
shareholders  were  interested  in  the  company.  Later  these 
secured  control  of  the  company,  and,  having  discovered  the 

»  0!d  Dom.  Copper  Co.  v.  Bigelow,  203  Mass.  isg,  188  (1909). 

*  Erlanger  v.  New  Sombrero  Phosphate  Co.,  s  Ch.  Div.  73;   affd.,  3  App.  Cases  1218. 


Ch.  22]  PROMOTERS'  PROFITS  787 

facts  as  to  the  sale  of  the  island,  promptly  brought  suit  against 
all  parties  concerned  in  its  sale  to  the  company.  As  a  result, 
the  sale  was  ordered  rescinded  and  the  vendors  were  ordered  to 
return  the  price  of  the  island  to  the  company,  upon  which  the 
island  was  to  be  restored  to  its  original  owners.  This  decision 
was  affirmed  upon  appeal.  The  Lord  Chancellor,  in  rendering 
the  decision,  said: 

I  do  not  say  that  the  owner  of  property  might  not  promote  and  '' 
form  a  joint-stock  company,  and  then  sell  his  property  to  it,  but  I 
do  say  that  if  he  does  he  is  bound  to  take  care  that  he  sells  it  to  the 
company  through  the  medium  of  a  board  of  directors  who  can  and 
do  exercise  an  independent  and  intelligent  judgment  on  the  trans- 
action, and  who  are  not  left  under  the  belief  that  the  property 
belongs,  not  to  the  promoter,  but  to  some  other  person. 

The  doctrine  of  the  case  was,  first,  that  independent  directors 
should  have  been  named;  and  second,  that  the  promoters  should 
have  made  full  disclosure  to  these  directors  of  all  material 
facts.  In  the  decision  it  was  intimated  that  if  one  director 
personally  beyond  suspicion  had  known  and  approved  the  real 
facts  as  to  the  increased  price,  it  might  have  been  sufficient  to 
validate  the  sale. 

The  doctrine  in  this  country  is  similar.  When  property 
is  taken  by  promoters  for  the  purpose  of  sale  to  the  corporation, 
whether  by  purchase,  option,  or  agreement,  they  are  bound 
to  disclose  any  private  bargain  or  secret  profits.  The  relations 
are  confidential  and  each  person  is  bound,  as  in  partnership,  to 
act  with  entire  openness  and  fairness  to  those  with  whom  he  is 
associated.  The  law  as  to  this  is  very  clear  and  has  been  passed 
upon  again  and  again. 

To  sum  the  matter  up,  any  special  profits  made  by  the 
promoter  are  illegal  unless  made  with  the  full  knowledge  of  all 
the  others  interested,  or  with  the  consent  of  an  independent 
and  fully,  informed  board  of  directors,  or  with  disclosure  of  the 
conditions  to  those  who  are  asked  to  subscribe  to  the  stock. 
If  special  profits  are  made  otherwise,  suit  for  redress  may  be 


7^8  CORPORATE  FINANCE  [Bk.  II 

brought  at  any  subsequent  time  by  the  corporation,  or,  under 
some  circumstances,  by  the  stockholders  who  have  contributed 
to  the  promoter's  improper  profits  by  the  purchase  of  stock 
on  its  first  issue,  or  of  treasury  stock  thereafter. 

§  224.    Improper  Profits  vs.  Overvaluations 

These  cases  where  suit  is  brought  for  the  restoration  of 
promoters'  profits  must  not  be  confused  with  that  other  class 
in  which  recovery  is  had  by  creditors  because  of  the  overvaluation 
of  property  turned  into  the  corporation  in  exchange  for  stock, 
or  bonds,  or  both.  The  two  cases  often  go  together,  but  are 
radically  different  in  their  nature.  An  improper  profit  to  pro- 
moters might  exist  without  any  overvaluation,  and  an  over- 
valuation might  exist  without  any  improper  profits  to  the 
promoters.  For  instance,  property  at  an  overvaluation  might 
be  accepted  by  the  corporation  and  its  stockholders  with  a  full 
knowledge  of  the  promoters'  profits.  They  would  then  have 
no  basis  for  proceedings  against  the  promoters.  A  creditor 
might,  however,  in  such  case  proceed  against  the  stockholders 
on  the  ground  of  an  overvaluation.  On  the  other  hand,  the 
property  might  be  put  into  the  corporation  at  a  fair  figure,  but 
the  promoters  receive  a  secret  commission,  or  rebate  or  other 
improper  profit  on  the  sale.  In  such  case  there  would  be  good 
grounds  for  proceeding  against  the  promoters  for  the  recovery 
of  the  improperly  gotten  profits. 

In  the  various  states  the  decisions  in  regard  to  promoters' 
profits  vary  in  their  tenor,  but  there  is  a  general  trend  toward 
a  stricter  construction  of  the  promoter's  duty  and  responsibility 
to  his  corporation.  5 

§  225.    Legitimate  Profits 

The  laws  are  very  clear  in  their  denunciation  of  the  pro- 
moter's secret  profits.     They  are  hardly  less  explicit  in  their 


'Old  Dom.  Copper  Co.  v.  Bigelow,  188  Mass.  315  (190s);   s.  c,  203  Mass.  159  (1909); 
See  V.  Heppenheimer,  69  N.  J.  Eq.  36  (1905);  Arnold  v.  Searing,  78  N.  J.  Eq.  146  (1910). 


/ 

Ch.  22]  PROMOTERS'  PROFITS  789 

recognition  of  the  promoter's  right  to  profits  if  secured  and 
taken  under  proper  conditions.  "There  is  no  rule  of  law  prohibit- 
ing a  person  from  forming  a  corporation  for  the  purpose  of 
selling  property  to  it  and  making  a  profit  from  the  sale.  The 
law  merely  requires  that  such  a  transaction  be  entirely  open  and 
free  from  deception  upon  the  company  and  those  who  become 
members.""  wii 

In  a  New  Jersey  case  the  court  said:'  It 

Buck,  as  the  promoter  of  the  corporation,  stood  in  a  fiduciary 
relation  to  the  company  as  soon  as  it  was  organized.  As  such 
promoter,  it  was  op)en  to  him  to  sell  property  which  he  owned  to 
the  company,  on  making  full  and  fair  disclosure  of  his  interest  and 
position  with  respect  to  that  property.  Not  only  was  such  dis- 
closure necessary,  but  it  was  incumbent  on  him,  as  sole  promoter  of 
the  company  formed  to  purchase  this  specific  property,  controlling 
and  moulding  its  organization,  to  furnish  it  with  an  executive  or 
board  of  directors  capable  of  forming  competent  and  impartial 
judgment  as  to  the  wisdom  of  the  purchase  and  the  price  to  be  paid.      ;/ 

§  226.    Rule  as  to  Property  Owned  by  Promoter 

Also,  if  the  promoter  purchased  or  otherwise  acquired  the 
property  in  question  before  the  inception  of  the  corporation 
and  before  he  assumed  in  any  way  to  act  for  it,  he  was  not,  and 
could  not  be  held  as,  the  agent  or  trustee  of  the  corporation  when 
he  purchased  the  property.  He  may  therefore  have  acquired  it 
at  any  price  or  in  any  way,  and  when  later  the  corporation  is 
organized,  he  is  at  liberty  to  offer  his  property  to  the  corporation 
at  any  advanced,  or  different  price  he  may  choose,  without 
divulging  the  profits  to  be  made  thereby.  The  one  essential 
in  such  cases  is  that  the  promoter's  interest  in  the  property 
shall  be  disclosed,  and  that  such  offering  shall  be  absolutely 
without  misrepresentation.  If  he  represents  that  the  property 
is  owned  by  him  when  held  only  by  option,  or  that  it  is  turned 
in  to  the  corporation  at  the  cost  to  him  when  he  is  really  making 


•  T.  Morawetz  on  Priv.  Corp.,  {  293. 

'  Plaquemines  Trop.  Fruit  Co.  v.  Buck,  $2  N.  J.  Eq.  210,  230  (1893). 


70d  CORPORATE  FINANCE  [Bk.  II- 

a  profit,  such  misrepresentations  are,  under  the  circumstances, 
material  and  render  the  pronioter  Hable  for  the  secret  profits 
so  secured.  Without,  such  misrepresentation,  however,  he  may- 
make  what  profit  he  will. 

In  a  case  that  came  up  in  the  New  York  courts,  property 
was  turned  in  at  a  gross  overvaluation,  but  the  only  persons  in 
interest  were  informed  of  all  details  and  did  not  object;  therefore 
the  promoters  were  held  to  be  within  their  rights  and  the  con- 
tract not  subject  to  rescission. » 

Also  in  a  Maryland  case,^  a  receiver  attempted  to  hold  the 
promoters  responsible  under  the  same  circumstances,  but  his 
application  was  denied  on  the  ground  that  there  was  no  conceal- 
ment and  therefore  no  wrong. 

From  this  it  would  appear  that,  if  with  the  full  knowledge 
of  all  concerned  as  to  the  circumstances  thereof,  a  corporation 
is  organized  and  property  is  exchanged  for  a  portion  or  the 
whole  of  its  stock,  the  completed  transaction  has  harmed  no  one, 
is  absolutely  legal,  and  is  not  open  to  later  objection  by  any 
of  the  parties  consenting  thereto.  The  promoters  may  make 
such  profits  as  they  please,  provided  the  other  participating 
parties  consent  thereto,  and  up  to  this  point  the  transaction  is 
legitimate  and  unobjectionable. 

Nor  is  there  danger  of  any  subsequent  objection,  no  matter 
what  profit  may  have  been  made  by  the  promoters,  if  the  price 
paid  for  the  property  taken  was  within  reason,  or  capable  of 
justification.  Nor  is  there  any  danger  of  adverse  legal  action 
even  if  the  price  and  profits  were  entirely  out  of  reason  and 
totally  unjustifiable,  provided  creditors  and  subsequent  stock- 
holders are  informed  as  to  the  conditions  before  they  give 
credit  to  the  corporation  or  invest  in  its  securities. 


•  Parsons  v.  Hayes,  14  Abb.  N.  C.  (N.  Y.)  419  (1883). 

•  Tompkins  v.  SiJerry,  Jones  &  Co.,  96  Md.  560  (1903), 


CHAPTER  XXIII 
SOURCES  OF  CAPITAL  FUNDS 

§  227.    Capital  from  Stock  Subscriptions 

The  typical  corporation  starts  in  much  the  same  way  as 
the  typical  partnership — through  an  agreement  on  the  part  of 
two  or  more  men  who  are  acquainted  with  each  other,  to  join 
forces  in  a  business  enterprise.  In  a  partnership,  these  men 
sign  a  formal  partnership  agreement  and  pool  part  or  all  of  their 
capital  and  other  resources;  in  a  corporation,  they  mutually 
agree  upon  the  amount  of  capital  required,  the  amount  of 
capital  stock  to  be  authorized,  and  the  issuance  of  the  stock  for 
cash,  property,  and  services.  No  matter  which  financial  form 
is  adopted,  the  essential  fact  common  to  both  is  that  the  money 
and  the  business  ability  required  are  supplied  by  the  same  men. 

As  the  corporation  expands  (assuming  that  it  is  a  success) 
and  fresh  capital  is  needed,  it  may  come  in  whole  or  in  part  from 
the  same  group  of  men.  In  case  their  capital  has  been  exhausted 
or  is  otherwise  tied  up,  the  next  move,  frequently,  is  to  find 
some  other  man  who  has  capital  to  invest  and  who  at  the  same 
time  will  be  a  valuable  addition  to  the  executive  staff  of  the 
business.  Some  concerns  keep  on  growing  in  this  way  for  a 
long  time.  Other  concerns — by  far  the  vast  majority — soon 
attain  their  normal  volume  of  business  and  thereafter  need  little 
if  any  fresh  capital.  In  both  these  cases,  the  source  of  capital 
plainly  is  the  man  or  group  of  men  who  are  themselves  active 
in  the  management  of  the  business. 

§  228.    Capital  from  Operating  Profits 

A  second  source  of  capital,  which  usually  operates  in  con- 
nection with  the  source  just  named,  consists  of  savings  out  of 

791 


792  CORPORATE  FINANCE  [Bk.  li- 

the profits  of  the  business.  Practically  every  concern  saves 
and  adds  to  its  permanent  capital  a  portion  of  its  profits.  In 
corporations  which  are  owned  by  the  people  active  in  the  busi- 
ness, the  tendency  is  strong  toward  putting  a  large  proportion 
of  the  profits  back  into  the  business.  The  active  men  realize 
the  needs  and  the  possibilities  in  the  business  better  than  outside 
stockholders  could  possibly  do.  Sometimes  they  are  willing 
to  put  back  practically  all  the  profits  and  to  keep  up  this  policy 
over  a  period  of  years.  The  enormous  capital  of  the  Carnegie 
Steel  Company  was,  for  example,  almost  wholly  built  up  by  this 
method.  Much  the  same  thing  is  true  of  the  Winchester  Repeat- 
ing Arms  Company  before  its  absorption  by  the  Winchester 
Company,  and  of  many  other  closely  held  and  highly  successful 
concerns.  Until  the  time  of  the  Great  War  with  its  insistent 
demands  for  new  capital,  the  Bethlehem  Steel  Corporation  was  a 
conspicuous  example  of  the  results  which  may  be  achieved  by 
the  patient  saving  and  reinvesting  of  profits  over  a  series  of  years. 
At  the  present  time  the  United  States  Steel  Corporation  has  a 
surplus  of  over  $500,000,000  built  up  from  earnings. 

§  229.    Outside  Sources  of  Capital  Funds 

Most  companies  that  are  successful  on  a  large  scale  reach 
the  point,  in  the  course  of  a  few  years,  where  more  capital  is 
needed  than  can  possibly  be  supplied  by  the  people  who  are 
directly  engaged  in  handling  the  business.  Some  corporations,  as 
we  shall  see,  reach  this  stage  at  the  very  beginning;  that  is  to  say, 
they  start  full  blown  as  publicly  owned  enterprises.  They  are, 
however,  exceptional.  Whenever  it  is  necessary  to  go  outside 
the  group  of  men  who  are  directly  connected  or  directly  familiar 
with  the  enterprise,  the  capital  may  be  said  to  be  raised  from  the 
public  at  large.  For  our  purpose  we  may  divide  this  public, 
as  is  customarily  done  in  nearly  all  writing  or  thinking  on 
financial  subjects,  into  two  fairly  distinct  groups:  those  who 
invest  and  those  who  speculate. 

The  investing  public  consists  of  the  people  who  are  more 


Ch.  23]  SOURCES  OF  CAPITAL  FUNDS  793 

concerned  over  the  safety  of  their  principal  than  they  are  over 
large  returns.  The  speculative  public  consists  of  those  who 
are  desirous  of  large  returns  and  to  secure  these  are  willing  to 
accept  more  or  less  risk  on  their  principal.  Distinct  types  of 
security  issues  are  designed  to  appeal  to  these  two  groups.  There 
is,  of  course,  no  sharp  dividing  line  between  the  two  types. 

§  230.    The  Investing  Public 

The  word  "public"  suggests  a  large  crowd  of  individuals, 
and  the  term  "investing  public"  may  easily  call  up  a  vivid 
picture  of  thousands  of  staid  and  prosperous  persons,  buying 
bonds,  putting  them  away  in  their  strong  boxes,  and  periodically 
cutting  off  the  coupons.  This  picture  is  to  a  certain  degree  true 
when  we  come  to  the  purchasers  of  those  investments  which 
have  a  slightly  speculative  tinge,  such  as  bonds  that  sell  on  a 
basis  of  6%  or  more.  John  Moody,  however,  is  authority  for 
the  statement  that  the  really  "gilt-edge"  investment  securities 
are  taken  chiefly,  not  by  individuals,  but  by  institutions.  These 
securities  sell  on  the  basis  of,  say,  4^%  to  5K%)  and  the  indi- 
vidual investor  is  much  more  apt  to  be  a  contributor  in  some 
way  to  the  support  of  these  large  investing  institutions,  rather 
than  a  direct  purchaser  of  this  type  of  securities. 

§231.     Investing  Institutions 

First  among  the  institutional  investors,  we  find  banks. 
Savings  banks  are  enormous  purchasers  of  the  highest  grade 
bonds.  Under  the  laws  of  most  states  their  purchases  are 
closely  restricted  to  bonds  of  a  certain  approved  class  which 
are  frequently  referred  to  in  Wall  Street  as  "savings  bank 
bonds."  Commercial  banks,  also,  from  time  to  time  take 
large  quantities  of  investment  securities,  chiefly  short-term 
obligations.  Insurance  companies  spend  a  vast  amount  an- 
nually in  the  purchase  of  investment  securities.  All  institu- 
tions the  funds  of  which  are  held  in  trust,  such  as  universities, 
philanthropic  institutions,  and  the  like,  must  confine  themselves 


754  CORPORATE  FINANCE  [Bk.  II- 

strictly  to  investment  securities.  Estates  of  deceased  persons, 
administered  in  trust,  are  large  purchasers. 

Institutions,  then,  constitute  the  public  to  which  the  highest 
grade  investment  securities  must  be  sold.  Individuals  handling 
their  own  funds  are  free  to  exercise  their  discretion  and  take 
whatever  degree  of  risk  there  may  be  in  the  purchase  of  securities 
that  do  not  comply  with  the  strict  terms  of  the  laws  covering 
institutional  investment. 

It  will  be  readily  seen  that  there  are  noteworthy  advantages 
to  the  corporation  which  can  adapt  any  important  part  of  its 
securities  to  the  requirements  of  institutional  investment. 
First  of  all,  such  securities  are  in  high  demand  and  sell  at  excellent 
prices.  Second,  they  are  likely  to  "stay  put"  after  they  are  sold. 
The  institution  ordinarily  does  not  die  or  become  hard  up  or 
panic-striken;  consequently,  securities  which  it  has  once  pur- 
chased are  likely  to  remain  with  it  until  they  mature.  Through- 
out the  crisis  in  the  affairs  of  the  New  Haven  Railroad  Company 
in  1913-1914,  the  debentures  of  the  company,  which  were  closely 
held  by  insurance  companies  and  savings  banks,  did  not  to  any 
great  extent  come  on  the  market. 

§  232.    Investment  Associations 

In  other  countries,  even  those  individual  investors  who  in 
this  country  would  buy  securities  direct  are  apt  to  efface  them- 
selves as  individuals  and  join  investment  trusts  or  investment 
associations.  These  associations  are  common  in  Great  Britain, 
France,  and  Holland,  and  are  not  uncommon  in  other  countries. 
The  investment  associations  frequently  sell  their  own  bonds 
as  well  as  their  own  shares.  They  take  the  money  thus  obtained 
and  invest  it  in  securities  of  other  corporations.  What  is  the 
advantage,  it  may  be  asked,  of  this  indirect  method  of  investing? 

The  great  advantage  is  that  the  uninformed  judgment  of 
the  individual  who  purchases  only  a  few  stray  securities  from 
time  to  time,  is  replaced  by  the  trained  and  experienced  judg- 
ment of  men  well  acquainted  with  investment  securities  and 


Ch.  23]  SOURCES  OF  CAPITAL  FUNDS  795 

the  investment  market.  This  at  least  is  the  theory  of  the 
situation.  There  is  another  advantage,  also,  in  the  fact  that, 
instead  of  having  available  for  investment  only  the  small  savings 
of  individuals,  the  investment  association  deals  in  large  sums 
and  is  therefore  in  a  position  to  buy  advantageously.  Further- 
more, on  account  of  its  large  purchases  it  can  distribute  its 
risk  over  a  wide  field.  Its  securities,  for  instance,  would  not 
all  be  bought  in  one  country  but  in  several  countries;  they 
would  not  all  be  in  one  or  two  lines  of  business,  but  in  many 
lines,  and  so  on.  This  principle  of  the  distribution  of  risk  is 
the  most  practical  form  of  insuring  the  safety  of  the  investment 
that  has  yet  been  brought  forth.  The  investment  associations, 
as  a  rule,  are  managed  with  skill  and  ability,  and  in  the  long  run 
make  money,  though  there .  are  of  course  some  unfortunate 
exceptions. 

§  233.    Speculative  Public 

The  purchasers  of  speculative  or  even  semi-investment 
securities  are,  with  negligible  exceptions,  individuals.  The 
term  "semi-investment"  in  this  connection  is  applied  to  such 
securities  as  high-grade  preferred  stocks  and  junior  bonds, 
which  are  customarily  regarded  as  reasonably  safe  but  which 
are  not  savings  banks'  investments,  and  are  subject  to  a  greater 
degree  of  fluctuation  and  uncertainty  than  the  strictly  high-grade 
investments.  There  is  a  fairly  clear  threefold  division  of  the 
immense  number  of  purchasers  and  possible  purchasers  of  specu- 
lative and  semi-investment  securities: 

1.  The  buyers  who  have  in  view  primarily  the  safety  of 
their  principal,  in  which  they  do  not  anticipate  any  great 
appreciation  in  value,  but  who  desire  a  larger  rate  of  return  than 
can  be  obtained  from  strictly  investment  securities.  These  are 
the  purchasers  of  junior  bonds,  preferred  shares,  and  the  like. 

2.  The  purchasers  who  are  looking  primarily  for  an  increase 
\n  the  value  of  their  principal,  though  they  do  not  object, 
naturally,  to  a  high  percentage  of  yield.     These  are  the  pur- 


796  CORPORATE  FINANCE  [Bk.  II- 

chasers  of  common  shares,  especially  those  which  are  not  so 
thoroughly  seasoned  as  to  approach  the  semi-investment  grade 
of  securities.  The  members  of  this  group  are  likely  to  be  for  the 
most  part  people  who  have  some  especial  connection  with,  or 
interest  in,  the  corporation,  the  shares  of  which  they  are  pur- 
chasing; often  they  are  minor  officers  or  employees  of  the  cor- 
poration. c>  :S^i 
3.  The  speculators  on  margin,  who  operate  on  the  Wall 
Street  and  other  stock  exchanges.  A  large  number  of  them 
are  merely  gambling;  others  have  some  special  information 
as  to  a  given  corporation  the  shares  of  which  are  listed  on  the 
stock  exchange,  and  are  trying  to  make  capital  out  of  their 
information.  Still  others  are  observers  of  general  market 
conditions,  and  buy  and  sell  standard  issues  with  little  regard 
to  their  intrinsic  value,  but  with  a  great  deal  of  regard  for  the 
buying  and  selling  movements  on  the  exchange, 

§  234.    The  Scope  of  the  Market 

A  remarkable  feature  of  the  last  ten  or  fifteen  years  in  the 
United  States  has  been  the  widening  distribution  of  the  shares 
of  large  corporations,  indicating  that  a  greater  and  greater 
number  of  people  who  possess  or  can  save  capital  are  putting 
their  money  into  corporate  securities.  Taken  in  the  aggregate, 
the  size  of  the  speculative  public  in  the  United  States  is  enormous. 
This  is  well  illustrated  by  the  number  of  stockholders  in  the 
five  great  corporations  given  below,  these  five  having  among  them 
over  640,000  stockholders. 

No.  of 
Stockholders 

United  States  Steel  Corporation 189,060 

Pennsylvania  Railroad  Co 141,699 

American  Telephone  &  Telegraph  Co 185,000 

General  Motors  Corporation 70,504 

Cities  Service  Co 62,322 

.-jn  648,585 


Ch.  23]  SOURCES  OF  CAPITAL  FUNDS  797 

The  United  States  Steel  Corporation  has,  as  shown,  over 
189,000  shareholders  of  record,  among  whom  are  included  many 
foreign  investment  associations  and  other  holders  who  are 
practically  trustees  for  a  considerable  number  of  people,  so 
that  the  total  number  of  persons  financially  interested  in  United 
States  Steel  shares  is  probably  well  over  200,000.  In  1901  the 
average  holding  of  United  States  Steel  shares  was  $32,000; 
in  1906,  $15,000;  in  1913,  $7,000;  in  the  early  part  of  1922  it  was 
estimated  at  less  than  $5,000.  This,  while  there  is  a  steady  and 
rapid  increase  in  the  number  of  stockholders,  shows  a  material 
decrease  in  the  average  amount  of  stock  held  by  each.  ^ 

It  is  clear  from  all  these  facts,  that  the  most  successful 
and  most  popular  corporations  are  carefully  cultivating  the 
good-will  of  the  owners  of  small  amounts  of  capital,  including 
their  own  employees,  and  that  a  notable  transfer  of  ownership 
into  the  hands  of  a  larger  number  of  people  is  in  process.  This 
does  not,  for  the  present,  necessarily  mean  a  transfer  of  control, 
which  is  usually  safely  in  the  hands  of  a  few  large  holders  of 
shares.  Yet  it  involves  some  tendency  at  least  toward  corporate 
democracy,  both  in  the  ownership  and  in  the  control  of  large 
corporations. 

§  235.    Small-Scale  Selling 

From  this  same  source^- the  speculative  public — must  come 
the  capital  for  small  enterprises.  After  an  enterprise  has  passed 
the  stage  in  which  the  capital  is  furnished  by  those  directly 
engaged  in  the  enterprise,  if  the  business  itself  is  worthy  and 
suj65ciently  profitable,  there  is  no  good  reason  why  it  should 
ever  fail  from  lack  of  sufficient  capital.  The  failure  in  most 
instances  where  needed  capital  is  not  obtained  is  due  to  a 
misconception  of  method. 

When  one  of  the  enormous,  nationally  known  corporations, 
with  years  or  perhaps  generations  of  success  behind  it,  desires 
to  obtain  fresh  capital — perhaps  from  $5,000,000  to  $25,000,000 
— its  officers  enter  into  a  contract  with  some  banking  firm  which 


798  CORPORATE  FINANCE  [Bk.  II- 

undertakes  to  furnish  the  capital  and  which  in  turn  disposes 
of  the  securities  of  the  corporation  among  its  own  clientele. 
This  is  the  big-scale  method  of  raising  fresh  capital  from  the 
speculative  public.  The  actual  work  of  selling  the  corporate 
stock  is  not  performed  by  the  corporation's  officers.  All  that 
they  do  is  to  make  the  right  kind  of  contract. 

Often  the  manager  of  a  small  local  corporation  forms  the 
idea  that  he  should  and  can  raise  his  capital  in  the  same  im- 
personal way,  or  that  he  must  go  far  from  home  to  get  the 
money  he  needs.  He  altogether  forgets  that  his  neighbor  Jones 
has  just  sold  a  farm  and  has  $10,000  lying  idle  in  the  bank; 
that  his  customer  Smith  is  a  good  personal  friend  of  his  and 
can  raise  any  reasonable  amount  of  money;  that  his  employee 
Brown  is  building  up  a  good-sized  savings  account  and  would 
save  more  and  work  better  if  he  were  stimulated  by  the  pride 
of  owning  an  interest  in  his  employer's  business.  Instead  of 
interviewing  Jones,  Smith,  and  Brown,  with  money  in  their 
pockets  which  they  would  willingly  exchange  for  shares  in  his 
enterprise,  the  corporate  manager  of  this  type  is  apt  to  think 
that  some  broker  in  a  distant  city  could  easily  raise  the  $10,000 
or  $50,000  that  is  needed  if  he  could  only  be  persuaded  to 
undertake  the  job. 

The  best  place  to  begin  looking  for  purchasers  of  specu- 
lative or  semi-investment  securities  of  a  small  corporation  is 
among  business  acquaintances  of  the  men  who  are  already 
interested  in  the  corporation.  After  a  few  of  these  acquaint- 
ances have  themselves  become  shareholders,  they  will  co-operate 
in  reaching  other  people,  and  so  the  list  of  prospective  pur- 
chasers of  the  securities  will  expand  in  an  ever-widening  circle 
until  the  whole  amount  of  the  capital  required  has  been  raised. 
Often  the  best  person  to  whom  to  turn  for  advice  is  the  most 
progressive  banker  in  the  community  or— if  it  is  a  large  city — 
the  banker  best  acquainted  with  the  trade  in  which  the  cor- 
poration is  engaged.  It  is  the  banker's  business  to  know  the 
standing  of  his  customers  and  advise  as  to  their  investments. 


CHAPTER  XXIV 

SELLING  SECURITIES  DIRECT 
TO  BUSINESS  ASSOCIATES 

§  236.    Four  Methods  of  Sale 

When  a  corporation  is  organized,  and  in  many  cases  from  time 
to  time  during  its  life,  some  of  its  securities  must  be  sold.  The 
initial  capital  must  of  course  be  raised  by  the  sale  of  securities; 
subsequent  capital  may  come  either  by  savings  out  of  profits 
or  by  fresh  sales  of  securities.  We  shall  take  up,  in  the  order 
named,  the  four  methods  of  sale  commonly  used: 

1.  Allotment  to  insiders  or  to  previous  shareholders. 

2.  Direct  sale  to  the  outside  public. 

3.  Sale  to  banking  houses,  which  in  turn  dispose  of  the 

securities  by  direct  sale  to  the  outside  public. 

4.  Sale  to  banking  houses  or  brokerage  houses,  which  in 

turn  dispose  of  the  securities  through  the  machinery 
of  stock  exchanges. 

The  term  "insiders,"  as  used  above,  includes  all  who  are 
either  active  in,  or  closely  connected  with,  the  management  of 
the  corporation.  The  term  is  not  used  in  any  derogatory  sense, 
but  merely  as  a  convenient  designation  for  those  who  have 
intimate  relations,  so  to  speak,  with  the  concern.  In  very  small 
or  closely  held  corporations — assuming  that  there  is  good  feeling 
among  the  various  persons  interested — it  is  customary  to  allot 
securities  as  they  are  issued,  to  all  those  actively  interested 
under  some  kind  of  mutual  agreement.  The  universal  rule  of 
law  is  that  where  new  voting  shares  are  issued  by  an  established 
corporation,  every  voting  shareholder  must  have  an  opportunity 
to  take  up  the  new  shares  in  proportion  to  his  holdings  of  the 

799 


8oo  CORPORATE  FINANCE  [Bk.  II- 

old  shares.  Unless  there  is  some  agreement  to  the  contrary, 
it  is  generally  found  advisable  in  close  corporations  to  allot  new 
issues  of  common  stock  on  this  basis.  Preferred  stock  and  bonds 
are  more  likely  to  be  sold  to  outsiders. 

§  237.    Cultivating  the  Stockholders'  Good-Will 

Corporations  already  established  and  going  ahead  success- 
fully which  require  fresh  capital  from  time  to  time  for  expansion 
of  their  activities,  find  it  highly  profitable  to  cultivate  the 
active  good-will  of  the  stockholders.  This  applies  especially 
to  companies  having  many  stockholders,  most  of  whom  are 
not  in  close  touch  with  the  management  of  the  business.  The 
man  who  has  invested  money  in  the  stock  of  a  corporation  is 
likely  to  feel  a  certain  personal  interest  in  its  continued  success 
and  growth;  he  usually  likes  to  be  considered,  not  as  a  complete 
outsider,  but  as  a  person  who  is  entitled  to  special  information 
and  privileges.  He  therefore  follows  its  fortunes  with  more 
than  usual  interest  and  is  peculiarly  approachable,  if  he  is  kept 
in  an  interested  frame  of  mind,  when  a  proposition  to  make  a 
further  investment  is  brought  before  him.  In  the  language  of 
salesmanship,  two  steps — making  a  favorable  approach  and 
arousing  interest — have  already  been  taken.  The  corporation 
presumably  possesses  his  confidence.  The  succeeding  steps 
creating  a  desire  to  invest  further  and  securing  his  decision  to 
do  so — should  be  comparatively  easy  if  he  is  in  a  position  to 
make  further  investments  in  anything. 

The  idea  of  deliberately  setting  to  work  to  cultivate  the  friend- 
ship of  the  body  of  shareholders  not  identified  with  the  manage- 
ment, may  be  regarded  as  a  recent  development  in  business 
finance.  Even  yet,  there  are  comparatively  few  corporations 
which  have  grasped  and  consistently  apply  the  idea.  The  ten- 
dency still  persists  among  the  corporate  officials  to  regard  the 
average  stockholder — usually  unknown  personally — as  merely  a 
name  which  some  clerk  enters  upon  the  books.  We  may  go  a 
step  farther  and  say  that  in  many  corporate  offices  he  appears  to 


Ch.  24]  SELLING  SECURITIES  DIRECT  801 

be  regarded  as  an  unavoidable  nuisance  who  insists  on  draining 
away  with  his  dividend  checks— if  he  is  fortunate  enough  to  get 
them — the  earnings  which  the  officers  and  directors  would  much 
prefer  to  retain  for  themselves.  The  truth  is  that  the  average 
stockholder  is  a  human  being  who  likes  to  be  treated  as  such  and 
who  will  readily \respond  if  he  is  treated  with  fairness,  courtesy, 
and  some  degree  of  cordiality. 

§  238.    Methods  of  Cultivating  the  Good- Will  of  Stockholders 

There  are  many  ways  in  which  the  interest  and  good-will  of 
the  stockholders  can  be  cultivated.  On  one  occasion  when  the 
stockholders  of  a  great  railroad  received  their  dividend  checks, 
they  were  at  least  mildly  surprised  and  to  some  extent  interested 
to  find  enclosed  an  attractive  account  of  a  trip  to  the  Yellowstone 
National  Park,  which  the  railway  company  was  promoting, 
together  with  a  return  post  card  on  which  the  stockholder  might 
inquire  for  further  details. 

The  National  Biscuit  Company  some  years  ago  sent  out  to 
their  stockholders  a  "Pandora  Box"  which  contained  samples  of 
many  of  the  company's  products.  The  Loose-Wiles  Biscuit 
Company  followed  their  example.  Swift  and  Company  not  only 
furnish  their  stockholders  with  a  formal  annual  report,  but  with 
an  attractively  illustrated  "Year  Book"  which  contains  an 
intimate  review  of  the  internal  workings  of  the  company.  As 
stated  in  the  preface  of  the  1920  edition,  "Originally  this  annual 
publication  was  intended  for  the  information  of  shareholders; 
the  demand  from  the  general  public  has  increased  to  such  an 
extent,  however,  that  it  has  been  enlarged  from  year  to  year 
and  is  now  distributed  in  large  numbers  to  all  who  wish  to  send  for 
it." 

Among  the  many  subjects  discussed  in  the  192 1  edition,  are: 
Earnings,  Dividends  and  Surplus,  Number  of  Shareholders, 
Sales,  Beef  Prices,  Proposed  Legislature,  Wages,  Relations  with 
Employees,  Prospects,  and  "Shareholders  Should  Use  Our  Pro- 
ducts," under  which  title  it  is  said,  "If  every  one  of  the  40,000 


8o2  CORPORATE  FINANCE  [Bk.  II- 

shareholders  should  become  familiar  with  our  products  and  insist 
upon  buying  them,  it  would  have  a  valuable  effect  on  the  busi- 
ness." Armour  and  Company  also  get  out  a  handsome  annual 
publication,  illustrated  in  colors,  for  the  information  and  interest 
of  their  shareholders. 

Of  a  somewhat  different  order  and  severely  plain  in  appear- 
ance, but  issued  for  the  same  general  purpose,  is  the  annual 
report  of  the  American  Telegraph  and  Telephone  Company, 
The  following  quotation  is  from  the  192 1  report: 

To  THE  Stocichglders: 

It  is  the  purpose  of  these  reports  to  make  clear  to  a  large  and 
steadily  increasing  body  of  stockholders  not  only  the  present 
financial  status  of  their  properties,  but  also  such  facts  as  to  the 
broad  and  far-reaching  extent  of  the  Company's  business,  the  in- 
sistent and  steadily  increasing  demand  for  additional  telephones 
and  facilities,  as  wUl  enable  them  to  form  accurate  judgments  as  to 
the  soundness  of  the  structure  which  has  been  successfully  created, 
and  the  assurance  of  continuing  returns  on  their  investments. 

In  addition  to  the  annual  report,  many  of  the  larger  corpor- 
ations publish  periodicals  or  issue  special  reports  from  time  to 
tilne  which  are  sent  to  their  stockholders,  and  which  not  only 
keep  these  latter  informed  as  to  what  the  corporation  is  doing, 
but  are  an  efficient  aid  in  cultivating  their  good-will  and  in 
increasing  their  friendly  interest  in  the  corporation  whose  shares 
they  hold.  Corporations  which  work  along  such  lines-  may 
safely  count  on  finding  their  shareholders  responsive  when  a  new 
issue  of  securities  is  offered  to  them. 

§  239.    Cultivating  the  Good-Will  of  Employees 

In  discussing  this  subject  of  relations  with  shareholders, 
it  is  convenient — although  it  might  logically  come  a  little  later 
— to  treat  the  subject  of  relations  with  employees.  The  modern 
corporation  with  broad-gauged  management  is  no  longer  in- 
cUned  to  treat  its  employees  as  if  they  were  outsiders  entitled 
to  no  special  consideration.  On  the  contrary,  a  direct  conscious 
effort  is  continually  being  made  to  bring  them  into  sympathy 


Ch.  24]  SELLING  SECURITIES  DIRECT  803 

with  the  point  of  view  of  the  management  and,  whenever 
possible,  to  persuade  them  to  participate  actively  as  share- 
holders in  the  risks  and  profits  of  the  business. 

An  effective  appeal  to  employees  is  that  of  Swift  and  Com- 
pany.    The  following  statement  is  from  the  1920  report: 

1919  Employees'  Stock  Savings  Plan 
In  order  to  encourage  saving,  thrift,  and  loyalty  on  the  part  of 
employees,  a  new  plan  was  put  into  effect  on  June  2,  1919,  permit- 
ting employees  to  purchase  some  of  Swift  and  Company's  treasury 
stock  at  par  ($100  per  share)  when  the  market  value  was  about 
$136.00  per  share. 

Employees  earning  less  than  $20.00  a  week  were  allowed  to  pur- 
chase one  share,  the  number  of  shares  increasing  with  the  weekly 
salary  so  that  those  earning  $50.00  and  over  could  purchase  five 
shares. 

Payment  is  on  the  instalment  plan,  $1.00  a  share  a  week  to  be 
deducted  from  employee's  wages  until  paid  in  fuU. 

The  results  a  year  later  are  given  in  the  192 1  report: 

Swift  and  Company  now  has  over  40,000  shareholders  of  record, 
over  13,000  of  whom  are  employees.  There  are  only  four  or  five 
other  corporations  in  the  United  States  whose  shares  are  more 
widely  held. 

In  addition  to  our  shareholders  of  record,  there  are  more  than 
7,000  other  employees  who  have  subscribed  for  shares  under  our 
1919  Employees'  Stock  Savings  Plan,  making  a  total  of  over  20,000 
of  our  60,000  employees  who  are,  or  will  soon  become,  shareholders 
of  record.  The  results  from  the  Employees'  Stock  Savings  Plan 
upon  which  we  reported  at  the  last  annual  meeting  have  been  very 
encouraging,  and  we  have  thought  it  wise  to  keep  this  plan  in 
operation. 

In  192 1  the  United  States  Steel  Corporation  sold  255,325 
shares  of  stock  to  81,722  employees. 

§  240.    Cultivating  the  Good- Will  of  Customers 

In  a  field  which  is  entirely  unrelated,  the  same  plan  was 
adopted  by  one  of  the  great  public  utility  corporations  of  the 
United  States — the  Pacific  Gas  and  Electric  Company.    The 


8o4  CORPORATE  FINANCE  [Bk.  H- 

report  of  this  company  for  the  year  ended  December  31,  19 14, 
states  that  a  campaign  to  induce  its  customers  to  become 
further  interested  in  the  operation  of  the  company  by  pur- 
chasing first  preferred  stock  had  been  successful,  $4,000,000 
of  this  stock  having  been  taken  up  by  customers  and  over 
$500,000  additional  by  employees.  In  the  first  six  months  of 
191 5,  an  additional  $1,800,000  of  the  stock  was  sold  to  1,069 
customers. 

It  is  clear  that  one  result  of  this  policy  must  be  to  secure 
a  higher  degree  of  local  public  interest  and  to  strengthen  the 
bonds  which  unite  the  corporation  in  friendly  relations  with 
the  communities  which  it  serves. 

The  same  idea  is  available  for  almost  any  kind  of  enterprise. 
The  Hammond  Typewriter  Corporation  of  New  York,  in  the 
early  part  of  1922,  sent  out  the  following  appeal  to  its  customers: 

The 

Board  of  Directors 

of  the 

Hammond  Typewriter  Corporation 

extends  to 

Mr.  James  Wilson 

an  invitation  to  inquire  concerning  his  privilege  of  becoming  a 

member  of  its  Founders  Underwriting  Syndicate  and  participating 

in  the  $437,000  of  underwriting  stock  profits  to  be  divided  among 

syndicate  mernbers. 

The  enclosed  card  of  inquiry,  mailed  promptly  will  bring  you 
full  particulars. 

Very  truly  yours, 

G.  J.  Edmonson, 

Vice-President 

In  explanation  of  the  above  appeal,  the  company  says: 
"In  order  to  provide  the  additional  working  capital  for  this 
business  expansion,  the  Hammond  Typewriter  Corporation  is 
inaugurating,  through  its  Founders'  Underwriting  Syndicate,  a 
plan  of  stock  distribution  which  marks  a  new  era  in  industrial 
financing."  :jJ 


Ch.  24I  SELLING  SECURITIES  DIRECT  805 

The  same  idea  has  recently  been  used  with  success  in  securing 
additional  capital  for  a  moving  picture  company,  which  appealed 
to  the  patrons  in  attendance  at  its  theaters;  similarly  the  W.  L. 
Douglas  Shoe  Company  advertised  an  issue  of  preferred  stock  in 
connection  with  the  advertisements  of  its  shoes  and  presumably 
with  success,  as  its  outstanding  preferred  stock  increased  from 
$2,500,000  on  July  5,  1919,  to  over  $3,700,000  in  December, 
1920 — the  period  during  which  the  advertising  appeared. 

In  all  probability  the  same  policy  of  appealing  to  customers 
and  prospective  customers  could  be  applied  advantageously  in 
thousands  of  other  enterprises.  Many  an  owner  of  a  small 
business  who  chafes  helplessly  against  his  "lack  of  capital" 
and  blames  the  "trust"  for  his  poor  success,  could  obtain  all 
the  capital  he  needs  if  he  would  work  out  a  sound  proposition 
and  present  it  by  letter  or  in  person  to  the  people  who  are 
already  interested  as  his  customers. 

§  241.    The  "Stock  Right"  » 

When  a  corporation  desires  to  obtain  capital  by  issuing 
additional  stock,  it  extends  to  its  stockholders  the  privilege  of 
subscribing  to  the  new  stock,  in  proportion  to  their  individual 
holdings,  at  a  price  fixed  below  the  market  value  of  the  outstand- 
ing stock.  This  privilege  of  subscribing,  technically  known  as 
a  "stock  right,"  is  evidenced  by  a  formal  document  or  "warrant," 
which  in  appearance  resembles  a  securities  certificate. 

Stockholders  are  permitted  to  assign  or  transfer  this  subscrip- 
tion privilege  to  others  in  case  they  do  not  care  to  take  advantage 
of  it  themselves.  Such  transfers  are  made  in  the  open  market 
and  as  the  new  stock  is  offered  at  less  than  the  market  price  of  the 
old  stock,  the  rights  possess  value. 

§  242.    Two  Definitions  of  the  Stock  Right 

In  offering  new  stock  to  its  shareholders,  the  corporation 
announces  that  those  of  record  on  a  particular  date  will  be 

*  The  disctission  of  "rights"  which  follows  is  written  by  Thomas  York,  author  of  "Foreign 
Exchange." 


8o6  CORPORATE  FINANCE  [Bk.  II- 

entitled  to  subscribe  to  the  new  stock  on  the  basis,  say,  of  one 
new  share  for  every  two  shares  of  the  old  stock  owned  by  them 
on  the  specified  day. 

In  different  localities  usage  varies  as  to  what  a  single  "stock 
right"  is.  According  to  one  usage,  the  term  refers  to  the  privi- 
lege of  subscribing  for  one  new  share.  Thus,  if  the  holder  of 
two  old  shares  is  entitled  to  purchase  one  new  share  at  the 
specified  price,  he  is  considered  to  have  one  right,  a  holder  of  loo 
old  shares  to  have  50  rights,  etc.  Each  stockholder,  in  other 
words,  has  as  many  rights  as  the  number  of  new  shares  he  may 
subscribe  for  under  the  company's  offer. 

In  its  other  usage  the  term  "stock  right"  means  the  sub- 
scription privilege  attaching  to  each  share  of  the  old  stock.  In 
the  example  cited  the  holder  of  two  old  shares  has  two  rights  as 
thus  defined,  the  owner  of  100  shares  has  100  rights,  etc.  When 
this  meaning  is  assigned  to  the  term,  a  stockholder  has  as  many 
rights  as  he  has  shares  of  the  old  stock.  This  is  the  signification 
ordinarily  attached  to  the  term  stock  rights  in  New  York,  and 
as  it  is  proposed  here  to  describe  rights  as  they  are  bought  and 
sold  in  the  New  York  market,  the  term  will  be  used  in  this  latter 
sense  only. 

§  243.    Conditions  of  Subscription  Ofifer 

To  take  a  hypothetical  example,  suppose  the  Manufacturing 
Corporation  of  America  with  a  capital  stock  of  $1,000,000  divided 
into  10,000  common  shares,  each  of  $100  par  value,  all  outstand- 
ing and  with  a  market  value  well  above  par,  decides  to  offer  to 
its  stockholders  5,000  shares  of  additional  stock  at  par.  The 
first  official  announcement  of  this  sale  of  new  stock  is  made  to 
the  company's  stockholders  and  reads  in  substance  as  follows: 

The  Manufacturing  Corporation  of  America  will  extend  to  its 
shareholders  of  record  on  May  i,  1922,  the  privilege  of  subscribing, 
at  $100  a  share,  to  5,000  shares  of  additional  common  stock,  of  $100 
par  value,  in  the  ratio  of  one  share  of  new  stock  for  every  two  shares 
of  old  stock  held.     Subscriptions  will  be  payable  on  or  before 


Ch.  24]  SELLING  SECURITIES  DIRECT  807 

June  1,1922.     Transferable  warrants  specifying  the  number  of  new 
shares  for  which  they  are  entitled  to  subscribe  will  be  mailed  to 
stockholders  of  record  as  soon  after  May  i  as  practicable. 
New  York,  April  2,  1922 

§  244.    Trading  in  the  Rights 

The  three  dates  in  the  foregoing  announcement  define  the 
period  in  which  the  stock  rights  may  be  sold  and  the  two  distinct 
stages  of  trading  into  which  this  period  is  divided. 

Trading  in  the  rights  commences  April  2,  immediately  upon 
the  public  announcement  of  the  new  issue.  The  prospective 
rights,  however,  go  with  the  shares  until  May  i,  and  therefore 
the  market  value  of  the  shares  up  to  that  date  includes  the  value 
of  the  rights;  or  as  it  is  commonly  expressed,  the  stock  sells 
"rights  on." 

§  245.    Sales  of  Rights  on  a  "When  Issued"  Basis 

All  rights  traded  in  between  April  2  and  May  i  are  bought  and 
sold  on  a  "when  issued"  basis.  That  is  to  say,  a  stockholder 
who  does  not  wish  to  sell  his  stock  but  does  wish  to  sell  his 
rights  before  May  i,  may  make  such  sale  for  delivery  and  pay- 
ment a  few  days  after  May  i,  when  the  warrant  will  be  avail- 
able. The  sale  is  made  at  the  prevailing  market  price,  and  the 
first  problem  is  how  that  price  is  determined. 

If  upon  the  company's  announcement  of  the  new  subscription 
on  April  2,  Jones  purchases  in  the  market  two  shares  of  the  old 
stock  at  $150  a  share,  he  will,  on  May  i,  receive  the  two  rights 
that  will  entitle  him  to  subscribe  for  one  new  share.  This  he 
does,  and  on  June  i  he  is  the  owner  of  three  shares  in  the  com- 
pany's increased  stock,  which  have  cost  him  a  total  of  $400,  or 
an  average  of  $1333^  per  share. 

Suppose  that  instead  of  exercising  the  two  rights  and  sub- 
scribing for  one  share  of  new  stock,  Jones  sold  the  rights  on 
April  2,  each  for  the  amount  of  the  difference  between  $150  (the 
prevailing  market  price  of  the  old  stock)  and  $133^  (the  aver- 
age cost  per  share  of  the  old  and  new  stock  combined)  that  is, 


8o8  CORPORATE  FINANCE  [Bk.  II- 

for  $i6%.  The  cost  of  each  of  his  two  shares  would  be  in  that 
case  reduced  by  this  amount  to  $133^,  as  is  evident  from  the 
following: 

Cost  of  two  shares  of  old  stock  at  $150  per  share $300 

Amount  realized  on  the  sale  of  the  two  rights 33  J^ 

Net  cost  of  the  two  shares $266% 

Net  cost  of  one  share $133^        '^' 

From  the  foregoing  it  is,  plain  that  a  purchaser  of  the  old 
stock  at  $150  fares  the  same  on  the  sale  of  the  rights  at  $16% 
as  he  does  when  he  retains  the  rights  and  subscribes  for  the  new 
stock  at  $100,  as  in  either  case  the  cost  is  $1333^  a  share. 

§  246.    Parity  Value  of  Rights  Dealt  in  "When  Issued" 

In  this  situation,  with  the  rights  quoted  at  $16%  and  the 
stock  at  $150,  there  is  neither  gain  nor  loss  in  dealing  in  the 
rights,  for  it  then  matters  not  whether  one  purchases  two  shares 
of  the  stock  and  subscribes  for  a  share  of  the  new  stock  against 
the  two  rights  which  accompany  the  two  shares ;  or  whether  he 
purchases  six  rights  and  acquires  three  shares  by  subscription. 
In  either  case  the  cost  per  share  is  $1333^.  In  this  price 
relationship  the  rights  are  said  to  be  at  parity  with  the  stock 
and  their  value  is  referred  to  as  the  parity  value. 

The  rule  for  ascertaining  the  parity  value  of  a  right  when  the 
market  quotation  for  the  stock  is  given,  is  easily  deduced  from 
our  example.  It  will  be  observed  that  the  difference  between  the 
market  price  of  $150  for  the  old  stock  and  the  subscription  price 
for  the  new  is  equal  to  three  times  the  parity  value  of  $16^  for 
the  right.  Hence  the  parity  value  is  equal  to  this  difference  of 
$50  divided  by  3,  which  divisor,  it  will  be  noticed,  is  equal  to  the 
sum  of  the  terms  of  the  ratio  of  subscription,  i  and  2.  It  will 
be  found  that  this  rule  is  of  general  application  where  the  sub- 
scription ratio  is  given  in  terms  of  the  number  of  old  shares 
entitled  to  subscribe  to  one  new  share.  Hence,  if  m  represents 
the  market  price  of  the  old  stock,  s  the  subscription  price  of  the 


Ch  24]  SELLING  SECURITIES  DIRECT  809 

new,  and  n  the  number  of  old  shares  carrying  the  subscription 

privilege  to  one  new  share,  then  p,  the  parity  value  of  the  right, 

.   m  —  s 

equals 

n   +  1 

§  247.    Tendency  of  Rights  to  Parity  Value 

As  for  the  actual  market  price  of  the  rights,  this  shows  a 
constant  tendency  to  equal  the  parity  value,  and  therefore  also 
fluctuates  with  the  market  value  of  the  stock ;  for  whenever  any 
appreciable  difference  arises  between  the  parity  value  and  the 
market  priced  of  the  rights,  it  becomes  profitable  to  undertake 
certain  market  operations  in  the  rights  and  the  stock,  the  effect 
of  which  is  to  render  the  market  price  of  the  rights  equal  to  their 
parity  value.    These  operations  are  of  three  kinds,  as  follows: 

1.  Purchase  of  Rights. — Suppose  that  the  price  of  the  old 
stock  is  $150,  so  that  the  parity  value  of  the  rights  is  $16  3^,  and 
the  market  price  of  the  rights  is  $15  In  such  case  rights  are 
relatively  cheaper  than  the  stock,  and  those  who  wish  to  acquire 
stock  in  the  company  will  do  better  to  purchase  rights  and  sub- 
scribe for  new  shares  than  to  buy  old  shares,  as  is  shown  below: 

(a)  When  old  stock  is  purchased : 

Cost  of  purchasing  two  shares  of  old  stock  at  $150 $300 

Subscription  price  of  one  new  share  (the  two  rights  being 
acquired  with  the  purchase  of  the  old  stock) 100 

Cost  of  the  three  shares $400 

Cost  of  one  share $133^ 

(b)  When  rights  are  purchased: 

Cost  of  six  rights  at  $15  per  right $  90 

Subscription  price  of  three  new  shares 300 

Cost  of  the  three  shares $390 

Cost  of  one  share $130 

Thus  the  saving  by  purchasing  rights  is  $33^  per  share. 

2.  Sale  of  Stock  and  Purchase  of  Rights. — If  the 
market  price  for  rights  is  less  than  parity,  a  profit  accrues  to 
owners  of  the  old  stock  who  sell  and  at  the  same  time  buy  the 


8io  CORPORATE  FINANCE  [Bk.  II- 

number  of  rights  necessary  to  secure  a  like  amount  of  new  stock. 
Thus:  hq 

Sale  of  two  old  shares  (with  rights)  at  $150  yields $300 

Value  of  the  two  rights  attaching  to  the  two  shares  sold 30 

Amount  realized  for  the  stock  exclusive  of  the  rights $270 

Purchase  price  of  four  rights  at  $15  per  right $  60 

Subscription  price  of  two  new  shares 200 

Total  cost  of  the  new  shares 260 

Profit  on  the  two  shares $  10 

Profit  on  one  share *. .     $    5 

The  proper  basis  for  comparing  the  amount  realized  on  the 
old  stock  with  the  cost  of  purchasing  rights  and  subscribing  to  the 
new  stock,  is  to  compare  the  old  and  the  new  stock  as  they  will 
be  after  May  i  when  the  old  stock  loses  the  value  of  the  rights. 
This  is  done  in  the  computation  by  deducting  the  market  value 
of  the  rights  from  the  proceeds  of  the  sale  of  the  old  shares. 

3.  Arbitraging  Transactions. — The  disparity  between  the 
market  price  for  the  stock  and  that  for  the  rights  gives  oppor- 
tunity also  for  profitable  operations  by  brokers  who  make  more 
or  less  a  specialty  of  this  class  of  business.  These  transactions 
are  called  ''arbitraging  transactions,"  and  consist  of: 

(a)  Selling  the  stock  "short"  (i.e.,  the  broker  does  not  have 

the  stock  but  borrows  it  to  make  delivery) . 

(b)  Buying  rights  and  subscribing  to  the  new  stock. 

(c)  Turning  this  stock  over  to  the  lender  of  the  old  stock. 
The  following  example  indicates  the  method  of  computing 

the  arbitrageur's  profit: 

He  sells  two  old  shares  "short"  at  $150 $300 

At  the  same  time  he  purchases  six  rights  at  $15  per  right .    $  90 
He  subscribes  for  two  new  shares 200 

Total  cost  of  the  two  new  shares 290 

His  total  profit  on  the  turnover  of  two  shares $  10 

His  profit  on  one  share $    5 


Ch.  24]  SELLING  SECURITIES  DIRECT  811 

It  will  be  noticed  that  the  arbitraging  broker  purchases  two " 
rights  more  than  the  four  required  for  subscription  to  two 
shares  of  new  stock.  These  two  extra  shares  he  delivers  to  the 
lender  of  the  two  old  shares  after  the  stock  sells  ex-rights  and  the 
warrants  are  issued.  That  is,  he  borrowed  two  shares  which 
carried  with  them  the  rights,  and  he  now  returns  their  equiva- 
lent in  the  shape  of  two  rights  and  two  shares  of  the  new  stock, 
the  latter  of  which  he  delivers  when  the  certificate  is  available 
after  June  i . 

The  effect  of  the  foregoing  three  classes  of  operations,  occa- 
sioned as  they  are  by  the  presence  of  a  disparity  between  the 
market  quotations  for  the  stock  and  the  rights,  is  to  cause  a 
readjustment  in  the  demand  and  the  supply  of  the  stock  and  the 
rights.  The  demand  for  the  rights  is  increased,  while  the  offer- 
ings of  the  stock  are  augmented.  As  a  consequence  of  this, 
the  market  price  of  the  rights  rises  above  $15,  and  the  market 
price  of  the  stock  falls  below  $150;  and  with  that  the  two  quota- 
tions are  drawn  toward  mutual  parity.  If  this  tendency  hap- 
pens to  be  strong  enough  to  overcome  any  forces  operating  in 
the  opposite  direction,  parity  between  the  quotations  is  eventu- 
ally realized,  as  when  the  stock  is  quoted  at  $148  and  the  right 
at  $16  ($148  minus  $100,  divided  by  3,  equals  $16). 

§  248.    Rights  Quoted  at  a  Discount  and  a  Premium 

Almost  invariably  any  disparity  between  the  stock  and  the 
rights  is  a  discount  from  the  parity  value  of  the  rights  at  the 
moment.  The  reason  for  this  is  that  when  the  privilege  of  sub- 
scribing to  additional  stock  is  extended  to  shareholders,  many  of 
them  sell  instead  of  exercising  their  rights.  Pressure  is  thus 
exerted  on  the  market  for  the  rights  and  causes  their  price  to  fall 
below  parity.  This  in  turn,  through  the  operations  of  those  who 
take  advantage  of  the  disparity  to  effect  a  saving  or  reap  a 
profit,  reacts  on  the  price  of  the  stock  and  may  cause  it  to  fall 
also,  though  not  necessarily,  as  parity  may  be  brought  about 
simply  by  the  market  price  of  the  rights  rising. 


8i2  CORPORATE  FINANCE  [Bk.  II- 

Instances  of  the  opposite  disparity,  in  which  the  market  price 
of  the  rights  is  at  a  premium  above  the  parity  value,  are  extremely 
rare.  Perhaps  the  most  notable  case,  in  recent  years,  of  this 
sort  of  disparity  was  in  the  sale  of  rights  to  a  new  issue  of  Texas 
Company  stock  in  191 5.  At  one  time  the  stockholders  stood  to 
save  as  much  as  $6.50  a  share  by  buying  the  old  stock  and  selling 
their  rights  to  the  new  stock. 

§  249.    Stock  Selling  Ex-Rights 

When  the  company  closes  its  stock  ledger  on  May  i,  it  takes 
the  list  of  stockholders  and  prepares  warrants  to  evidence  the  pro 
rata  subscription  privilege  of  each.  The  outstanding  shares 
no  longer  carry  a  right  to  the  subscription  of  J^  share  of  the 
new  stock,  and  thereafter  are  sold  "ex-rights,"  that  is,  minus  the 
rights.  Dissociated  from  the  stock,  the  rights  become  the  sub- 
ject of  independent  trading,  free  and  apart  from  the  stock,  in 
the  manner  of  ordinary  securities. 

On  the  New  York  Stock  Exchange,  stock  begins  to  be  quoted 
ex-rights  at  the  commencement  of  trading  on  the  day  the  sub- 
scription privilege  takes  effect,  May  i  in  our  example.  This  is 
because  of  the  Stock  Exchange's  system  of  settlement,  which 
calls  for  the  payment  and  deUvery  of  the  stock  on  the  day  fol- 
lowing the  transaction. 

On  May  i,  when  the  stock  ceases  to  carry  the  right,  its  market 
quotation  loses  the  value  of  the  right.  Accordingly,  when  the 
market  opens  on  that  day,  the  price  of  the  stock  is  marked  down 
from  the  closing  quotation  of  the  previous  day  by  the  amount  of 
that  value.  Suppose,  for  example,  that  the  last  quotation  for 
the  stock  on  April  30  was  $150,  and  for  the  right  $16.  Other 
things  being  equal,  the  stock  will  begin  the  next  day  at  $134. 
But  as  other  things  are  generally  not  equal,  instead  of  starting 
at  $134,  the  stock  is  very  hkely  to  begin  above  or  below  that 
figure.  In  expressing  the  price  change  from  the  last  quotation 
of  the  preceding  day,  account  is  only  taken  of  this  deviation 
from  $134,  because  the  amount  deducted  for  the  value  of  the 


Ch.  24]  SELLING  SECURITIES  DIRECT  813 

right  has  not  been  lost  through  any  depreciation  but  is  now  simply 
represented  by  what  is  virtually  a  separate  security. 

§  250.    Parity  Value  of  Rights  When  Stock  Is  Quoted  Ex-Rights 

It  has  been  noticed  that  in  the  first  period  of  trading  in  the 
rights,  when  the  stock  sells  "rights  on,"  the  difference  between 
the  market  price  of  the  shares  and  the  subscription  price  of  the 
new  stock  is,  in  our  example,  three  times  the  parity  value  of  the 
right.  Since  the  price  of  the  stock  is  reduced  on  May  i  by  the 
value  of  one  right,  it  is  evident  that  in  the  second  period  of  the 
trading,  from  May  i  to  June  i,  when  the  stock  sells  ex-rights, 
the  difference  between  the  stock  quotation  and  the  subscription 
price  is  only  twice  the  parity  value  of  the  right.  Thus  the 
parity  value  of  the  right  is  now  found  by  taking  the  difference 
between  the  market  quotation  for  the  old  stock  and  the  sub- 
scription price,  and  dividing  this  difference  by  the  number  of 
rights  necessary  to  subscribe  to  one  share  of  new  stock.  Hence 
the  formula  for  finding  the  parity  value  of  the  right  when  the 

^  m  —  s 

stock  is  selling  ex-rights,  is . 

n 

The  market  price  of  the  rights  during  this  second  period  tends 

to  coincide  with  this  parity  value,  because  any  wide  divergence 

from  the  parity  value  at  once  opens  an  opportunity  for  arbi- 

traging  and  other  transactions  entered  into  for  a  profit,  which 

bring  the  stock  and  the  rights  closer  to  parity,  just  as  when  the 

stock  is  selling  "rights  on." 

.ifr. 


-ft  1':n\  n-j^ff  ton  ^rrf  irfr^h 


CHAPTER   XXV 

SELLING  SECURITIES  DIRECT 

TO  OUTSIDERS,.    .-  -u::  ,<.• 

rj:x3  luo  nx ,  //mi 

§251.    The  Problem  >)« 'jfiHo  9'jnq  arft  9Dm<J     .irigh 

We  may  next  take  up  the  case  of  a  corporation  which  desires 
to  raise  a  considerable  amount  of  new  capital  either  at  its  organi- 
zation or  at  some  later  stage  in  its  development,  and  which  can- 
not count  on  meeting  its  needs  by  selling  to  its  own  stockholders 
or  to  those  intimately  associated  with  the  business  as  employees 
or  customers.  The  corporation,  we  will  assume  for  the  present, 
either  cannot  command  or  does  not  desire  to  obtain  the  services 
of  bankers  or  stock  exchange  brokers,  but  wishes  to  deal  directly 
with  the  prospective  purchasers  of  its  securities.  In  other  words, 
the  corporation  is  in  the  position  of  wishing  to  sell  its  own  securi- 
ties to  the  public  at  large  without  the  employment  of  inter- 
mediaries. 

In  such  case  the  corporation  must  look  for  prospective  buy- 
ers and  must  carry  on  an  active  campaign  for  the  purpose  of 
disposing  of  its  securities.  To  determine  the  amount  and  nature 
of  the  securities  to  be  offered  belongs  to  the  field  of  financing 
proper;  what  methods  should  be  adopted  in  disposing  of  these 
securities  directly  to  investors  is  primarily  a  selling  problem. 
This  problem  as  applied  to  the  sale  of  securities  may  be  analyzed 
as  follows: 

1.  How  shall  the  names  of  prospective  buyers  be  obtained? 

2.  What  is  the  most  suitable  and  attractive  manner  of  ap- 

proaching these  prospective  buyers? 

3.  How  shall  their  interest  be  aroused? 

4.  How  shall  their  confidence  be  secured? 

814 


Ch.  25]  SELLING  SECURITIES  DIRECT  815 

5.  How  shali  a  desire  be  created  on  their  part  to  purchase 

the  securities  that  are  being  sold? 

6.  How  shall  a  favorable  decision  and   consummation  of 

the  sale  be  secured? 

It  is  necessary  here  only  to  present  a  few  remarks  as  to  the 
application  of  the  principles  of  salesmanship  to  this  problem  of 
disposing  of  securities. 


§  252.    Selling  by  Mail  Order  Methods 

The  first  method  of  reaching  prospective  buyers  which  occurs 
to  many  organizers  or  managers  of  small  corporations,  is  ad- 
vertising or  extensive  circularizing.  This  method,  however,  has 
proved  itself  almost  worthless  for  sound,  legitimate  enterprises, 
although  it  is  extensively  used  by  unsound  enterprises.  First  of 
all,  the  very  fact  that  swindling  promoters  endeavoring  to  float 
the  securities  of  worthless  oil  companies,  mining  companies,  and 
the  like,  have  used  this  method  so  largely  is  almost  a  decisive 
argument  against  it.  It  has  become — perhaps  unfortunately — 
so  closely  associated  with  fraud  that  any  offer  of  stocks  through 
widespread  advertising  and  circularizing  is  at  once  looked  upon 
with  suspicion  by  conservative  men.  A  more  fundamental  ob- 
jection is  that  the  method  is  bound  to  be  expensive.  It  is  not 
likely  that  any  securities,  unless  they  should  be  the  securities  of 
companies  already  widely  and  favorably  known,  could  be  sold 
by  advertising  and  circularizing  at  an  expense  of  less  than  25% 
to  50%  of  their  offered  price,  which  is  entirely  too  high  for  a 
legitimate  enterprise.  Generally  speaking,  the  selling  expense  of 
legitimate  securities  ought  not  to  exceed  5%  to  10%. 

While  this  is  true,  it  is  also  true  that  the  government  of  the 
United  States  employed  mail  order  methods  in  selling  Liberty 
bonds,  and  in  connection  with  other  methods,  employed  it  with 
signal  success.  It  is  also  true  that  oil  companies,  reputable  and 
fairly  prosperous,  can  be  found  in  Texas  and  elsewhere,  whose 
securities  have  been  sold  through  mail  order  and  general  adver- 


8l6  CORPORATE  FINANCE  [Bk.  II- 

tising  work.  It  is  also  true  that  the  method  may  be — and  has — 
at  times  been  employed  economically  and  with  success  by  cor- 
porations in  other  lines  and  in  other  places.  Nevertheless  the 
general  condemnation  of  the  method  is  sound. 

It  may  also  be  said  that  this  condemnation  of  mail  order 
methods  of  selling  securities  does  not,  of  course,  extend  to  the 
advertising  of  high-grade  securities  by  reputable  and  conserva- 
tive banking  houses.  Such  advertising  is  customary,  dignified, 
and  usually  effective. 

§  253.    Circularizing  iSpecial  Lists 

The  usual  mail  order  method  of  selling  securities  may  be 
modified  by  limiting  it  to  selected  lists  made  up,  for  instance,  of 
the  customers  or  probable  customers  of  the  enterprise.  If  the 
list  is  carefully  selected,  and  the  circularizing  carried  on  in  a 
dignified  and  effective  manner,  this  method  may  sometimes  prove 
inexpensive  and  successful.  The  suggestion  in  the  preceding 
chapter  as  to  the  possibilities  of  securing  capital  from  customers 
and  employees  supports  this  view.  It  must  be  borne  in  mind, 
however,  that  there  is  grave  danger  here  of  arousing  the  suspicion 
that  the  corporation  is  financially  embarrassed,  or  at  any  rate  is 
not  sufficiently  well  financed  to  provide  funds  in  the  usual  ways 
for  its  proper  development.  *'/; 

§  254.    Personal  Selling 

The  third  and  ordinarily  the  best  method  of  finding  prospec- 
tive buyers  for  securities  of  small  corporations  is  through  per- 
sonal effort.  It  may  seem  at  first  glance  that  this  statement  is 
in  contradiction  to  the  customary  practice  in  marketing  commodi- 
ties. "Experience  has  long  ago  proved,"  it  may  be  argued,  "that 
personal  salesmanship  is  a  slow  and  highly  expensive  method  of 
selling  automobiles,  real  estate,  and  many  other  high-priced 
commodities.  At  any  rate,  it  should  be  supplemented  and  sup- 
ported by  advertising,  circularizing,  and  other  cheaper  methods. 
Why  should  not  the  same  principle  apply  to  the  sale  of  securities?" 


Ch.  25]  SELLING  SECURITIES  DIRECT  817 

The  answer  to  this  natural  inquiry  is  that  the  element  of  con- 
fidence in  the  management  of  an  enterprise — and  in  the  salesman 
— is  a  vastly  more  important  factor  in  effecting  the  sale  of  stocks 
and  bonds  than  it  is  in  effecting  the  sale  of  such  things  as  auto- 
mobiles and  real  estate.  The  purchaser  of  a  security  does  not 
regard  the  transaction  as  terminated  when  he  pays  over  his 
money  and  receives  his  certificate  or  his  bond.  On  the  contrary, 
he  is  just  beginning  at  this  point  his  relations  with  the  corpora- 
tion and  its  management.  If  he  is  wary,  therefore — and  the 
majority  of  people  with  capital  to  invest  are  wary — he  will  not 
part  with  his  capital  until  he  feels  well  assured  of  the  honesty 
and  competence  of  the  management  of  the  enterprise.  When  the 
corporation  is  well  established  and  well  known,  or  when  the  offer 
comes  to  the  prospective  purchaser  through  a  banking  house  of 
high  standing,  or  even  through  a  salesman  whom  he  knows  and 
believes  in,  or  when  he  is  personally  acquainted  with  the  man- 
agers, the  necessary  feeling  of  confidence  is  quickly  established. 
If  none  of  these  favoring  conditions  exist,  however,  the  best  sub--; 
stitute  is  for  the  salesman  to  approach  the  prospective  buyer 
with  a  personal  introduction  or  recommendation  which  tends  to 
establish  confidence. 

Here  we  have  the  basic  reason  for  the  unquestionable  fact 
that  only  through  the  personal  influence  and  activities  of  the  re- 
sponsible officers  or  of  trusted  representatives  can  the  securities 
of  a  small  corporation  be  successfully  sold  to  the  general  public. 
For  this  reason  the  expense  of  finding  prospective  purchasers 
through  such  impersonal  methods  as  advertising  or  circularizing 
is  in  almost  every  case  prohibitive. 

The  organizer  or  manager  of  a  small  corporation  which  needs 
capital  may  as  well  make  up  his  mind  at  once  that  he  is  the  man 
who  should  find  the  capital,  and  that  he  should  work  through  his 
acquaintances  and  through  the  respected  business  men  of  his 
community  or  of  his  line  of  business.  He  may  be  greatly  sur- 
prised to  find  how  quickly  and  easily  he  can  locate  capital,  the- 
existence  of  which  he  ha4  not  previously  suspected.  kIiMik 


8i8  CORPORATE  FINANCE  [Bk.  II- 

§  255.    The  Prospectus 

For  the  same  reason  that  the  seller  of  most  commodities  needs 
either  a  sample  or  a  catalogue,  the  seller  of  securities  needs  a 
prospectus.  This  in  its  essential  characteristic  is  a  written  state- 
ment of  the  history,  the  present  condition,  and  the  prospects  of 
the  corporation  and  of  the  terms  on  which  its  securities  are 
offered  for  sale.  No  prospective  purchaser  of  securities,  who  is 
not  one  of  the  inside  managers  of  the  concern,  will  be  likely  to 
buy  until  after  a  written  statement  has  been  put  into  his  hands 
and  he  has  had  an  opportunity  to  look  it  over.  Even  though  his 
analysis  of  the  statement  may  not  be  thorough,  still  the  fact  that 
it  is  made  in  writing  tends  to  increase  his  confidence.  Verbal 
assurances  which  he  discounts  acquire  greater  strength  when  they 
are  committed  to  permanent  written  form.  The  written  state- 
ment may  take  the  shape  of  a  private  letter;  it  may  be  a  some- 
what more  formal  typewritten  statement;  or  if  intended  for 
wider  distribution,  it  may  be  printed.  The  form  in  which  the 
statement  is  given  does  not  change  its  essential  character:  it 
contains  the  definite  representations  on  the  strength  of  which  the 
security  is  being  sold,  and  for  this  reason  is  of  importance  both  in 
effecting  the  sale  and  in  connection  with  any  legal  questions  that 
may  later  arise.  ■  '♦  uiui  i 

§  256.     Statements  of  the  Prospectus  p 

If  the  corporation  which  is  selling  the  securities  is  well  estab- 
lished and  has  been  running  for  some  years,  the  most  important 
statements  in  the  prospectus  are  the  records  of  earnings  and  the 
balance  sheets.  These  statements  should  be  scrutinized  and 
analyzed  with  the  greatest  care.  Attention  should  be  given  to 
omissions  as  well  as  to  allegations  of  fact.  The  record  of  earn- 
ings, for  example,  should  go  back,  not  one  or  two  years,  but  pos- 
sibly five  or  six  years.  The  list  of  assets  in  the  balance  sheet 
should  be  checked  with  a  suspicious  eye,  and  it  should  be  noted 
whether  ample  reserves  for  depreciation  and  loss  have  been  es- 
tablished.   Sometimes  it  is  claimed  that  it  would  be  inadvisable 


Ch.  25]  SELLING  SECURITIES  DIRECT  819 

for  a  prospectus  to  present  records  of  earnings  over  a  period  of 
years,  on  the  ground  that  this  would  be  making  public  informa- 
tion that  might  be  of  value  to  competitors.  If  the  business  is  of 
so  secret  a  character  that  even  its  records  of  profits  are  not  to  be 
made  known  to  its  stockholders  or  prospective  stockholders,  it  is 
certainly  not  the  kind  of  a  business  which  should  offer  securities 
to  the  public  at  large. 

A  common  practice  in  writing  prospectuses,  and  one  which 
properly  arouses  suspicion,  is  the  presentation  of  vague  and 
plausible  statements  that  do  not  commit  the  corporation  or  its 
promoter  to  anything  definite,  and  yet  are  intended  to  create  the 
impression  that  remarkable  profits  are  in  prospect.  In  the  pros- 
pectus of  a  small  copper  mining  company,  for  example,  it  is 
stated  that  "copper  mining  has  proved  a  source  of  some  of  the 
greatest  fortunes  the  world  has  ever  known,  and  its  possibilities 
are  not  yet  exhausted."  This  statement  is  literally  true,  and  in 
its  proper  context  is  certainly  not  objectionable.  But  when  it 
appears  in  a  prospectus,  with  the  obvious  intention  of  suggesting 
that  the  particular  company  which  is  offering  its  stock  is  likely 
to  prove  a  boundless  source  of  wealth,  it  may  well  cause  suspicion 
as  to  the  entire  sincerity  and  good  faith  of  the  authors  of  the 
prospectus.  Because  of  the  fact  that  glowing  statements  beget 
suspicion  rather  than  confidence,  the  writers  of  prospectuses  for 
high-grade  companies  frequently  go  to  the  other  extreme  and 
decline  to  commit  themselves  in  any  way  as  to  the  future.  They 
will  not  even  express  an  opinion.  By  so  doing  they  may  avoid 
straining  anyone's  confidence  in  their  statements,  but  they  lose 
the  persuasive  power  of  their  own  well-founded  belief  in  the 
future  growth  of  the  enterprise.  The  skilled  prospectus  writer 
will  steer  his  way  carefully  between  these  extremes.  "^'*^^ 

§  257.    Names  in  the  Prospectus  '^^  ^ 

An  important  factor  in  creating  confidence,  especially  in  a 
new  corporation,  is  the  list  of  names  of  men  who  are  identified 
with  the  management  or  have  consented  to  join  the  board  of 


820  CORPORATE  FINANCE  [Bk.  II- 

directors.  It  is  entirely  proper  that  these  names  should  appear 
in  the  prospectus,  and  if  they  are  the  names  of  men  known  for 
their  probity,  business  ability,  and  general  standing,  nothing 
better  can  be  brought  in.  Knowing  tnis  to  be  true,  however,  un- 
scrupulous promoters  of  doubtful  undertakings  frequently  and 
deliberately  set  to  work  to  secure  "ornamental"  directors  who, 
for  some  consideration  or  because  of  personal  vanity,  are  willing 
to  become  members  of  the  new  board.  The  practice  is  a  vicious 
one  and  the  careful  purchaser  of  securities  is  likely  to  be  repelled 
rather  than  attracted  when  he  sees  a  number  of  widely  advertised 
names  of  this  kind  included  in  the  directorate. 

§  258.     Style  of  the  Prospectus 

It  is  always  desirable  that  the  prospectus  should  be  dignified 
in  its  form  and  in  its  contents.  Red  ink  and  buffoonery  may  con- 
ceivably help  to  sell  some  commodities,  but  they  will  not  help  to 
sell  thousands  of  dollars  of  stock  and  bonds.  A  man  who  is 
thinking  of  putting  his  money  into  securities,  generally  looks 
upon  the  proposition  seriously  and  does  not  ask  to  be  either 
startled  or  amused. 

However,  this  need  not  prevent  a  strong  appeal  at  times  to 
other  motives  besides  money-making.  A  trust  company  in  a 
small  Texas  city,  for  example,  which  had  been  unable  to  raise 
additional  capital  that  it  badly  needed,  found  that  it  had  no 
difficulty  in  getting  capital  as  soon  as  it  put  its  appeal  on  the 
ground  of  the  local  pride  which  should  be  felt  by  the  leading 
ranchers  and  merchants  of  the  community  in  building  up  a  sound 
financial  institution.  The  sentimental  appeal,  if  it  is  used,  must 
of  course  be  sincere  and  legitimate.  Otherwise  it  becomes  mere 
bathos  and  a  destroyer  of  confidence. 

§  259.    Limitations  on  Direct  Sale  of  Securities 

One  advantage  of  selling  securities  direct,  rather  than  through 
bankers  and  brokers,  is  the  belief  commonly  held  by  the  pur- 
chasers that  in  this  way  they  avoid  paying  the  expenses  of  the 


Cn.  25]  SELLING  SECURITIES  DIRECT  821 

sale.  They  argue  to  themselves  that  if  a  brokerage  firm  were  to 
dispose  of  a  block  of  securities,  it  would  require  a  commission  of, 
say,  5%  to  10%  or  more,  whereas  when  the  corporation  itself, 
through  its  officers  or  direct  representatives,  disposes  of  its 
securities,  no  commission  need  be  paid.  It  is  of  course  obvious 
that  there  is  very  apt  to  be  a  fallacy  here,  inasmuch  as  the  effort 
and  expense  on  the  part  of  the  corporation  in  conducting  the  sale 
is  just  as  truly  selhng  cost  as  would  be  a  commission  paid  to 
bankers  or  brokers.  As  a  matter  of  fact,  the  moment  direct  sell- 
ing of  its  own  securities  by  a  corporation  goes  beyond  a  certain 
limited  field,  it  usually  becomes  impracticable  on  account  of  its 
high  cost.  As  already  stated,  advertising  and  circularizing  ordi- 
narily will  not  produce  the  right  kind  of  inquiries  for  legitimate 
propositions  except  at  excessive  cost.  Personal  work  on  the  part 
of  officers  or  promoters  of  a  corporation,  who  inquire  among  their 
friends  and  proceed  from  one  man  to  another  until  they  reach 
people  with  money  to  invest,  is  also  likely  to  be  slow  and  expen- 
sive. The  idea  is  not  impracticable — indeed  at  times  is  very  ad- 
vantageous when  the  amount  of  capital  to  be  raised  is  compara- 
tively small — but  as  the  amount  of  capital  increases,  the  diffi- 
culty and  expense  of  this  method  become  progressively  greater. 

§  260.    Effect  on  Public  of  Direct  Sale  of  Securities 

Another  factor  when  direct  selling  of  large  issues  of  securities 
by  a  corporation  is  under  consideration  is  the  effect  on  the  public. 
Such  a  sale  is  not  considered  "good  form."  As  stated  by  a  lead- 
ing financial  writer: 

I  Investment  securities  of  standing  are  sold  through  investment 

bankers;  those  of  little  or  doubtful  value  may  be  sold  direct  by  the 
issuing  corporation  or  distributed  by  irresponsible  promoters  or 
fiscal  agents,  with  the  help  of  extravagant  advertising  matter.  .  .  . 
In  this  respect  there  is  a  very  strong  prejudice  to  deter  a  corpora- 
tion engaged  in  the  railroad,  lighting  or  manufacturing  business 
from  trying  to  sell  its  own  securities.  So  strong  is  this  feeling  that 
investors  assume  that  the  corporation  cannot  find  a  reputable 
banker  to  offer  its  securities  if  it  resorts  to  offering  them  itself.  ,  .  . 


822  CORPORATE  FINANCE  (Bk.  li- 

lt is  true  that  in  spite  of  all  reasons  why  corporations  should  not 
market  their  own  securities  there  are  many  instances  in  which  they 
have  tried  to  do  it.  If  the  corporation  enjoys  strong  credit,  if  the 
securities  are  conspicuously  attractive,  and  if  general  investment 
conditions  are  very  favorable,  the  sale  will  succeed.  This  does  not 
prove,  however,  that  such  a  policy  is  wise.^ 

This  does  not  of  course  apply  to  the  smaller  corporations,  and 
especially  when  their  stock  is  sold,  presumably  among  friends  and 
acquaintances,  by  their  officers.  It  is,  though,  impossible  to  say 
definitely  how  much  capital  can  properly  be  raised  in  this  man- 
ner. That  will  depend  in  part  on  the  personal  resources  and  ac- 
quaintanceships of  the  officers.  When  the  Continental  Rubber 
Company — later  absorbed  by  the  Intercontinental  Rubber  Com- 
pany— was  organized  as  a  close  corporation  by  a  small  group  of 
wealthy  New  York  capitalists,  it  had  a  capital  stock  of  $10,000,- 
000,  and  all  of  this  was  readily  sold  by  personal  solicitation.  On 
the  other  hand,  an  inventor  who  is  not  in  touch  with  business 
men  may  find  it  a  matter  of  great  difficulty  to  raise  a  few  hundred 
dollars. 

We  can  perhaps  form  some  approximate  idea  of  what  the  pos- 
sibilities are,  by  considering  the  fact  that  banking  and  brokerage 
houses  rarely  care  to  consider  the  sale  of  securities  of  corporations 
capitalized  at  less  than  $1,000,000;  also  that  they  do  not  care  to 
undertake  the  sale  of  an  issue  of  securities  of  less  than  $200,000. 
Blocks  of  securities  of  smaller  amounts,  therefore,  cannot  be  sold 
ordinarily  in  any  other  manner  than  through  the  personal  efforts 
of  the  promoters  or  managers  of  the  corporation.  Blocks  of 
securities  of  larger  amounts  can  generally,  but  not  always,  be 
sold  more  cheaply  through  banking  and  brokerage  houses  than 
through  direct  personal  efforts. 


>  Dewing  on  Finan.  Policy  of  Corp.,  pp.  146,  148. 


CHAPTER  XXVI 

SELLING  SECURITIES  THROUGH  DEALERS; 
STOCK  EXCHANGE  METHODS 

§  261.    Classes  of  Security  Dealers 

The  general  classes  of  security  dealers  correspond  to  the 
classes  of  dealers  in  merchandise,  as  follows: 

1.  Wholesalers 

2.  General  retailers 

3.  Retail  specialists 

It  will  quickly  appear  that  these  three  classes  are  not  clearly 
defined;  nevertheless  it  is  usually  possible  to  classify  a  given 
banking  or  brokerage  house  as  belonging  to  one  of  these  groups. 
The  wholesale  dealers  are  interested  only  in  the  largest  issues 
and  make  little  effort  to  sell  in  small  lots  direct  to  individuals. 
In  the  United  States,  J.  P.  Morgan  and  Company,  Kuhn,  Loeb 
and  Company,  Speyer  and  Company,  and  a  number  of  other  firms 
not  quite  so  well  known,  constitute  this  group.  When  a  house 
of  this  type  undertakes  to  sell  a  large  issue,  it  usually  proceeds 
to  form  an  underwriting  syndicate  composed  of  firms  which 
belong  wholly  or  partly  in  the  second  group  and  which  are 
equipped  to  sell  the  securities  direct  to  the  purchasing  public. 

The  second  group  includes  such  houses  as  Spencer  Trask  and 
Company,  Harris,  Forbes  and  Company,  and  the  National  City 
Company — which  might  also  be  placed  in  the  first  group. 
These  houses  maintain  large  organizations  of  bond  and  security 
salesmen  and  keep  comprehensive  and  valuable  lists  of  people 
who  are  known  to  have  money  available  for  investment.  Such 
houses,  when  they  are  members  of  underwriting  syndicates,  are 
prepared  to  assume  a  large  share  of  •  the  burden  of  actually 

823 


824  CORPORATE  FINANCE  [Bk.  II- 

disposing  of  the  securities  offered.  They  may  also  take  up 
smaller  issues  of  securities  wholly  on  their  own  account  without 
forming  an  underwriting  syndicate,  and  may  dispose  of  these 
issues  to  the  public.  There  is  no  sharp  line  between  houses  in 
this  group  and  houses  in  the  first  group. 

The  third  group,  consisting  of  specialists  in  the  different 
classes  of  securities,  is  more  clearly  defined.  It  is  distinguished 
from  the  second  group  by  the  fact  that  the  list  of  prospective 
buyers  in  a  specialty  house  is  made  up  exclusively  of  people  who 
have  shown  an  interest  in  the  specialty  and  is  not  merely  a  gen- 
eral list  of  people  who  have  money  to  invest.  The  difference  is 
much  the  same  as  between  a  department  store  and  a  retail  shop 
which  specializes  in  one  line  of  goods.  These  specialty  houses 
again  differ  from  the  stock  exchange  brokerage  firms  which  are  de- 
scribed a  Uttle  later  in  this  chapter.  It  would  be  impossible  to 
list  all  of  the  specialty  houses.  One  deals  exclusively  in  oil 
stocks;  another  in  the  securities  of  the  steel  and  iron  companies; 
another  in  equipment  bonds  and  car  trusts;  another  in  the 
first  mortgage  bonds  of  public  utilities;  another  in  bank,  trust 
company,  and  insurance  company  securities. 

We  may  also  include  in  this  third  group  a  large  number  of 
small  banking  and  brokerage  houses  scattered  over  the  country 
which  specialize  in  local  securities.  Every  city  of  any  size  has  a 
considerable  number  of  successful  corporations  the  securities  of 
which  are  from  time  to  time  bought  and  sold.  These  local  firms 
handle  business  of  this  type.  Usually  they  are  also  the  corre- 
spondents and  representatives  of  New  York  houses  and  are  in 
position  to  help  sell  the  big  security  issues  in  which  New  York  is 
interested.  o 

§  362.    Handling  an  Issue  ,,^ 

A  brokerage  house  in  good  standing  which  undertakes  to 
sell  a  bond  or  a  stock  issue,  will  first  of  all  wish  to  inform  itself 
fully  and  accurately  as  to  the  soundness  of  the  issue.  It  will 
carry  on  a  preliminary  investigation  along  the  same  lines  that 


Ch.  26]  SELLING  SECURITIES  THROUGH  DEALERS  825 

have  been  fully  described  in  the  chapters  on  promotion.  In  case 
the  preliminary  investigation  is  satisfactory  and  the  terms  are 
agreed  upon,  the  house  will  then,  probably  through  its  own 
engineers  and  accountants,  delve  still  deeper  into  the  records 
of  the  corporation  and  satisfy  itself  beyond  a  doubt  of  the  con- 
servatism of  all  statements  upon  which  the  sale  of  the  security 
is  to  be  based.  Then  it  will  proceed  to  dispose  of  the  securities. 
Some  general  advertising  of  the  security  may  be  decided  upon, 
and  there  is  likely  to  be  some  circularizing  with  a  dignified 
prospectus.  Generally  speaking,  the  real  object  of  this  adver- 
tising and  circularizing  is  not  so  much  to  dispose  of  the  issue 
immediately  in  hand,  as  to  reinforce  the  work  of  its  salesmen,  and 
build  up  the  firm's  list  of  prospective  buyers  of  securities. 

It  is  this  list  of  prospective  buyers  which  is  the  firm's  chief 
asset.  Having  this  list,  it  is  not  necessary  that  it  should  incur 
anew  the  expense  of  securing  names  of  prospective  buyers 
through  advertising  and  circularizing  each  time  an  issue  of  se- 
curities is  to  be  sold;  that  is,  this  expense  is  spread  over  the  cost 
of  selling  many  different  issues  instead  of  being  chargeable  wholly 
to  one  issue. 

§  263.    Commission  Pa3anents 

It  is  clear  that  so  far  as  investigation  is  concerned  the  ex- 
pense involved  is  almost  as  great  for  a  small  issue  as  for  a 
large  issue.  Furthermore,  the  large  issue  is  likely  to  be  the 
issue  of  a  better  known  corporation,  can  generally  be  sold  in 
larger  blocks  than  can  the  small  issue,  and  as  a  rule  is  more 
easily  sold.  All  three  of  these  reasons  operate  to  make  the 
brokerage  house  anxious  to  secure  the  privilege  of  selling  large 
issues  at  small  commissions,  and  reluctant  to  undertake  the 
disposal  of  small  issues  even  at  high  commissions. 

When  the  joint  loan  of  the  English  and  French  governments 
amounting  to  $500,000,000  was  placed  in  this  country  in  the  fall 
of  191 5,  the  bankers  who  handled  it  received  a  commission  of 
iK%-     When  the  National  City  Bank  of  New  York  in  the  pre- 


826  CORPORATE  FINANCE  [Bk.  II- 

ceding  year  undertook  to  sell  $15,000,000  of  the  notes  of  the 
Argentine  government  in  this  country,  the  commission  was 
3/^%-  The  large  bond  issues  of  great  railroad  corporations  are 
ordinarily  sold  on  a  commission  of  3%  to  5%.  The  smaller 
bond  issues  and  the  first-class  preferred  stock  issues  of  industrial 
concerns  are  sold  at  commissions  of  5%  to  10%,  and  the  pre- 
ferred stock  of  the  small  industrial  may  have  to  pay  as  high  as 
20%.  These  higher  commissions  are  not,  however,  usual,  for 
the  reason  that  the  better  established  houses  do  not  care  to  iden- 
tify themselves  with  any  security  which  requires  so  high  a  com- 
mission. It  is  of  course  true  that  even  higher  commissions  and 
special  bonuses  payable  in  stock  of  the  issuing  corporation  are 
not  unknown. 

When  a  brokerage  house  is  handling  a  small  issue  and  finds 
it  difficult  to  make  cash  sales,  it  may  resort  to  "swapping"  for 
other  better  known  securities  that  are  owned  by  its  clients.  In 
this  way  the  brokerage  house  may  obtain  bonds  or  stocks  which 
it  can  actually  sell  for  cash.  The  process,  however,  is  more  or 
less  risky  and  expensive  and  amply  justifies  a  high  commission. 

§  264.     Obligation  of  the  Brokerage  House 

A  question  that  is  bound  to  arise  whenever  a  bond  or  broker- 
age house  recommends  a  security  which  afterward  turns  out  to 
be  a  poor  purchase,  concerns  the  extent  of  the  obligation  which 
the  house  should  be  willing  to  assume.  So  far  as  the  legal  obli- 
gation goes,  the  house  is  always  careful  to  protect  itself  by  dis- 
claiming responsibility  for  the  statements  of  fact  which  it  trans- 
mits from  the  corporation  to  the  purchaser.  Thus  the  National 
City  Company,  in  announcing  an  issue  of  $25,000,000  Gold 
Notes  of  the  Consolidated  Gas  Company  of  New  York,  adds  the 
following  cautious  note:  "The  information  contained  in  this  cir- 
cular is  based  upon  oflScial  statements  and  statistics  on  which  we 
have  reHed  in  purchasing  these  notes.  We  do  not  guarantee, 
but  believe  it  to  be  correct." 

Also  the  selhng  house  is  careful  that  it  shall  always  be  clearly 


Ch.  26]  SELLING  SECURITIES  THROUGH  DEALERS  827 

understood  that  any  prophecies  as  to  the  future  represent  only 
its  opinions  and  are  not  definite  promises.  This  attitude  is  in 
itself  entirely  correct;  yet  there  remains  a  certain  moral  obliga- 
tion which  the  better  houses  are  quite  willing  to  recognize.  As 
to  how  far  this  obligation  extends  there  is  naturally  considerable 
difference  of  opinion. 

Clearly  there  is  a  well-marked  community  of  interest  in  this 
matter  between  a  well-established  banking  house  of  high  repute 
and  its  customers.  The  prosperity — the  very  existence — of  the 
house  is  dependent  upon  its  ability  to  retain  the  unquestioning 
confidence  of  a  large  number  of  investors.  Every  time  a  security 
which  it  handles  goes  wrong,  that  confidence  is  perceptibly  dimin- 
ished. The  reputable  banking  house,  therefore,  takes  great  pains 
in  the  first  place  to  make  certain  that  its  statements  of  fact  are 
fully  verified  and  that  its  recommendations  are  justified.  As  a 
further  protection,  it  is  customary  for  the  banking  house  to 
obtain  for  itself  some  kind  of  representation,  direct  or  indirect, 
on  the  board  of  directors  of  the  corporation.  It  is  thus  in  posi- 
tion to  keep  itself  informed  and  to  exercise  some  influence  on  the 
future  policies  of  the  enterprise. 

If  in  spite  of  every  precaution  the  corporation's  record  is 
unsatisfactory  and  the  market  value  of  its  securities  declines,  the 
banking  house  will  frequently  try  to  maintain  the  market  price. 
If  the  market  decline  seems  to  be  due  to  extraneous  factors  rather 
than  to  any  real  falling  off  in  the  financial  standing  or  profits  of 
the  corporation,  the  banking  house  will  perhaps  be  satisfied  with 
doing  what  it  can  to  maintain  the  price  and  with  reassuring  its 
own  clients.  In  case  the  situation  becomes  worse  and  the  cor- 
poration finally  goes  through  insolvency  and  reorganization,  the 
banking  house  will  do  its  best  to  secure  favorable  terms  for  the 
holders  of  the  securities  which  it  has  itself  recommended.  It  has 
even  sometimes  happened  that  the  banker  will  repurchase 
securities  which  he  has  sold  and  which  have  afterward  declined 
in  value,  at  their  original  selling  prices;  but  this  is  exceptional 
and  is  not  to  be  expected  as  a  regular  policy. 


828  CORPORATE  FINANCE  [Bk.  II- 

On  the  whole,  as  the  investing  public  comes  to  be  better 
educated  in  financial  affairs,  and  as  the  standards  of  correct 
practice  in  these  matters  become  better  established,  there  is  a 
strong  tendency  toward  more  complete  and  unquestioning 
recognition  on  the  part  of  the  security  merchant  of  his  moral 
obligation.  It  is  but  rarely  that  the  purchaser  of  securities  from 
a  reputable  house  has  any  cause  for  serious  complaint. 

§  265.    Limitations  on  Sale  through  Dealers 

It  was  pointed  out  in  the  preceding  chapter  that  issues  below 
$200,000  are  too  small  to  interest  the  security  dealers,  and  must, 
therefore,  ordinarily  be  sold  direct  by  the  corporation  or  its 
promoters.  This  establishes  in  a  general  way  a  lower  limit  of  the 
security  merchant's  activities.  On  the  qther  hand,  very  large 
issues  of  bonds  or  shares  which  soon  after  their  issue  will  enjoy 
an  active  market  on  an  important  stock  exchange,  are  frequently 
best  handled  with  the  assistance  of  stock  exchange  operations. 
This  does  not  mean,  as  will  be  explained  a  little  further  on  in  this 
chapter,  that  the  large  banking  houses  do  not  underwrite  and  dis- 
pose of  these  securities.  It  means  only  that  they  use  a  slightly 
different  method.  Speaking  in  general  terms,  it  is  usually  true 
that  issues  of  say  $10,000,000  to  $20,000,000  and  over,  are  listed 
on  the  New  York  Stock  Exchange  at  once  if  the  issue  can  meet 
the  Stock  Exchange  requirements,  and  the  efforts  of  the  houses 
which  handle  the  issue  are  directed  toward  encouraging  pur- 
chases through  the  exchange  as  well  as  toward  making  sales 
direct  to  their  own  customers. 

Another  limitation  on  the  direct  sale  of  securities  by  dealers 
to  their  customers  is  found  in  its  cost.  Besides  paying  the 
bankers'  commission  for  selling  its  securities,  the  issuing  cor- 
poration must  frequently  pay  heavy  expenses  for  legal  opinions 
as  well  as  fees  to  accountants,  intermediary  brokers,  and  others, 
which  run  to  a  high  figure.  Inasmuch  as  arrangements  of  this 
kind  are  of  a  confidential  nature,  they  are  not  often  accessible 
and  for  this  reason  it  is  difficult  to  give  exact  figures. 


Ch.  26]  SELLING  SECURITIES  THROUGH  DEALERS  829 

Following  is  a  statement  showing  the  expenses  incurred  by 
A.  L.  Barbour  in  1896,  in  carrying  through  the  sale  in  London 
of  £400,000  6%  debenture  bonds  of  the  Trinidad  Lake  Asphalt 
Company: 

Underwriting  commission,  10% £40,000 

Fee  to  City  of  London  Contract  Corporation,  Limited,  and 

to  Henry  Bell,  Esq 15,000 

Expenses  of  the   City  of  London   Contract   Corporation,  ' 

Limited 1,022          f 

Fees  to  Seward,  Guthrie  and  Steele,  Attorneys  in  New  York .  2, 183 

Fees  to  Ashurst,  Morris  and  Crisp,  Attorneys  in  London ....  1,500 

Fees  to  accountants  and  brokers  and  miscellaneous  expense  10,293  *  '^ '- '' 

£69,998 

This  is  a  selling- expense  of  i7K%-  It  is,  to  be  sure,  ex- 
ceptionally high,  but  it  must  be  admitted  that  it  has  often 
subsequently  been  equaled.  1 

A  further  Hmitation  on  the  possibility  of  selHng  securities 
through  dealers  is  to  be  found  in  the  fact  that  the  decisions  of 
these  dealers  as  to  taking  on  new  issues  are  frequently  determined 
as  much  by  their  own  position  as  by  the  intrinsic  strength  and 
salability  of  the  propositions.  If  a  banking  house  has  already 
undertaken  as  much  as  it  can  carry  through,  it  will  not  entertain 
any  other  propositions  to  sell  securities  until  it  has  cleared  its 
shelves.  Similarly,  if  it  has  already  entered  into  arrangements 
to  sell  certain  issues  of  a  given  type,  it  will  not  be  in  position  to 
take  on  new  issues  of  the  same  type.  For  its  own  safety,  it 
would  prefer  to  offer  to  its  customers  a  diversified  list.  It  has 
sometimes  happened,  for  these  reasons,  that  a  really  excellent 
proposition  has  been  refused  by  houses  which  would  otherwise 
have  been  glad  to  take  it  up. 

Stock  Exchange  Methods 
§  266.    The  Stock 

Earlier  in  the  chapter  it  was  remarked  that  when  security 
issues  of  great  size  are  to  be  floated,  it  is  generally  advisable  to 

*  Figtires  from  Dewing  on  Corp.  Prom,  and  Reorg.,  p.  419. 


830  CORPORATE  FINANCE  [Bk.  II- 

have  them  at  once  listed  on  the  stock  exchange  and  to  effect  at 
least  a  portion  of  the  sales  through  stock  exchange  transactions. 
One  advantage  is  that  the  ready  marketability  of  the  security  is 
at  once  estabHshed.  Another  even  more  direct  advantage  is  the 
fact  that  considerable  quantities  may  be  purchased  through  the 
exchange  by  people  who  are  not  listed  as  customers  of  any  of  the 
bond  houses  which  float  the  issue,  or  who  prefer  to  buy  and  sell 
through  the  exchange  rather  than  "over  the  counter." 

Inasmuch  as  a  full  description  of  stock  exchange  methods 
would  require  more  space  than  is  available,  it  is  only  feasible  to 
give  here  a  brief  review  of  the  main  features. 

Fundamentally  an  exchange  is  simply  a  meeting  place  for 
people  who  wish  to  buy  and  sell  securities'.  In  the  eighteenth 
century  the  London  coffee  houses  grew  to  be  the  natural  centers 
for  business  dealings,  and  gradually  the  custom  arose  of  buying 
and  selling  through  agents,  who  made  it  a  point  to  meet  for  this 
purpose.  It  was  a  natural  step  forward  to  form  an  organization 
of  these  agents  or  brokers  and  to  establish  definite  hours  and 
fixed  rules  to  govern  the  trading,  and  when  that  step  was  taken 
the  stock  exchange  came  into  existence.  Much  the  same  series 
of  stages  has  marked  the  evolution  of  exchanges  in  all  the  other 
principal  commercial  cities  of  the  world.  There  are  important 
exchanges  today  not  only  in  London,  New  York,  and  Paris,  but 
in  Antwerp,  Rotterdam,  Buenos  Aires,  Rio  de  Janeiro,  Val- 
paraiso, and  numerous  other  cities.  Within  the  United  States 
the  chief  exchanges  outside  of  New  York,  are  in  Boston, 
Philadelphia,  Baltimore,  Cleveland,  Cincinnati,  Chicago,  New 
Orleans,  and  San  Francisco.  This  is  by  no  means  a  complete 
list.  Even  some  of  the  smaller  cities  have  stock  exchanges  of 
some  importance. 

All  the  exchanges  are  organized  on  the  same  general  plan. 
They  are  non-stock  corporations,  similar  in  their  essential  con- 
stitution to  clubs.  Members  are  admitted  on  payment  of  dues, 
provided  a  membership  or  "seat"  has  been  purchased  from  some 
member  who  wishes  to  retire.     The  mere  fact  that  membership 


Ch.  26]  STOCK  EXCHANGE  METHODS  83 1 

has  been  purchased,  however,  is  not  sufficient  In  itself  to  guar-' 
antee  admission.  The  membership  committee  may,  for  any 
reason  that  it  sees  fit,  decUne  to  accept  the  applicant. 

Seats  on  the  leading  stock  exchanges,  i.e.,  the  right  to  deal  in 
the  exchange  and  enjoy  its  privileges,  frequently  sell  at  very 
high  figures.  Their  value  fluctuates  widely  from  time  to  time, 
depending  upon  the  amount  and  profitableness  of  the  business 
which  is  being  handled  by  the  exchange.  Seats  on  the  New 
York  Stock  Exchange  sold  for  $115,000  in  the  early  part  of  1920; 
a  year  later  they  brought  but  $88,000. 

§  267.    Brokers'  Commissions 

The  brokers  who  hold  membership  on  an  exchange  are  re- 
quired to  charge  standard  commissions  for  buying  and  selling. 
On  the  New  York  Stock  Exchange  these  commissions  are  as 
follows : 

On  stocks  selling  below  $10  per  share 7X  cents  per  share 

On  stocks  selling  at  $10  per  share  and  above, 

but  under  $125  per  share 15 

On  stocks  selling  at  $125  per  share  or  over. ...  20 

provided,  however,  that  the  minimum  commission  on  an  indi- 
vidual transaction  shall  not  be  less  than  $1. 

The  buying  and  selling  of  securities  on  the  large  exchanges 
often  reach  an  enormous  volume;  million-share  days  on  the 
New  York  Stock  Exchange  are  by  no  means  uncommon.  Natur- 
ally, much  of  this  buying  and  selling  is  at  once  offset  by  a  cor- 
responding resale  or  repurchase.  A  certain  portion  of  the 
brokers  are  known  as  "scalpers"  and  make  it  their  sole  business 
to  take  advantage  of  quick  fluctuations  in  prices.  A  broker  of 
this  type  may  buy  100  shares  of  stock  with  the  full  intention  of 
reselling  within  a  few  minutes,  or  at  any  rate  before  the  close  of 
the  day.  He  is  satisfied  if  he  makes  a  profit  of  }/s%  to  J4%  o^ 
the  transaction,  that  is,  $12.50  to  $25. 

Other  members  of  the  Stock  Exchange  seldom  or  never  appear 
on  the  floor,  but  operate  entirely  through  their  fellow  brokers. 


832  CORPORATE  FINANCE  [Bk.  II- 

The  advantage  to  them  of  membership  lies  in  the  fact  that  the 
regular  commission  on  transactions  for  fellow  brokers  is  reduced 
to  a  very  low  figure.  By  far  the  great  majority  of  the  brokers 
do  little  or  no  trading  on  their  own  account,  but  are  satisfied 
with  handling  the  orders  given  them  by  their  customers. 

§  268.    Stock  Exchange  Settlements 

On  the  New  York  Stock  Exchange  the  transactions  of  every 
day  are  "cleared"  at  the  end  of  the  day  and  settlements  are 
made  the  following  day.  That  is  to  say,  purchases  and  sales  of 
the  same  security  are  checked  off  against  each  other  to  avoid 
the  excessive  passing  of  certificates  from  hand  to  hand  which 
would  be  the  case  if  every  sale  were  to  be  accompanied  by  an 
actual  dehvery.  After  purchases  and  sales  have  been  checked 
there  remains  only  a  comparatively  small  residue  of  actual  de- 
liveries required  in  order  to  close  the  day's  transactions. 

§  269.    Speculative  Dealings  on  the  Exchanges 

The  great  mass  of  transactions  on  most  of  the  stock  exchanges 
have  a  speculative  character.  A  great  many  securities,  to  be 
sure,  are  actually  taken  out  of  safe  deposit  boxes  and  brought 
into  the  market  to  be  sold  outright,  and  a  great  many  securities 
are  every  day  purchased  to  be  held  as  permanent  investments; 
yet  the  speculative  buying  and  selling  on  the  exchanges  over- 
shadows investment  buying  and  selling. 

The  activities  of  the  "floor  traders"  or  "scalpers"  who  buy 
and  sell  for  a  profit  of  %%  to  ^4%  have  been  mentioned.  Many 
of  these  traders,  though  not  all,  make  it  a  point  to  match  all  their 
purchases  and  sales  before  the  end  of  every  business  day,  thus 
reducing  their  risk  of  heavy  loss  to  a  minimum.  These  men 
proceed  almost  as  much  by  intuition  as  by  reasoning.  If  they 
see  in  the  manner  of  bidding  of  other  brokers,  or  "feel  it  in  the 
air,"  that  a  given  security  is  tending  upward,  they  will  help 
along  the  movement  by  making  a  purchase  with  the  expectation 
of  reselling  a  little  later  at  a  slight  profit.     One  result  of  their 


Ch.  26]  STOCK  EXCHANGE  METHODS  833 

activities  is  to  concentrate  attention  and  the  volume  of  trans- 
actions on  a  few  active  securities.  Their  business  thrives  on 
rapidity  of  fluctuation  in  prices.  However,  their  operations  tend 
to  restrict  the  range  of  fluctuation,  for  they  are  ready  to  buy  on 
a  momentary  drop  in  price  or  to  sell  on  a  momentary  rise,  and 
to  resell  or  rebuy  as  soon  as  the  normal  level  is  again  reached. 

A  second  group  of  speculators  consists  of  brokers  and  of  others 
who  are  in  close  touch  with  the  Wall  Street  market  and  who  carry 
on  buying  and  selling  campaigns  with  the  expectation  of  "cashing 
in"  within  a  few  weeks  or  months.  Sometimes  a  group  of  these 
operators  will  form  a  syndicate  or  "pool"  for  the  purpose  of 
"bulling"  or  "bearing"  the  price  of  a  particular  security.  Through 
"matched"  orders  for  buying  and  selling  they  create  an  artificial 
activity  and  bring  about  great  changes  in  quotations.  Their  cal- 
culation is  that  sooner  or  later  outsiders  will  be  attracted  by  the 
movement  and  will  buy  in.  By  gradually  feeding  out  or  repur- 
chasing the  security  in  which  they  are  interested,  they  may  be 
able  to  clear  a  large  profit  for  themselves.  r 

A  third  group  of  speculators  consists  of  men  who  possess  a 
real  or  fancied  knowledge  of  the  intrinsic  value  of  a  security,  and 
who  buy  or  sell  when  the  market  price  is  a  considerable  distance 
away  from  what  they  believe  to  be  the  normal  price,  in  the 
expectation  that  at  some  later  date  the  normal  price  will  be 
reached  and  they  may  realize  a  profit.  Included  in  this  group 
are  officers  and  directors  of  corporations  the  securities  of  which 
are  listed  on  the  exchange,  who  should  be  in  position  to  know 
more  about  the  real  standing  and  probable  future  showing  of  their 
corporation  than  anyone  else.  Unfortunately  for  these  men,  it 
frequently  happens  that  they  do  not  give  proper  weight  to  gen- 
eral market  influences  which  affect  the  whole  level  of  security 
prices.  Also  it  is  not  an  uncommon  case  for  a  man  who  is 
thoroughly  well  acquainted  with  a  given  corporation,  to  forip  an 
entirely  mistaken  idea  as  to  the  market  value  of  its  securities. 

A  fourth  group  of  speculators  consists  of  the  "lambs"  who 
are  not  equipped  with  the  experience  and  insight  of  the  "floor 


%4  CORPORATE  FINANCE  [Bk.  II- 

traders,"  do  not  possess  the  knowledge  of  market  conditions  and 
financial  resources  of  the  larger  operators,  and  are  not  acquainted 
with  given  securities  as  corporation  officials  are.  For  the  most 
part  they  simply  gamble  on  the  strength  of  "tips"  or  of  hazy 
impressions;  and  it  can  never  be  more  than  a  temporary  accident 
if  they  happen  to  make  profits.  The  number  of  these  people 
and  the  volume  of  their  transactions  is  often  exaggerated,  but 
their  losings  nevertheless  provide  a  steady  source  of  revenue  for 
the  better  informed  and  more  skilful  speculators. 

§  270.    Making  a  Market  j 

In  disposing  of  the  securities  through  stock  exchange  opera- 
tions, it  is  essential,  first  of  all,  that  public  interest  should  be 
aroused  and  that  the  volume  of  transactions  should  be  of  suffi- 
cient size  to  attract  attention;  otherwise  the  speculative  buying, 
which  constitutes  the  great  bulk  and  which  must  be  relied  upon 
to  take  the  new  securities  off  the  hands  of  the  syndicate  managing 
the  flotation,  will  be  lacking. 

"Making  a  market,"  as  it  is  called,  is  accomplished  chiefly 
through  two  lines  of  effort;  first,  by  providing  for  a  sufficient 
volume  of  transactions  to  arouse  the  interest  of  brokers  and 
professional  stock  market  .operators  who  will  then  buy  and  sell 
in  the  hope  of  making  substantial  profits  out  of  the  fluctuations. 
When  the  market  has  been  brought  to  this  point,  the  volume  of 
transactions  will  become  so  large  that  the  syndicate  carrying 
through  the  flotation — which  probably  will  be  engaged  simul- 
taneously in  buying  and  selling  so  as  to  maintain  control  over 
the  price — should  find  it  possible  to  sell  each  day  a  little  more 
than  it  buys.  Thus  it  will  gradually  get  rid  of  its  own  holdings 
without  causing  a  fall  in  the  price.  At  the  same  time,  through 
direct  sales  outside  the  exchange,  which  will  be  facilitated  by 
the  excellent  quotations  on  the  exchange,  it  will  probably  dispose 
of  the  rest  of  its  holdings. 

The  second  essential  factor  in  making  a  market  for  a  new 
security  is  favorable  publicity.     When  the  security  is  to  be 


Ch.  26]  STOCK  EXCHANGE  METHODS  835 

brought  out  and  listed  on  the  stock  exchange,  for  some  weeks  or 
possibly  for  some  months  in  advance,  the  financial  press  and 
the  financial  pages  of  the  daily  newspapers  are  liberally  supplied 
with  press  notices  intended  to  arouse  glowing  visions  of  the 
prosperity  of  the  corporation.  This  aids  both  the  stock  ex- 
change activities  and  also  the  direct  outside  sale  of  the  stock, 

§  271.    Limitations  on  Sale  through  Stock  Exchanges 

On  the  basis  of  the  brief  description  given,  it  is  apparent  that 
floating  new  issues  exclusively  through  stock  exchange  operations 
is  an  uncertain  process,  and  moreover  is  suitable  only  for  securi- 
ties of  a  distinctly  speculative  character.  The  expense  and  risk 
of  floating  a  comparatively  small  issue  by  this  method  are  seldom 
justified. 

Just  how  expensive  an  operation  of  this  character  is  likely  to 
prove  is  a  question  that  cannot  be  satisfactorily  answered.  It 
is  evident,  however,  that  even  though  it  may  be  completely  and 
quickly  successful,  there  must  be  a  large  outlay  for  brokerage 
commissions  alone.  The  buying  and  selling  transactions  must 
total  a  great  many  times  the  nominal  value  of  the  issue  which  is 
being  floated,  and  the  commission  on  each  transaction  may 
easily  amount  to  a  considerable  sum.  In  addition,  the  risk 
undertaken  by  the  underwriting  syndicate  must  necessarily  be 
recompensed  by  the  possibility  of  earning  a  large  profit.  On 
the  whole,  it  is  questionable  whether  the  average  expense  of  sell- 
ing by  this  method  is  any  less  than  by  the  other  methods  that 
have  been  described. 

In  conclusion,  it  must  not  be  understood  that  every  new 
security  which  is  Usted  on  the  stock  exchange  and  immediately 
becomes  active,  is  in  process  of  flotation  through  stock  exchange 
manipulation.  It  is  often  the  case  that  the  security  is  listed 
simply  as  an  incident  to  its  flotation,  and  is  allowed  practically 
to  take  its  own  course  except  for  receiving  some  support  from 
time  to  time  in  case  its  price  tends  to  sag  below  the  direct  "over 
the  counter"  price.  •  In  this  case  the  fact  that  the  security  is 


836  CORPORATE  FINANCE  [Bk.  II- 

listed,  and  that  its  quoted  price  is  slightly  above  the  "over  the 
counter"  price,  is  a  powerful  and  legitimate  aid  in  selling  the 
security.  There  can  be  no  question  but  that  any  security  which 
enjoys  the  advantage  of  being  listed  and  of  having  a  regular 
market  is,  for  that  very  reason,  worth  more  than  a  security  of 
equally  high  intrinsic  value  which  is  not  so  readily  marketable. 


boJ'jI  Hi 


CHAPTER  XXVII 

UNDERWRITING 

§  272.    Underwriting  Contracts 

The  practice  of  underwriting  arose  in  connection  with  ship- 
ping ventures  during  the  seventeenth  century.  The  leading  ship 
merchants  of  London  were  accustomed  to  assemble  in  Lloyd's 
Coffee  House  to  transact  their  mutual  business.  In  the  course 
of  time,  the  custom  arose  of  dividing  the  risk  of  venturesome 
voyages  among  a  number  of  different  merchants,  each  one  agree- 
ing to  stand  a  fixed  share  of  the  loss  or  to  receive  a  proportionate 
share  of  the  profits.  The  contract  to  this  effect  was  passed  about 
and  each  merchant  who  agreed  to  it  wrote  his  name  under  the 
contract — hence  the  word  "underwriting."  As  is  well  known,  the 
term  is  used  chiefly  in  relation  to  the  distribution  of  insurance 
risks;  though  when  applied  to  bond  and  share  issues  the  essential 
thought  is  the  same,  namely,  that  of  distributing  the  risk 

Perhaps  it  would  be  more  correct  to  say  that  an  underwriting 
contract  for  the  sale  of  securities  generally  relieves  the  corpora- 
tion which  issues  the  security  of  all  risk.  As  will  be  explained  a 
little  later,  there  are  a  number  of  different  types  of  underwriting 
agreements,  but  in  all  cases,  as  a  main  feature,  a  banking  house 
or  a  group  of  banking  houses  undertakes  that  the  corporation  re- 
ceive not  less  than  an  agreed  sum  for  the  underwritten  issue 
within  a  fixed  period.  The  underwriters  either  buy  the  securities 
outright,  or  obligate  themselves  to  take  over  the  issue  in  case  it 
cannot  be  sold  to  the  public  at  the  agreed  price. 

§  273.    Advantages  of  Underwriting 

The  advantages  of  this  arrangement  to  a  corporation  are 
material.    In  the  first  place,  an  issue  once  underwritten  by  re- 

837 


838  CORPORATE  FINANCE  [Bk.  II- 

liable  brokers  is  an  assured  success.  The  corporation  may  at 
once  proceed  with  whatever  projects  the  fresh  capital  is  designed 
to  finance.  There  is  no  tedious  and  costly  period  of  waiting  dur- 
ing which  the  securities  are  in  process  of  being  sold.  Many  new 
enterprises  are  of  such  a  nature  that  time  is  an  important  element 
in  making  them  successful.  If,  for  example,  a  new  plant  is  being 
built  in  order  to  handle  certain  contracts,  or  if  an  effort  is  being 
made  to  forestall  competition,  it  might  be  fatal  to  the  project  if 
progress  must  be  delayed  until  securities  were  sold. 

A  second  highly  important  advantage  is  that  a  sound  under- 
writing assures  success  in  raising  the  entire  sum  required.  Fre- 
quently any  amount  less  than  the  entire  sum  would  be  a  burden 
rather  than  a  source  of  strength  to  the  corporation.  For  exam- 
ple, a  company  operating  department  stores  intends  to  establish 
a  new  store  on  a  large  scale  in  another  city.  The  stores  previously 
owned  are  developed  as  far  as  can  profitably  be  done.  To  estab- 
lish the  proposed  new  store  with  insufficient  capital  would  be 
merely  to  make  it  second-rate  and  to  invite  quick  failure. 

Let  us  suppose  that  the  company  needs  $1,000,000  for  the 
new  store ;  that  it  authorizes  an  issue  of  additional  stock  for  that 
amount,  but  sells  only  one-half  the  stock,  thus  raising  $500,000. 
It  is  then  in  a  position  where  it  can  go  neither  forward  nor  back- 
ward. It  cannot  very  well  return  the  money  which  has  been 
raised,  nor  can  it  proceed  with  the  new  store.  It  is  possible,  in  a 
case  of  this  kind,  to  take  subscriptions  to  the  new  issue  under  the 
agreement  that  they  shall  not  be  binding  unless  the  complete 
issue  is  subscribed  for  within  a  given  period.  However,  this  in- 
troduces an  element  of  uncertainty  that  interferes  with  the  sale 
of  the  securities.  A  reliable  underwriting  protects  the  corpora- 
tion against  all  risks  and  difficulties  of  this  nature.  It  can  be 
certain  of  receiving  the  amount  of  capital  that  is  agreed  upon 
within  a  definite  period. 

Incidentally,  the  underwriting  method  of  marketing  securi- 
ties carries  with  it  the  co-operation  of  the  banking  house  that  is 
to  market  the  corporate  securities.    The  corporation  thus  gets 


Ch.  27]  UNDERWRITING  839 

the  benefit  of  the  specialized  experience  and  judgment  of  the 
bankers  as  to  the  form,  price,  and  other  details  of  the  new  securi- 
ty, and  the  possibility  of  mistakes  is  thus  reduced  to  a  minimum. 
Not  only  is  the  underwriting  agreement  advantageous  to  the 
corporation  which  issues  the  securities  but  also  to  the  purchasers 
of  these  securities.  The  mere  fact  that  an  underwriting  syndicate 
has  been  formed — provided  it  is  made  up  of  first-class  houses — 
is  in  the  nature  of  a  guaranty  that  the  securities  are  sound.  Even 
more  important  is  the  guaranty  that  the  issue  will  be  sold  in  ac- 
cordance with  the  predetermined  plan  and  the  money  secured  be 
made  available  for  the  corporate  purposes,  for  it  must  be  borne 
in  mind  that  the  moment  the  purchaser  becomes  a  stockholder 
or  a  bondholder  in  the  corporation,  he  begins  to  share  in  its  good 
or  evil  fortunes.  If,  therefore,  the  new  securities  sell  slowly,  or 
perhaps  are  not  entirely  disposed  of,  the  injury  to  the  corporation 
is  also  an  injury  to  the  purchaser  of  the  securities. 

§  274.    The  Underwriting  Syndicate 

We  have  seen  that  originally  underwriting  consisted  in  the  dis- 
tribution of  the  risk  of  a  venture  among  several  different  mer- 
chants. This  remains  a  characteristic  feature  of  present-day 
financial  underwriting.  It  is  true  that  the  term  is  frequently  ap- 
plied to  an  agreement  between  a  corporation  and  a  single  banking 
house,  under  which  the  banking  house  agrees  to  take  over  a  block 
of  securities  at  a  given  price.  A  transaction  of  this  type  may 
better  be  called  a  sale — or,  at  any  rate,  a  contract  of  sale — rather 
than  an  underwriting.  However,  an  arrangement  of  this  kind,  in 
which  only  one  banking  house  is  involved,  is  practically  unknown 
except  to  cover  issues  of  small  size.  A  foreign  government  loan 
of  as  much  as  $6,000,000  was  recently  "swallowed" — to  use  the 
bankers'  own  term — by  a' single  banking  house;  but  ordinarily 
only  issues  of  less  than  $2,000,000  to  $3,000,000  are  taken  up  by 
an  individual  house. 

Usually,  however,  the  original  agreement  is  made  between 
the  corporation  and  a  single  banking  house,  which  thereupon  in- 


840  CORPORATE  FINANCE  [Bk.  II- 

vites  other  banking  houses  to  join  with  it  in  floating  the  issue, 
each  taking  an  agreed  proportion  of  the  risk  and  profits.  These 
houses,  together,  form  the  underwriting  syndicate. 
"  ■  There  are  two  reasons  which  make  it  preferable  for  a  banking 
house  to  participate  in  a  number  of  underwriting  syndicates 
rather  than  to  undertake  fewer  underwritings  in  which  it  assumes 
for  itself  all  of  the  risk  and  all  of  the  profits.  The  first  and  obvi- 
ous reason  is  in  order  to  minimize  risk.  When  many  are  inter- 
ested, a  false  step  in  a  syndicate — and  even  the  ultimate  failure 
of  the  syndicate — would  not  prove  ruinous;  whereas  the  failure 
of  one  good-sized  issue  in  which  but  a  single  house  was  concerned 
might  not  only  tie  up  enough  capital  to  wreck  the  house  finan- 
cially but  might  also  wreck  its  reputation,  which  is  an  asset  of 
even  greater  importance.  The  second  motive  for  preferring  syn- 
dicate participation  is  that  it  enables  the  bond  and  brokerage 
houses  to  offer  to  their  customers  a  well-diversified  list  of  securi- 
ties. The  general  retail  security  dealer  should  be  prepared  to 
deliver  any  kind  of  security  customers  fancy,  just  as  the  de- 
partment store  is  ready  to  sell  anything  from  pins  to  motor  cars. 

§  275.    Community  of  Interest  among  Underwriting  Houses 

If  one  banking  house  closes  a  good  contract  for  an  issue  of 
securities  .with  an  excellent  chance  of  profits,  others  are  usually 
invited  to  come  in  as  members  of  the  underwriting  syndicate. 
In  this  way  all  of  the  more  prominent  banking  houses  of  the  par- 
ticular financial  center  participate  in  all  the  more  important 
underwritings.  There  is  of  course  no  formal  agreement  to  this 
effect,  but  it  is  tacitly  understood  that  when  one  house  permits 
its  neighbor  and  rival  to  join  in  a  profitable  underwriting,  the 
favor  is  to  be  returned  at  the  first  opportunity.  So  well-under- 
stood is  this  arrangement,  that  frequently — in  the  Wall  Street 
district  at  least,  and  probably  in  other  centers — the  firms  which 
become  members  of  an  underwriting  syndicate  are  scarcely  con- 
sulted. The  banking  house  which  has  made  the  agreement  with 
the  corporation  and  which  is  managing  the  syndicate,  simply  dis- 


Ch.  27]  UNDERWRITING  841 

tributes  the  issue  as  it  thinks  best  and  notifies  each  of  the  partici- 
pants making  up  the  syndicate.  Most  of  these  somewhat  per- 
emptory invitations  are  profitable,  and  it  is  safe  to  say  that  invi- 
tations of  this  kind  from  one  of  the  three  or  four  most  important 
banking  houses  are  but  seldom,  if  ever,  refused.  In  testifying 
during  the  course  of  the  Hughes  investigation,  J.  P.  Morgan,  the 
elder,  explained  that  several  highly  important  syndicates  involv- 
ing tens  of  millions  of  dollars  were  organized  by  his  firm  through 
the  simple  process  of  calling  up  the  selected  list  of  participating 
houses  on  the  telephone  and  notifying  them  how  much  each  was 
expected  to  take  over. 

An  important  result  of  this  "community  of  interest"  is  that 
it  eUminates  any  keen  competition  for  underwritings  among  the 
leading  banking  houses.  It  is  comparatively  of  minor  importance 
whether  one  house  or  another  carries  through  the  negotiations 
with  the  issuing  corporation  and  becomes  the  active  manager  of 
the  syndicate,  because  in  any  case  each  of  the  important  houses 
will  participate  in  the  syndicate  and  in  a  fair  share  of  the  profits. 

§  276.    Results  of  Community  Interests 

In  New  York  it  is  well  understood  that  negotiations  for  the 
flotation  of  any  large  issue  of  securities  should  be  taken  up  with 
only  one  of  the  important  banking  houses  at  a  time.  In  case 
negotiations  with  one  house  fail  definitely,  they  may  possibly  be 
taken  up  with  another  house.  But  the  important  banking  houses 
will  not  directly  compete  with  each  other;  nor  will  one  of  them 
even  interfere  with  suggestions  or  investigations  while  another 
has  the  matter  in  hand.  Much  the  same  kind  of  a  tacit  under- 
standing exists  in  most  financial  centers.  Many  business  men 
who  are  accustomed  to  dealing  under  highly  competitive  condi- 
tions resent  the  existence  of  this  invisible  and  indefinite  bond  of 
union  among  the  large  underwriting  houses.  If  they  are  bringing 
an  issue  into  the  market  to  be  sold,  naturally  they  would  like  to 
have  it  eagerly  bid  for.  They  are  looking  for  competition  and 
they  find  a  silent,  but  inflexible  understanding. 


843  CORPORATE  FINANCE  [Bk.  II- 

The  bankers,  on  the  other  side,  claim  first  of  all  that  un- 
checked competition  would  be  disastrous  not  only  to  them,  but 
also  to  the  whole  business  community  which  they  serve.  It 
would  mean  reckless  extension  of  credit,  overfinancing,  and  dis- 
regard of  conservative  principles.  They  also  claim  that  they 
make  no  oppressive  terms  or  restrictions,  and  that  there  is  no 
monopoly.  Finally,  they  assert  that  the  relations  between  the 
financial  managers  of  a  corporation  and  the  banking  house  which 
handles  their  securities  ought  to  be  of  an  intimate,  permanent, 
and  semi-professional  nature.  A  corporate  official  entrusted  with 
the  sale  of  his  corporation's  securities  ought  to  select  a  banking 
house  for  his  underwriting  in  which  he  has  implicit  confidence, 
just  as  he  picks  out  a  physician  or  a  lawyer  in  whom  he  has  confi- 
dence, and  once  selected  ought  to  stick  to  his  banker  until  that 
confidence  is  shaken  or  there  is  some  real  reason  for  a  change. 
Then  he  should  cut  off  all  relations  as  quickly  as  possible  and 
entrust  his  financial  affairs  to  some  other  banking  house.  In 
other  words,  the  banker  is  rendering  a  personal  and  partly  pro- 
fessional service  rather  than  merely  buying  and  reselling  a  certain 
commodity. 

§  277.    Syndicate  Agreements 

There  are  four  distinct  types  of  agreements  between  the 
underwriting  syndicate  and  the  corporation  which  puts  out  the 
underwritten  issue.  Possibly  other^  variations  from  these  basic 
tj^es  might  be  found. 

I .  The  corporation  may  itself  sell  the  issue  and  the  syndicate 
simply  insure  that  the  whole  issue  will  be  disposed  of  within  a 
given  time  at  a  minimum  price.  The  corporation,  we  will  say,  is 
bringing  out  an  issue  of  $1,000,000  6%  bonds,  which  it  offers  at 
par.  The  underwriting  syndicate  agrees  that  it  will  take  any 
bonds  left  unsold  at  the  end  of  the  year  at  a  special  price  of  90. 
The  syndicate  would,  perhaps,  receive  a  commission  of  2%  to 
5%  for  making  this  agreement.  If  the  issue  were  successfully 
sold,  the  syndicate  would  merely  collect  and  distribute  its  com- 


Ch.  27)  UNDERWRITING  843 

mission  and  dissolve.  If  the  issue  at  the  agreed  price  were  un- 
successful, the  syndicate  would  take  over  the  unsold  balance  and 
dispose  of  it  as  best  it  might.  This  type  of  agreement  is  now  un- 
common except  when  a  corporation  has  given  a  subscription 
privilege  to  its  own  shareholders  and  is  apprehensive  that  the 
offering  will  not  be  taken  up  in  full. 

2.  A  banking  house  may  conclude  an  arrangement  with  a  cor- 
poration to  handle  the  sale  of  a  block  of  its  securities  and  may 
afterward  call  in  other  banking  houses  to  take  over  certain  pro- 
portions of  the  risk  and  of  the  profits.  The  corporation,  however, 
has  no  dealings  with  the  syndicate  as  such,  but  only  with  the 
original  underwriter  which  becomes  the  manager  of  the  syndicate. 

3.  The  syndicate  may  be  formed  before  a  final  agreement 
with  the  corporation  is  signed,  and  the  agreement  be  directly 
between  the  corporation  and  the  syndicate,  though  the  manage- 
ment of  the  whole  transaction  and  the  actual  selling  of  the  securi- 
ties may  be  left  in  the  hands  of  the  one  banking  house  which  has 
taken  the  initiative.  This  banking  house  carries  through  the 
sale  of  securities  and  does  not  distribute  them  to  the  other  mem- 
bers of  the  syndicate  unless  the  sale  fails  in  whole  or  in  part. 

4.  The  agreement  is  made  between  the  syndicate  as  a  whole 
and  the  issuing  corporation,  and  the  securities  are  at  once  dis- 
tributed among  the  members  of  the  syndicate  in  proportion  to 
their  participations.  This  form  of  underwriting  is  almost  in  the 
nature  of  a  joint  purchase,  each  of  the  banking  houses  being  ex- 
pected to  act  independently  in  disposing  of  its  proportion  of  the 
issue.  This  is  perhaps  the  most  common  and  most  useful  type 
of  agreement  for  handling  large  issues. 

It  is  clear,  from  the  varying  descriptions  above  given,  that 
the  term  "underwriting"  is  used  in  a  loose  sense.  It  is,  in  fact, 
often  difficult  to  distinguish  in  practice  between  the  underwriting 
of  a  block  of  securities  and  its  purchase.  Even  when  a  single 
banking  house  takes  over  outright  a  complete  security  issue  and 
pays  the  corporation  an  agreed  price,  the  transaction  is  com- 
monly referred  to  as  an  underwriting. 


84l  CORPORATE  FINANCE  [Bk.  II- 

§  278.    The  Syndicate  Manager 

Whatever  the  type  of  syndicate  issue  may  be,  there  is  always 
this  common  characteristic :  that  the  active  management  is  un- 
reservedly in  the  hands  of  the  banking  house  which  organized  the 
syndicate.  In  the  published  agreement,  for  example,  of  the 
United  States  Steel  syndicate  it  is  provided  that:  '^ 

J.  P.  Morgan  and  Company  shall  be  sole  managers  of  the 
syndicate,  and  in  behalf  of  the  syndicate  they  may  make  any  and 
all  arrangements,  and  may  perform  any  and  all  acts,  even  though 
not  herein  provided  for,  in  their  opinion  necessary  or  expedient  to 
carry  out  the  provisions  of  this  agreement;  or  to  promote  or  to 
protect  what  they  deem  to  be  the  best  interests  of  the  syndicate. 
The  enumeration  of  specific  powers  in  this  or  any  other  article  of 
this  agreement,  shall  not  be  construed  as  in  any  way  abridging  the 
general  powers  of  this  article  intended  to  be  conferred  upon  or 
reserved  to  J.  P.  Morgan  and  Company.  * 

Throughout  this  agreement  other  reservations  of  the  same 
general  character  abound,  and  in  this  respect  the  contract  is 
t5^ical  of  most  underwriting  syndicate  agreements. 

In  return  for  its  special  efforts  the  managing  house  usually 
receives  a  commission  as  manager,  which  is  deducted  from  the 
syndicate  profits  before  distribution  of  the  remaining  profits. 
This  payment  to  the  managing  house  varies  a  great  deal,  depend- 
ing on  the  profitableness  of  the  transaction.  It  will  probably 
average  1%  to  2%  on  the  par  value  of  the  block  of  securities. 

§  279.    Underwriting  Commissions 

The  commissions  of  underwriting  syndicates  may  vary  all  the 
way  from  i j^%  to  10%,  or  even  more.  If  the  comrhissions  are 
high,  it  is  quite  the  custom  to  make  them  payable  partly  in  securi- 
ties. In  1910,  for  example,  the  newly  organized  International 
Cotton  Mills  Corporation  was  in  need  of  working  capital,  which 
it  secured  by  selling  to  Blair  and  Company  $2,000,000  6%  5-year 
notes  at  par,  in  consideration  of  a  commission  of  $1,000,000  par 
value  of  the  corporation's  common  stock.  These  notes  were 
offered  to  the  public  by  Blair  and  Company  at  98.    In  1898  the 


Ch.  27]  UNDERWRITING  845 

Union  Pacific  Railroad  Company  paid  a  syndicate  $5,000,000  of 
preferred  stock,  then  quoted  at  59,  for  underwriting  a  subscribed 
capital  of  $15,000,000.  This  amounted  to  a  commission  of  19%.^ 
These  examples  refer  to  companies  which  at  the  time  did  not 
have  a  high  credit  standing,  and  are  not  to  be  taken  as  typical. 
In  the  underwriting  of  $20,000,000  face  value  of  the  common 
stock  of  the  American  Woolen  Company,  in  1920,  the  price  to 
the  public  was  par;  to  the  underwriters,  95. 

§  280.     Speculative  Underwritings 

Most  of  the  preceding  remarks  in  this  chapter  refer  to  the 
underwriting  of  high-grade  bond  and  preferred  stock  issues  by 
financial  houses  of  the  highest  standing.  However,  this  is  by  no 
means  the  only  situation  in  which  underwriting  is  undertaken. 
In  addition  to  disposing  of  large  blocks  of  securities  for  estab- 
lished corporations,  syndicates  may  be  formed  for  the  purpose  of 
underwriting  the  issues  of  new  or  of  reorganized  corporations. 

In  any  of  these  cases  the  issue  that  is  being  brought  out  may 
be  of  a  speculative  character  and  the  syndicate  itself  may  be  far 
less  stable  and  more  speculative  than  has  been  assumed  in  what 
has  been  said  above.  Frequently  underwriting  syndicates  are 
made  up,  not  of  first-class  banks  or  banking  houses,  but  in  whole 
or  in  part  of  individuals  and  of  second-rate  houses. 

§  281.    United  States  Realty  and  Construction  Company 

A  striking  instance  of  such  underwriting  was  that  of  the 
United  States  Realty  and  Construction  Company:' 

In  1902,  prominent  financial  interests  in  New  York  promoted  a 
consolidation  of  real  estate  building  and  owning  companies,  known 
as  the  United  States  Realty  and  Construction  Company.  The 
promoters  having  been  impressed  with  the  speculative  enhance- 
ment of  New  York  realty  values  wished  to  obtain  a  large  fund  of 


« Railroad  Reorganizations,  by  Stuart  Daggett,  pp.  347,  348. 

'  The  description  of  this  underwriting  is  taken  by  permission  from  2  Dewing  on  Pinan. 
Policy  of  Corp.,  pp.  114,  iij. 


846  CORPORATE  FINANCE  [Bk.  II- 

ready  money  which  could  be  used  in  building  construction  and 
speculative  ventures.  Some  of  the  best  known  and  ablest  finan- 
ciers of  the  country  were  led  to  lend  their  financial  and  moral 
support  to  the  enterprise.  Mainly  through  the  efforts  of  James 
Stillman,  of  the  National  City  Bank,  a  syndicate  was  organized  to 
supply  $1 1,000,000  in  money  to  the  new  company.  The  syndicate 
received  $11,000,000  in  the  preferred  stock  and  $11,000,000  in  the 
common  stock  of  the  United  States  Realty  and  Construction  Com- 
pany in  return  for  the  money.  Of  the  $11,000,000  subscribed  by 
the  members  of  the  syndicate,  20  per  cent  was  immediately  paid  in 
money,  60  per  cent  was  paid  by  their  notes,  and  banks  arranged  to  . 
carry  the  remaining  20  per  cent  in  the  form  of  a  loan,  the  syndicate 
securities  being  used  as  collateral.  So  popular  and,  in  the  past,  so 
profitable  had  the  underwriting  of  new  industrial  promotions 
proved  to  be,  that  the  right  to  subscribe  to  the  syndicate  was  looked 
upon  as  a  privilege.  A  financial  journal  of  New  York  stated  that 
../^,  "nearly  every  important  financial  interest  in  this  city"  subscribed 
•  _  to  the  syndicate.  The  number  included  the  Equitable  and  New 
York  Life  Insurance  companies,  the  National  City,  and  other 
prominent  banks  and  trust  companies.  Messrs.  Hallgarten  and 
Company  acted  as  managers,  receiving  for  their  services  2  per  cent 
of  the  total  subscriptions,  or  $220,000. 

Just  a  year  after  its  formation  the  syndicate  was  liquidated.  ;' 
During  the  period  of  its  duration  the  managers  had  bought  and  sold 
both  the  preferred  and  common  stocks  of  the  United  States  Realty 
and  Construction  Company  and  had  collected  approximately 
$500,000  in  dividends.  As  a  result  of  these  operations  the  sub- 
scribers to  the  syndicate  received  for  each  $1,000  of  original  sub- 
scription, $1,155  P^^  value  in  preferred  stock,  $702  par  value  in 
.  ^ :  common  stock,  and  $16.66  in  money.  These  securities  had,  on  the 
day  the  syndicate  was  liquidated,  a  value,  including  the  money,  of 
$523.09  for  each  $1,000  original  subscription,  or  approximately 
one-half  what  had  been  subscribed  the  year  before.  If  the  interest 
on  the  subscription  should  be  deducted,  the  returns  to  the  members 
of  the  syndicate  were  actually  less  than  one-half  the  original  sub- 
scription. 

§  282.    Underwriting  of  United  States  Shipbuilding  Company 

An  even  more  disastrous  underwriting  failure  was  that  of  the 
United  States  Shipbuilding  Company.    The  promoters  were  re- 


Ch.  27]  UNDERWRITING  847 

quired  to  sell  enough  first  mortgage  bonds  to  produce  $7,500,000 
in  cash.  To  meet  this  requirement  $4,250,000  of  the  bonds  were 
underwritten  in  France  at  90,  and  $4,750,000  were  underwritten 
in  this  country.  The  public  offering  of  the  bonds  was,  however, 
a  failure,  inasmuch  as  only  $500,000  out  of  the  total  offering  of 
$9,000,000  was  subscribed  for.  The  promoters  of  the  consolida- 
tion therefore  fell  back  upon  the  French  and  American  under- 
wri tings  of  the  bonds. 

The  American  underwriters  stood  back  of  their  subscriptions 
and  accepted  about  $4,500,000  of  the  bonds  at  90.  Most  of  the 
French  underwriters,  however,  who  were  not  bankers  but  indi- 
viduals untrained  in  business  affairs,  declined  to  meet  their 
alleged  obligations.  They  asserted  that  those  in  charge  of  the 
matter  in  this  country  had  assured  them  that  their  underwritings 
would  never  be  called  and  had  later  cabled  them  that  the  public 
offering  of  the  bonds  was  a  success.  The  promoter  of  the  con- 
solidation went  to  Paris  in  a  strenuous  but  unavailing  attempt 
to  secure  payment  from  the  French  underwriters.  Meanwhile 
large  loans  had  been  made  in  this  country  on  the  strength  of  the 
French  underwriting,  and  when  this  underwriting  failed  to  mate- 
rialize the  results  were  calamitous,  involving  the  failure  of  a 
prominent  trust  company  identified  with  the  underwriting,  and 
the  suicide  of  one  of  the  more  prominent  participants. 

§  283.    Underwriting  of  the  American  Woolen  Company 

A  more  recent  underwriting  failure  was  that  of  the  American 
Woolen  Company  in  1920.  The  company  decided  to  issue  an 
additional  $20,000,000  face  value  of  common  stock.  This  was 
first  offered  to  the  stockholders  of  the  company  at  par,  on  the 
basis  of  one  share  of  the  new  stock  for  every  three  shares  of  stock 
owned  by  the  shareholder.  Any  stock  not  taken  by  the  share- 
holders was  later  to  be  sold  to  the  public  at  not  less  than  par. 
The  stock  was  underwritten  by  a  group  of  New  York  bankers 
at  95.  But  a  small  percentage  of  the  stock  was  purchased  by 
the  company's  stockholders  and  the  outside  public,  and,  accord- 


848  CORPORATE  FINANCE  [Bk.  II- 

ing  to  the  newspaper  reports  of  the  day,  the  underwriters  were 
themselves  forced  to  purchase  over  f  18,000,000  face  value  of  the 
new  stock  at  the  underwriting  price  of  $95  a  share,  and  this  at  a 
time  when  the  stock  was  quoted  in  the  open  market  at  $62.50 
per  share. 


Part  V — Internal  Financial  Management 


CHAPTER  XXVIII 
BORROWED   CAPITAL 

§  284.    Advantages  of  Borrowing 

"The  habit  of  borrowing,"  says  Hartley  Withers,  "is  a  mod- 
em invention."  There  was  formerly  a  custom  among  all  well- 
ordered  governments  and  business  enterprises,  of  amassing  treas- 
ure for  use  in  emergencies;  without  hoarded  treasure  even  the 
largest  owner  of  property  would  have  been  helpless.  Today  the 
wisest  financial  policy  is  to  pile  up  not  treasure,  but  credit.  To 
be  sure,  sound  credit  may  require  the  possession  of  a  certain  pro- 
portion of  gold  and  securities ;  but  this  treasure  no  longer  exists 
for  its  own  sake  so  much  as  for  a  support  and  guaranty  to  credit. 

More  and  more  as  credit  facilities  increase  and  credit  machin- 
ery works  more  smoothly,  business  enterprises  are  financed  with 
borrowed  capital.  The  great  advantages  of  borrowing  are  its 
cheapness  and  its  ease.  It  is  cheaper  to  borrow  than  to  secure 
a  co-owner  or  a  group  of  co-owners  for  a  business,  because  of  the 
greater  security  that  is  offered  to  the  lender.  To  put  the  same 
thought  in  terms  of  corporate  financing,  first-class  bonds  may  be 
sold  on  a  5%  or  6%  basis,  whereas  preferred  shares  of  the  same 
relative  standing  sell  on  a  7%  or  8%  basis,  and  common  shares 
on  a  still  higher  basis.  Hence  the  larger  the  proportion  of  capi- 
tal which  the  individual  or  corporation  can  borrow,  the  larger  is 
the  yield  on  the  owned  capital. 

Take  a  very  simple  illustration.  Suppose  a  corporation  with 
$100,000  capital  is  regularly  earning  10%,  or  $10,000,  a  year;  let 

840 


8so  CORPORATE  FINANCE  [Bk.  II- 

us  say  that  $20,000  of  the  capital  Is  borrowed  at  6%,  making  the 
interest  payment  $1,200.  Then  the  $80,000  of  owned  capital 
will  have  left  an  income  of  $8,800,  or  1 1%.  Let  us  now  make  the 
assumption  that  the  business  is  of  such  a  character  that  $80,000 
can  be  borrowed  at  6%,  making  the  annual  interest  payment 
$4,800.  In  that  case  the  $20,000  of  owned  capital  will  have  left 
an  income  of  $5,200,  or  over  25%. 

We  have  here  an  explanation  of  the  profit-making  possibili- 
ties— when  properly  financed — of  enterprises  which  yield  only  a 
small  average  return  on  the  invested  capital.  Most  public  utility 
companies,  for  instance,  secure  only  a  moderate  yield  on  their 
actual  investment,  but  they  hold  properties  which  can  be  mort- 
gaged up  to  a  high  percentage  of  their  value.  Hence,  at  least 
one-half  the  capital  is  borrowed  and  the  owned  capital  may  ob- 
tain very  good  dividends. 

An  illustration  of  this  practice  and  its  results — in  this  particu- 
lar case  at  least — is  afforded  by  the  Kentucky  Utilities  Company, 
subsidiary  of  the  Middle  W^est  Utilities  Company,  which  had  out- 
standing January  i,  192 1:  ! 

Common  Stock I i'.<! .  .■  ':?}!i'l  i^?^: . . .  $1,000,000 

Preferred  Stock.  .  .  JIKH^U^ .li.liA xJl  A'jUSTl OH     7S5,ooo 
Funded  Debt -*...;.....  ."■.  ji^ 5,216,100 

This  funded  debt  bears  6%  interest.  The  net  earnings  of  the 
company  for  1920  before  pajnnent  of  any  interest  were  $591,588- 
This  was  disposed  of  as  follows : 

Total  Net  Earnings $591,588 

Interest  on  Bonds  and  Other  Indebtedness 361,537  'J 

Balance , $230,051 

.?J?MO     y     i:        ■ 

Preferred  Dividends,  at  6% n'trO'Hye'W'^  44,775 

Common  Dividends .-^  ...»...,      150,000 

'i<l:  'iff J  o'jn^H    .^l^ila  i 

$194,775 

Balance  to  Surplus $  65,764  > 

In  other  words,  the  dividend  rate  on  the  common  stock  was  two 
and  one-half  times  the  interest  rate  on  the  funded  indebtedness. 


Ch.  28]  BORROWED  CAPITAL  851 

§  285.    Ease  of  Borrowing 

As  to  the  ease  of  borrowing  on  a  good  bond  or  short-term 
note,  it  is  perhaps  sufficient  to  call  attention  to  the  immense 
quantities  of  bonds  and  notes  which  are  continually  being  issued 
and  sold.  Modern  efficiency  and  productivity  are  piling  up 
wealth  at  a  faster  rate  than  ever  before.  And  the  security  of 
property — except  as  it  may  be  disturbed  by  tremendous  inter- 
national confficts— is  increasing.  Now,  the  first  thought  of  a 
man  who  has  only  a  little  money  is  to  increase  that  little,  and  he 
is  willing  to  take  chances  in  so  doing.  Security  does  not  appeal 
to  him  so  strongly  as  the  prospect  of  profits.  For  that  reason,  it 
is  among  poor  people,  and  especially  poor  people  of  the  profes- 
sional classes,  that  the  swindling  promoter  finds  his  easiest  vic- 
tims. But  a  man  who  has  a  comfortable  amount  of  property 
wants  security  first  of  all — he  is  looking  for  safety  rather  than 
for  large  returns.  Hence,  as  the  average  wealth  of  a  country 
increases,  not  only  is  more  and  more  capital  released  for  invest- 
ment, but  a  larger  proportion  of  that  capital  is  looking  first  of  all 
for  safe  investment.  In  other  words,  its  owner  prefers  to  lend  it 
rather  than  to  take  greater  chances  as  a  proprietor  or  part 
proprietor. 

Another  factor  working  in  the  same  direction,  is  the  piling  up 
of  enormous  funds  held  in  trust;  estates  that  are  being  directed 
by  trustees;  the  funds  of  life  insurance  companies;  the  funds  of 
savings  banks  and  the  like.  All  these  trust  funds'  are  available 
only  for  lending  on  excellent  security.  For  these  reasons  a  man 
or  a  corporation  which  can  put  enough  owned  capital  into  a  sub- 
stantial enterprise  to  furnish  a  reasonable  margin  of  safety,  will 
generally  find  it  a  comparatively  easy  task  to  borrow  the  remain- 
der of  the  needed  capital. 

What  has  been  said  applies  more  especially  to  long-term  or 
"funded"  borrowing,  but  much  the  same  statements  hold  true  of 
short-term  borrowing.  It  is  a  fact  that  more  capital  is  needed 
today  than  used  to  be  needed,  but  notwithstanding  this,  an  indi- 
vidu,aj  does  not  ijeed  more  money  to  go  into  business. 


8S2  CORPORATE  FINANCE  [Bk.  II- 

The  explanation  for  this  apparent  paradox  is  to  be  found  in 
the  free  use  of  credit  which  is  a  striking  characteristic  of  all 
present-day  business  enterprises.  Manufacturers,  wholesalers, 
and  bankers  are  always  ready  to  extend  credit  freely  to  men  of 
ability  and  character.  The  silk  industry  because  of  its  use  of 
credit  is  notable  for  the  amount  of  business  that  can  be  done  on 
a  very  slim  margin  of  capital.  Raw  silk  is  sold  to  manufacturers 
on  a  credit  basis  that  resembles  "memorandum  credit"  among 
jewelers.  Many  of  their  factories  are  not  owned  but  rented  en- 
tire. It  is  said  that  the  extensive  cotton  industry  of  Philadelphia 
is  in  large  measure  carried  on  in  the  same  way.  Lofts  with  power 
and  machinery  are  rented;  materials  are  obtained  on  a  credit 
basis.  Much  the  same  conditions  obtain  in  the  shoe  business. 
The  United  Shoe  Machinery  Corporation  has  for  many  years 
made  a  practice  of  furnishing  its  machines  only  on  lease ;  it  does 
not  sell  them.  In  this  industry,  therefore,  a  man  with  large  capi- 
tal has  no  great  advantage,  so  far  as  obtaining  efficient  machinery 
is  concerned,  over  a  man  with  small  capital. 

§  286.    Risk  of  Borrowed  Capital 

Against  the  two  great  advantages  of  borrowed  capital — 
cheapness  and  ease  in  procuring  the  funds — there  must  be  offset 
the  obvious  disadvantage,  that  the  risk  to  the  owners  of  the  share 
capital  is  thereby  increased.  The  shareholders  have,  of  course, 
only  an  equity  in  the  property  and  income  of  the  corporation 
which  is  first  subject  to  all  prior  claims  of  the  holders  of  the  obli- 
gations. This  may  not  involve  a  serious  risk  in  the  case  of  cor- 
porations that  have  stable  earnings,  but  when  earnings  fluctuate 
widely  from  year  to  year,  even  though  the  average  return  on  the 
invested  capital  may  be  high,  the  position  of  the  shareholders 
with  a  large  indebtedness  ahead  of  them  may  become  very  un- 
comfortable. It  is  for  this  reason  that  the  tendency  has  been 
strong  in  recent  years  for  industrial  corporations  to  shun  even 
small  bond  issues  and  to  raise  their  capital  only  through  common 


Ch.  28]  BORROWED  CAPITAL  853 

and  preferred  shares.  Sometimes  this  cautious  policy  may  be 
carried  to  what  appears  to  be  an  extreme. 

Some  of  the  large  and  powerful  industrial  corporations  of  the 
country  have  no  securities  outstanding  except  stock.  This  is 
true,  for  instance,  of  the  Singer  Manufacturing  Company  with 
$90,000,000  of  common  stock,  and  neither  preferred  stock  nor 
funded  indebtedness  beyond  this.  Likewise,  the  Mergenthaler 
Linotype  Company  has  no  funded  obligations,  and  no  outstand- 
ing stock  save  common  stock.  The  same  may  be  said  of  the  Ford 
Motor  Company,  and  it  was  also  true  of  the  Pullman  Car  Com- 
pany up  to  the  time  of  its  consolidation  with  the  Haskell  and 
Barker  Car  Company,  Inc.  Among  the  corporations  having 
common  and  preferred  stock  outstanding  but  no  funded  indebt- 
edness, may  be  mentioned  the  United  Shoe  Machinery  Corpora- 
tion, National  Cash  Register  Company,  and  the  Standard 
Steel  Car  Company. 

The  unsoundness  of  too  heavy  borrowing  cannot  be  better 
shown  than  by  the  combined  figures  on  the  capitalization  of  thir- 
teen large  railway  systems  in  the  United  States  which  were  in 
receivers'  hands  in  the  summer  of  19 14.  The  funded  debt  of 
these  thirteen  railways  was  about  70%,  and  the  stock  issues  only 
about  30%  of  their  total  capitalization. 

§  287.    Rules  for  Borrowing 

To  lay  down  any  exact  rules  as  to  the  proper  proportion  of 
borrowed  capital,  would  clearly  be  out  of  the  question.  In  ordin- 
ary short-term  bank  borrowing  the  generally  accepted  ratio  of 
quick  or  current  assets  to  quick  liabilities  is  two  to  one.  In  long- 
term  borrowing  the  conditions  must  govern  in  each  case.  It  may 
be  said  generally,  however,  that  capital  should  not  be  borrowed 
unless  there  is  a  practical  certainty  that  both  interest  payments 
and  payments  on  principal  can  be  met  as  they  fall  due.  This  in- 
volves the  further  rule  that  the  annual  fixed  payments  of  a  cor- 
poration should  be  limited  to  a  reasonable  proportion,  not  of  the 
average  earnings,  but  of  the  lowest  probable  earnings.    The  fact 


8S4  CORPORATE  FINANCE  [Bk.  II- 

that  a  corporation  has  made  a  distribution  or  invested  big  profits 
in  one  year,  is  small  comfort  if  it  finds  itself  in  the  following  year 
unable  to  meet  its  obligations. 

As  to  payments  on  account  of  principal,  it  has  long  been  re- 
garded as  almost  axiomatic  that  companies  doing  a  stable  busi- 
ness, such  as  railways  and  public  utilities,  need  make  no  provision 
for  paying  off  and  permanently  retiring  their  funded  debts. 
These  companies,  it  has  sometimes  been  said,  will  never  cease  to 
borrow;  therefore,  when  one  obligation  matures,  the  proper  plan 
is  to  refund  it  by  issuing  another  obligation  in  its  place. i 

§  288.    Forms  of  Borrowing 

All  borrowing  is  of  two  general  classes,  "short-term"  and 
"long-term."  This  is  by  no  means  purely  a  verbal  difference,  for 
there  are  clear  market  distinctions  between  the  principles  that 
apply  in  these  two  classes.  Just  where  we  should  draw  the  line 
between  the  two  is  a  difficult  question  to  answer;  it  is  largely  a 
matter  of  usage.  In  Wall  Street,  "short-term"  usually  refers  to 
obligations  having  not  more  than  five  years  to  run;  "long-term" 
usually  refers  to  obligations  having,  say,  twenty  years  or  more 
to  run  from  date  of  issue.  Obhgations  running  in  intermediate 
periods  might  be  put  in  either  one  or  the  other  of  the  two  groups, 
according  to  conditions. 

Short-term  securities  consist  of  notes,  of  acceptances,  and  of 
accounts  payable.  The  notes  are  divided  into  three  well-marked 
classes:  (i)  merchandise  notes,  (2)  notes  discounted  at  banks, 
and  (3)  notes  sold  to  the  public.  For  our  present  purpose,  we 
will  group  accounts  payable,  acceptances,  and  merchandise  notes 
under  the  head  of  "trade  credit."  After  considering  this  subject, 
we  will  take  up  bank  credit.  This  is  a  convenient  division  of 
short-term  borrowing  which  conforms  to  commercial  practice. 
Short-term  notes  sold  to  the  public  have  already  been  consid- 
ered.2 


•  For  further  discussion  of  this  subject,  see  §  82,  "Maturity  of  Bonds." 
»  Ch.  X.  "Short-Term  Notes." 


Ch.  28]  .  BORROWED  CAPITAL  855 

§  289.    Trade  Credit 

The  fact  that  all  the  trade  credit  which  a  business  normally 
utilizes  is  in  fact  a  method  of  borrowing  capital,  seems  to  be  over- 
looked; yet  it  is  the  chief  source  of  capital  in  many  concerns 
which  do  a  trading  business.  There  are  literally  tens  of  thousands 
of  small  merchants  throughout  the  country  who  customarily  buy 
nearly  all  their  stock  in  trade  on  credit,  and  whose  own  capital 
is  no  more  than  sufficient  to  cover  the  purchase  of  store  fixtures 
and  perhaps  some  small  advances  on  their  first  orders  as  a  guar- 
anty of  their  good  faith.  It  is  out  of  the  question  for  them  to 
pay  their  accounts  with  the  wholesalers  from  whom  they  buy, 
until  after  they  have  sold  the  goods  and  thus  have  secured  cash 
funds  from  their  customers.  Very  often  the  wholesaler  in  his 
turn  is  "carried"  to  a  great  extent  by  the  manufacturers  and 
jobbers  from  whom  he  buys;  his  proportion  of  owned  capital, 
however,  is  likely  to  be  much  higher  than  the  retailer's  propor- 
tion. Going  one  step  further  back  we  reach  the  manufacturer 
with  whom  trade  credit  is  comparatively  a  minor  source  of  funds. 
Thus  we  have  the  whole  process  of  selling  goods  through  the 
ordinary  trade  channels  financed  to  a  considerable  extent  by  the 
extension  of  credit.  The  ultimate  customer  is  the  only  man  in 
the  chain  who  pays  cash — and  even  the  customer  may  in  his 
turn  be  living  on  trade  credit.  As  the  customer  pays  for  his  pur- 
chases, the  retailer  is  able  to  collect  current  funds  which  he  trans- 
mits to  the  wholesaler,  who  in  turn  pays  the  jobber  and  manu- 
facturer. 

§  290.    Extent  of  Trade  Credit 

The  extent  to  which  trade  credit  is  granted,  depends  chiefly 
upon  the  nature  of  the  goods  that  are  being  retailed,  and  on  the 
ability  of  the  ultimate  consumer  to  pay  promptly.  Prior  to  the 
Civil  War,  purchases  of  merchandise  were  customarily  settled  by 
notes  running  six,  eight,  or  ten  months  and  sometimes  longer. 
This  was  due  to  the  fact  that  buyers  came  to  market  only  once 
or  twice  a  year,  and  then  purchased  their  entire  stock  for  the 


8s6  CORPORATE  FINANCE  .  [Bk.  II- 

season,  the  buyers  giving  their  notes  which  were  readily  indorsed 
and  discounted.  These  were  usually  met  out  of  the  proceeds  of 
the  sale  of  the  goods  to  the  ultimate  consumer.  The  Civil  War 
upset  this  system.  During  the  war  and  for  some  years  after, 
merchandise  business  came  down  to  a  basis  of  cash  or  of  credit  of 
only  lo  to  30  days.  When  the  next  great  expansion  of  trade  took 
place  in  the  early  eighties,  the  increased  confidence  of  sellers  re- 
sulted in  offering  somewhat  longer  terms  of  credit,  but  these 
terms  were  combined  with  offers  of  liberal  discount  for  cash  pay- 
ments, which  is  the  custom  in  most  lines  today.  The  discounts 
were  so  attractive  that  retail  merchants  in  good  standing  began 
to  borrow  from  their  local  banks  in  order  to  take  advantage  of 
them.  Thus  the  present  practice  of  taking  discount  for  cash  was 
established;  and  prices  were  made  with  that  understanding. 
The  high  rates  of  discount  were  in  the  nature  of  a  penalty  im- 
posed on  a  merchant  who  took  the  long  terms  which  were  nomi- 
nally at  his  disposal. 

At  the  time  of  the  Great  War  a  determined  effort  was  made 
by  manufacturers  and  jobbers  to  cut  down  the  time  of  credit  and 
eliminate  or  reduce  the  trade  discount.  Where  time  was  desired 
the  use  of  the  trade  acceptance  was  urged.  These  efforts  were 
fairly  successful  as  long  as  the  "sellers'  market"  created  by  the 
Great  War  continued.  Since  then,  time  and  trade  discounts  have 
both  returned  to  practically  their  former  position  of  importance. 

Because  of  the  prevalence  of  the  cash  discount,  trade  credit 
in  this  country  is  relatively  less  important,  and  bank  credit  is 
more  important,  than  was  formerly  the  case.  Another  factor 
which  should  be  mentioned  as  contributing  powerfully  to  this 
result  is  the  decentralized  banking  system  of  the  United  States, 
which  puts  one  or  more  local  banks  at  the  door  of  every  merchant 
and  makes  it  easy  for  him  to  secure  and  utilize  bank  credit. 

§  291.    The  Trade  Acceptance 

The  European  system  of  financing  merchandise  purchases 
rests  upon  the  use  and  discounting  of  accepted  drafts  which  are 


Ch.  28]  BORROWED  CAPITAL  857 

in  effect  two-name  promissory  notes.  The  wholesaler  draws  a 
time  draft  upon  the  retailer  which  accompanies  the  shipment  of 
goods.  The  retailer  writes  or  stamps  his  acceptance  on  the  draft 
across  its  face  and  returns  it  to  the  wholesaler  who  is  then  in 
position  to  discount  it  with  his  bank.  This  is  a  method  of  financ- 
ing merchandise  transactions  which,  from  the  banker's  stand- 
point, has  a  number  of  advantages,  the  chief  of  which  is  that 
every  accepted  draft  represents  an  actual  transfer  of  goods,  and 
the  banker  is  not  compelled  to  lend,  therefore,  merely  on  the 
strength  of  the  general  credit  standing  of  his  customer.  Before 
and  during  the  Great  War  a  strong  effort  was  made,  under  the 
guidance  of  the  Federal  Reserve  Board,  to  introduce  this  system 
in  the  United  States  and  to  extend  it  to  the  consumer  as  well  as 
to  the  retailer  of  goods.  Although  the  movement  is  of  genuine 
importance,  we  need  not  for  our  purposes  consider  it  further.  It 
is  closely  similar  to  the  custom  which  prevails  in  certain  lines  of 
business  of  giving  notes  in  payment  for  purchases  of  merchandise. 
Some  of  the  principal  lines  in  which  note-giving  is  still  com- 
mon are  harvesting  machines,  plumbers'  supplies,  book  printing 
and  binding,  and  electric  trolley  supplies.  In  most  other  lines, 
however,  goods  are  sold  on  open  account  and  notes  are  asked  for 
only  when  the  sale  is  made  to  a  weak  concern. 

§  292.    Dangers  of  Trade  Credit 

Sellers  are  often  so  anxious  to  dispose  of  their  products,  and 
it  is  consequently  so  easy  for  established  firms  with  a  clean  record 
behind  them  to  secure  whatever  goods  they  require  on  terms  of 
30  to  90  days  or  even  longer,  that  trade  credit  may  almost  in- 
sensibly become  a  real  source  of  danger.  It  is  a  delicate  instru- 
ment which  requires  to  be  handled  with  watchfulness.  A  little 
carelessness  in  failing  to  meet  trade  accounts  on  the  day  they 
fall  due  may  be  sufficient  to  give  a  concern  the  reputation  of 
being  "slow  pay,"  and  thus  may  damage  not  only  its  credit  with 
the  firms  from  which  it  buys,  but  also  its  credit  with  banks  and 
its  general  business  standing  as  well. 


858  CORPORATE  FINANCE  [Bk.  II- 

§  293.    Danger  of  Too  Prompt  Payment  of  Trade  Accounts 

Curiously  enough,  there  is  also  danger  in  overzealousness  in 
paying  up  trade  accounts.  Not  only  is  there  an  actual  loss  of 
capital  to  the  extent  of  the  difference  between  a  normal  amount 
of  trade  credit  and  the  amount  which  the  company  secures,  but 
there  is  also  to  be  considered  the  fact  that  the  reputation  of  pay- 
ing accounts  ahead  of  time,  once  established,  involves  a  con- 
tinuance of  the  practice.  The  writer  has  in  mind  one  concern 
which  started  in  business  with  ample  funds.  The  treasurer  saw 
no  reason  why  he  should  utilize  the  credit  of  the  firm  and  paid 
all  bills  in  cash  as  they  were  presented,  even  though  he  obtained 
no  discount.  A  year  or  two  later  the  expansion  of  the  company's 
business  reduced  the  available  cash,  and  the  treasurer  began  to 
take  the  full  term  of  payment  to  which  he  was  entitled.  Im- 
mediately some  of  his  creditors  became  suspicious  as  to  the  sol- 
vency of  the  company,  and  such  serious  rumors  were  spread 
about  that  it  was  necessary  to  bring  more  cash  into  the  concern 
and  resume,  for  the  time  being  at  least,  the  prompt  payment  of 
bills.  Thereafter  the  company  proceeded  by  slow  degrees  to 
utilize  the  full  line  of  trade  credit  to  which  it  was  entitled.  There 
is  much  truth  in  the  remark  that  the  only  way  to  acquire  credit 
is  to  make  use  of  it, 

§  294.    Bank  Credit 

It  has  already  been  noted  that  it  is  customary  in  this  country 
for  merchandising  firms  to  take  advantage  of  cash  discounts  in 
paying  for  their  purchases  and  to  secure  the  funds  with  which  to 
make  immediate  payments  by  borrowing  from  their  own  banks. 
This  practice  spread  throughout  the  country  beginning  in  the 
eighties,  but  it  originated  in  New  York  some  years  before. 
Shortly  after  the  crisis  of  1873,  the  president  of  the  Importers  and 
Traders  National  Bank,  a  Mr.  Buell,  rapidly  built  up  the  busi- 
ness of  his  institution  by  showing  his  customers  how,  by  borrow- 
ing from  his  bank  on  their  own  single-name  paper,  they  could 
obtain  cash  prices  or  cash  discounts  and  thus  show  a  substantial 


Ch.  28]  BORROWED  CAPITAL  859 

profit  on  their  interest  and  discount  accounts  for  the  year.  The 
custom  is  now  so  firmly  established  that  practically  every  busi- 
ness concern  in  good  standing  counts  on  establishing  a  line  of 
credit  with  its  bank  which  will  enable  it  to  borrow  simply  by 
drawing  its  own  notes  and  depositing  them  with  the  bank. 

§  295.    The  Work  of  the  Note-Broker 

A  variation  of  this  custom  is  found  among  large  manufactur- 
ing and  commercial  corporations  which  on  occasion  turn  over 
their  notes  to  brokers  who  for  a  small  commission  sell  them  to 
any  bank  that  may  happen  to  have  idle  funds  available.  These 
note-brokers  sell  the  paper  of  large  concerns  throughout  the 
country.  At  the  time  of  the  failure  of  the  Booth  Fisheries  Com- 
pany a  number  of  years  ago,  and  later  at  the  time  of  the  failure 
of  the  H.  B.  Claflin  Company  and  associated  concerns,  the  notes 
of  these  companies  turned  up  among  banks  in  almost  every  part 
of  the  United  States.  At  that  time  the  banker  who  bought  a 
single-name  note  from  a  broker,  very  often  had  no  knowledge 
whatever  of  the  financial  affairs  of  the  company  which  issued  the 
note.  He  might  have  heard  the  name  of  the  company  frequently 
and  he  probably  considered  the  note-broker  a  good  fellow  in 
whose  honesty  and  judgment  he  had  confidence,  and  that  was 
the  extent  of  the  actual  information  before  him  when  he  made  his 
purchase.  This  loose  method  of  doing  business  has  to  a  consid- 
erable extent  worked  its  own  cure,  more  conservative  methods 
now  prevailing. 

A  few  large  concerns  which  sell  their  short-term  notes  in  the 
open  market  on  a  large  scale  have  instituted  the  custom  of  hav- 
ing all  their  notes  registered  by  a  trust  company,  just  as  bonds 
are  registered.  This  has  at  least  the  advantage  of  making  it 
easy  to  ascertain  how  many  notes  a  company  has  outstanding  at 
any  one  time,  thus  avoiding  large  overissues.  The  co-operative 
efforts  of  the  member  banks  of  the  Federal  Reserve  system  have 
also  resulted  in  better  credit  methods,  and  the  prevention  of  the 
grosser  abuses. 


86o  CORPORATE  FINANCE  [Bk.  II- 

An  accepted  rule  of  safe  finance  which  should  be  observed  by 

corporations  that  sell  their  notes  through  brokers,  is  that  they 

should  not  at  one  and  the  same  time  be  discounting  any  large 

quantity  of  notes  with  both  banks  and  brokers.    If  they  are  using 

both,  they  have  no  quick  method  of  raising  funds.    If  they  are 

using  either  their  banks  alone  or  note-brokers  alone,  then  they 

can  turn,  if  it  should  become  necessary,  to  the  method  that  has 

not  previously  been  utilized. 

ii 
§  296.    Reasons  for  Bank  Borrowing 

There  are  three  legitimate  reasons  for  making  bank  loans: 

1.  To  finance  a  temporary  shortage  of  funds. 

2.  To  increase  by  purchase  the  stock  of  salable  goods  on 

hand. 

3.  To  enable  the  dealer  to  extend  additional  credit  to  cus- 

tomers. 

The  first  reason  may  be  entirely  acceptable  to  the  banks,  but 
only  under  unusual  circumstances.  A  firm,  for  instance,  may 
have  suffered  a  loss  by  fire  and  have  insurance  payments  shortly 
due,  in  anticipation  of  which  it  may  properly  borrow  from  its 
bank;  or  it  may  have  funds  shortly  coming  in  from  its  stock- 
holders or  from  other  sources.  Each  case  of  this  kind  must  be 
decided  on  its  own  merits. 

The  second  reason  for  bank  borrowing  is  the  one  that  is  cus- 
tomary and  that  is  generally  considered  soundest.  It  is,  of  course, 
necessary  for  both  the  borrower  and  the  bank  to  be  reasonably 
certain  that  the  goods  being  purchased  are  salable,  so  that  there 
may  be  no  question  as  to  meeting  the  indebtedness  out  of  the 
proceeds  of  the  sale. 

The  third  reason  is  also  concerned  with  the  sale  of  goods,  but 
this  time  from  the  standpoint  of  the  seller.  It  is  necessary  here 
for  both  the  borrower  and  the  bank  to  make  sure  that  the  credit 
which  is  being  extended  to  its  customers,  is  both  well  placed 
and  sound. 


Ch.  28]  BORROWED  CAPITAL  861 

§  297.    Abuse  of  Bank  Credit 

The  abuse  of  bank  credit  has  long  been  a  weak  feature  of 
modern  business  life,  and  will  not  quickly  be  eliminated.  It  may 
arise  in  two  ways : 

1.  By  making  a  wrong  application  of  the  funds  secured  from 

the  bank. 

2.  By  obtaining  funds  on  the  strength  of  false  or  question- 

able claims. 

If  the  borrower,  instead  of  using  the  funds  he  receives  from 
the  bank  for  one  of  the  three  purposes  above  mentioned,  utilizes 
it  in  extending  his  plant,  in  the  purchase  of  non-salable  goods,  in 
general  advertising,  or  puts  it  into  any  other  property  or  expendi- 
ture that  is  not  readily  convertible  into  cash,  he  may  properly  be 
said  to  be  abusing  the  trust  of  his  banker.  More  than  that,  he  is 
seriously  jeopardizing  his  own  financial  safety.  "What  difference 
does  it  make  to  the  banker  whether  I  use  his  money  in  one  way 
or  another?"  is  the  answer  of  some  business  men;  "Sooner  or 
later  he  will  get  his  money  back  with  interest,  and  that's  all  he 
needs  to  fret  about."  Yes,  but  the  banker  is  not  in  the  business 
of  making  long-term  loans  or  loans  that  may  be  sound  enough 
but  cannot  be  paid  back  on  the  dot.  The  only  safe  banking  is 
short-term  banking,  and  he  is  absolutely  right  when  he  insists 
that  his  loans  be  used  only  in  quick  turns  and  not  for  permanent 
or  uncertain  investments. 

But  little  need  be  said  about  the  second  abuse  of  bank  credit. 
The  insistence  of  banks  on  full  financial  statements  from  would- 
be  borrowers  and  the  enactment  of  laws  making  any  material 
misrepresentation  in  these  statements  a  criminal  offense,  have 
ended  the  grosser  abuses  in  this  direction. 

§  298.    Bank  Collateral 

We  have  spoken  in  the  preceding  section  of  bank  credit  as  if 
it  were  always  obtained  on  the  strength  of  a  company's  standing. 
This  is,  in  fact,  the  case  when  a  concern  borrows  simply  by  giving 
its  unsecured  note,  and  even  when  it  indorses  and  discounts  a 


863  CORPORATE  FINANCE  [Bk.  II- 

note  which  it  has  received  from  some  customer  who  is  practically 
unknown  to  the  bank.  Bank  credit  is  even  more  extensivel}^ 
obtained,  however,  when  it  is  directly  backed  by  collateral 
security  of  some  kind.  Such  loans  are  more  easily  granted,  not 
only  because  the  banker  calculates  that  he  is  secured  against  loss, 
but  also  because  he  has  a  better  check  on  the  uses  to  which  his 
money  is  to  be  put. 

Collateral  may  be  conveniently  classified  under  three  heads : 

1.  Stocks  and  Bonds 

2.  Merchandise 

3.  Accounts  Receivable 

§  299.     (i)  Stocks  and  Bonds  as  Collateral 

As  security  for  loans,  stock  and  bonds  are  the  banker's  favor- 
ite, at  least  in  the  United  States.  This  is  due  to  the  fact  that  the 
stocks  and  bonds  available  as  collateral  are  usually  salable,  so 
that  in  case  of  default  on  the  part  of  the  borrower,  the  banker  has 
little  difficulty  in  disposing  of  the  collateral  and  repaying  most 
or  all  of  his  advances.  This  statement  is  not  to  be  taken  as  apply- 
ing indiscriminately  to  all  stocks  and  bonds ;  for  the  securities  of 
some  local  or  little  known  companies,  even  though  the  companies 
may  be  carrying  on  a  successful  business,  are  about  as  unmarket- 
able property  as  can  be  mentioned.  At  the  other  extreme  are  the 
active  securities  of  the  great  corporations  which  are  being  daily 
bought  and  sold  in  large  quantities  on  the  New  York  and  other 
stock  exchanges;  these  are  the  securities  that  serve  as  collateral 
for  the  enormous  amounts  of  call  loans  kept  outstanding  by  the 
banks  of  the  New  York  financial  district. 

Between  these  two  classes  of  collateral  there  are  many  sound 
securities  which  the  banker  regards  as  at  least  fairly  marketable, 
and  which  he  is  willing  to  take  as  collateral.  Some  of  these  securi- 
ties are  owned  by  commercial  and  manufacturing  corporations 
which  may  properly  use  them  as  a  basis  for  bank  credit.  There 
is,  however,  a  limitation  to  be  noted  here.  It  is  not  regarded  as 
sound  practice  for  a  corporation  to  post  as  ccilateial  the  stock 


Ch.  28]  BORROWED  CAPITAL  863- 

of  a  subsidiary  company.  In  the  first  place,  the  stock  probably 
has  no  active  market  and  the  bank  will  accept  it  only  reluctantly 
and  when  it  is  mixed  with  salable  collateral,  and  in  the  second 
place,  the  corporation  should  not  be  compelled  to  take  any  chance 
— even  a  remote  chance — of  losing  control  of  an  essential  piece 
of  property.  The  securities  of  subsidiary  companies  may  serve 
properly  as  collateral  for  long-term  bond  issues,  but  not  as  col- 
lateral for  bank  loans. 

§  300.     (2)  Merchandise  as  Collateral 

Merchandise  serves  as  collateral  when  a  company  posts  ware- 
house receipts,  bills  of  lading,  or  specific  liens  upon  specific  piece? 
of  its  personal  property  as  collateral.  The  first-named  case  i^ 
the  one  that  is  most  common.  Millions  of  dollars  of  holdings  of 
cotton,  wheat,  and  other  grains  are  carried  in  this  way  every 
year  following  the  harvesting  of  the  crops.  Once  in  a  while 
manufacturing  corporations  may  have  collateral  of  this  nature, 
as  when  a  steel  manufacturing  company  holds  pig  iron,  but  this 
is  unusual.  Bills  of  lading,  indorsed  to  the  order  of  the  bank, 
commonly  serve  as  collateral  for  drafts  discounted  by  the  seller 
of  merchandise.  Millions  of  dollars'  worth  of  goods  in  transit 
are  in  this  way  utilized  as  backing  for  loans  made  by  the  banks, 
and  accepted  as  collateral  up  to  a  fair  proportion  of  their  value. 

This  is  particularly  true  in  the  export  trade  where  the  banker 
does  not  feel  sure  enough  of  the  standing  of  the  drawer  of  the 
draft  or  of  the  salability  of  the  merchandise  to  risk  discount- 
ing the  whole  draft,  but  is  willing  to  make  advances  up  to,  say, 
50%,  60%,  80%,  or  more  of  its  face  value.  This  is  true  also 
when  the  merchandise  consists  of  goods  that  are  perishable  or 
that  do  not  have  a  ready  market.  A  draft,  covering  a  shipment 
of  fruit,  for  instance,  might  not  be  readily  discounted,  but  sev- 
eral of  these  drafts  would  be  regarded  as  good  collateral  for  an 
advance  of,  say,  50%  to  75%  against  their  face  value.  Liens  on 
specific  pieces  of  personal  property  are  not  common,  but  may  at 
times  be  perfectly  good  banking  collateral. 


864  CORPORATE  FINANCE  [Bk.  11- 

§  301'     (3)  Accounts  Receivable  as  Collateral 

Accounts  receivable  fall  into  a  different  class.  The  evidence 
of  indebtedness  of  a  third  party  to  the  borrower  is  so  uncertain 
and  the  claims  upon  specific  property  are  so  indirect,  that  ac- 
counts receivable  are  not  customarily  accepted  as  sound  collateral 
for  a  bank  loan.  It  is  considered  better  for  the  company  to  bor- 
row on  its  general  credit  rather  than  to  assign  its  accounts  receiv- 
able as  collateral.  As  a  result  of  the  unwillingness  of  most  banks 
to  accept  assignments  of  accounts  receivable  as  collateral,  a  con- 
siderable number  of  financing  and  discount  houses  have  come 
into  prominence  during  the  last  few  years,  which  make  a  specialty 
of  advancing  money  against  open  accounts. 

§  302.    Factors  Considered  by  Banks  in  Making  Lpans 

The  underlying  principles  followed  by  the  banker  in  extend- 
ing credit  have  been  touched  upon  in  the  two  preceding  sections. 
It  is  important  to  bear  in  mind  particularly: 

1.  That  the  commercial  banker  must  confine  himself  to 

making  short-term  loans. 

2.  That  he  should  satisfy  himself  that  the  money  he  loans 

is  to  be  invested  in  such  a  way  that  it  can  readily  be 
reconverted  into  cash. 

3.  That  credit  granted  on  the  general  standing  of  a  business 

enterprise  entitles  the  banker  to  a  full  and  detailed 
statement  of  the  company's  financial  standing. 

4.  That  collateral,  to  be  acceptable  to  a  banker,  must  con- 

sist either  of  securities  and  merchandise  which  are 
readily  salable,  or  of  drafts  which  are  quickly  convert- 
ible into  cash. 

Among  the  factors  considered  by  banks  in  making  loans,  must 
necessarily  be  the  legal  restrictions  in  force  at  the  time. 
The  banking  law  which  went  into  effect  in  19 14  provides  that 
"any  Federal  Reserve  Bank  may  discount  notes,  drafts,  and 
bills  of   exchange   arising  out  of  actual  commercial  transac- 


Ch.  28]  BORROWED  CAPITAL  865 

tions."  The  effect  of  this  law  is  to  increase  the  value  of  two- 
name  paper,  accepted  drafts,  and  other  evidences  of  debt,  which 
are  the  direct  results  of  commercial  transactions,  and  correspond- 
ingly to  decrease  the  value  of  paper  which  is  not  available  for  re- 
discounting  at  Federal  Reserve  banks.  Under  this  law,  the 
paper  issued  by  one  subsidiary  company  to  a  holding  company 
as  an  accommodation  note — such  as  the  30  to  40  million  dollars 
of  Clafiin  notes  previously  referred  to — would  not  be  available 
for  rediscounting.  One  result  of  the  collapse  of  the  Claflin  firm 
was  to  strengthen  greatly  the  movement  in  favor  of  putting  a 
premium  upon  paper  which  arises  out  of  commercial  transactions. 

§  303.    Bank  Customs  as  to  Loans 

Among  the  unwritten  rules  that  have  long  been  customary 
among  bankers  in  making  loans,  these  two  are  of  chief  impor- 
tance: 

1.  Of  the  amount  loaned  by  a  bank,  15%  to  25%  should  be 
left  in  the  bank  on  deposit,  the  other  75%  to  85%  only  being 
available  for  meeting  obligations.  This  is  a  long-standing  cus- 
tom, but  is  not  universal.  It  is  more  strictly  applied  by  some 
banks  and  in  some  lines  of  business  than  others.  When  a  line  of 
credit  is  granted,  the  company  to  which  it  is  granted  is  expected 
at  all  times  to  keep  an  amount  on  deposit  equal  to  from  15%  to 
25%  of  the  total  credit. 

2.  All  bank  loans  should  be  "cleaned  up"  at  least  once  a 
year  so  that  the  bank  may  make  sure  that  the  money  it  lends  is 
not  going  into  permanent  investments.  This  is  especially  neces- 
sary in  those  lines  of  business  which  have  well  marked  seasons  of 
activity.  It  would  be  clearly  inadvisable  for  a  bank  to  allow  a 
customer  in  such  a  line  credit  for  the  coming  season  until  after 
he  has  paid  up  his  loans  for  the  previous  season.  With  manu- 
facturing corporations  the  rule  is  not  so  strictly  applied ;  yet  even 
here  it  is  desirable  that  the  company's  balance  sheet  should  once 
in  a  while  be  wiped  clear  of  bank  loans.  If  this  cannot  be  done, 
it  is  clear  enough  evidence  that  the  company  is  using  bank  funds 


866  CORPORATE  FINANCE  [Bk.  li- 

as a  part  of  its  permanent  capital,  which  it  is  obvious  should  be 
reinforced  by  the  sale  of  more  stock  or  long-term  securities,  not 
by  bank  loans. 

§  304.    Banker  vs.  Borrower 

All  these  rules  of  successful  and  conservative  banking  are 
also  the  rules  of  successful  and  conservative  financing  of  all  busi- 
ness corporations  which  borrow  from  banks.  There  is  no  con- 
flict whatever  between  the  two  points  of  view.  A  barier  wishes 
in  normal  times  to  lend  as  much  as  he  can  safely  place ;  the  treas- 
urer of  a  borrowing  corporation  wishes  to  borrow  as  much  as  he 
can  safely  carry.  In  theory  there  should  never  be  a  disagreement 
or  a  hitch  between  them.  However,  the  frailties  of  human  nature 
are  not  so  easily  set  aside.  A  treasurer's  prejudices  and  fancied 
interests  frequently  lead  him  to  oppose  reasonable  requests  and 
criticisms;  on  the  other  hand,  a  banker  is  at  least  equally  liable 
to  suffer  from  obstinate  prejudices.  Recently  an  eastern  manu- 
facturer asked  his  banker  for  a  loan  of  $25,000.  "I  see,"  said  the 
banker,  looking  over  the  manufacturer's  statement,  ''that  your 
advertising  expense  for  last  year  just  about  equals  $25,000.  If 
you  would  cut  off  your  advertising  you  would  have  all  the  money 
you  need."  The  manufacturer  tried  to  explain  that  it  was  neces- 
sary for  him  to  advertise  in  order  to  sell  his  goods,  and  that  the 
money  borrowed  from  his  bank  was  required  in  order  to  purchase 
raw  materials  which  would  be  quickly  manufactured  into  salable 
articles.  But  the  banker  had  a  prejudice  against  advertising 
which  nothing  could  shake.  It  is  characteristic  of  the  banker's 
work  that  it  has  a  tendency  to  make  him  a  slave  to  routine  and 
to  fixed  ideas,  which  are  obstacles  to  the  prosperity  both  of  his 
customers  and  of  himself. 


CHAPTER  XXIX 

NET  INCOME 

•  ■■■'•■<•,  f. 
§  305.    A  Condensed  Income  Statement  ^'^ 

The  determination  of  income  may  be  regarded  as  primarily 
a  problem  of  accounting,  but  it  is  also  a  financial  problem.  We 
shall  therefore  take  up  for  brief  review  the  question  of  how 
corporate  income  is  and  should  be  determined. 

For  purposes  of  illustration  the  following  typical  statement 
of  income  is  reproduced  from  the  December  31,  192 1,  report  of 
the  Consolidation  Coal  Company. 

Earnings  from  Operations $25,179,374.42 

Operating  Expenses,  Taxes,  Insur- 
ance and  Royalties,  exclusive  of 
Income  and  Excess  Profits  Tax. .  $20,095,303.04 

Depreciation 1,258,761.66 

Depletion 1,003,262.17     22,357,326.S7 


Net  Earnings  from  Operations $  2,822,020.55 

Profit  from  sale  of  Capital  Assets 194,119.18 

Income  from  Other  Sources 1,055,273.09    $4,071,412.82 


Interest 1,332,819.27 


Net  Earnings  for  the  year,  before  deducting  Income  and  Excess 

Profits  Tax $2,738,593.55 

Less:  Reserve  for  Income  and  Excess  Profits  Tax 500,000.00 


Surplus  for  the  year $2,238,593.55 

Realization  of  Appreciation  of  Coal  Lands,  March  i,  1913 917,892.10 


Surplus  for  the  year  available  for  Dividends $3,156,485.65 

Less:  Cash  Dividends  declared  for  the  year  1921 2,411,980.50 


Net  surplus  for  the  year  carried  to  Profit  and  Loss $    744iSoSiS 

867 


868  CORPORATE  FINANCE  [Bk.  11- 

Ignoring  the  appreciation  in  value  of  coal  lands,  this  state- 
ment shows,  after  payment  of  dividends,  a  deficit  of  operations 
for  the  year  of  over  $173,000.  The  year  1921,  however,  shewed 
many  deficits  from  operation,  and  as  the  present  company  has 
a  surplus  exceeding  $90,000,000  the  matter  is  not  one  to  cause 
alarm. 

§  306.     Calculating  the  Corporate  Income 

The  above  example  of  an  income  statement  shows  the  essen- 
tial steps  in  calculating  income,  which  are  as  follows : 

1.  State  gross  earnings. 

2.  Deduct  operating  or  manufacturing  expenses,  including 

selling,  administrative,  maintenance,  depreciation,  de- 
pletion, etc. 

3.  The  result  is  net  earnings  from  operation.  . 

4.  Add  income  from  other  sources. 

5.  The  result  is  total  net  income. 

6.  Deduct  taxes,  interest,  rentals,  sinking  fund  and  any 

other  fixed  charges. 

7.  The  result  is  surplus  for  the  year  applicable  to  dividends. 

8.  Deduct  preferred  dividends. 

9.  Deduct  common  dividends. 

10.  The  result  is  surplus — or  deficit — from  the  year's  opera- 
tions to  be  credited  or  debited  to  surplus  account. 

§  307.    What  Constitutes  Income 

It  seems  hardly  worth  while  to  point  out  that  income  and 
expenditure  are  by  no  means  identical  with  cash  receipts  and 
cash  disbursements,  though  this  elementary  distinction  is  not 
always  grasped.  Income  as  understood  in  modern  business  in- 
cludes all  the  various  kinds  of  realized  gain  from  operations 
during  a  given  period.  This  gain  may  be  realized  in  the  form  of 
increased  accounts  receivable,  enlarged  facilities  for  production, 
reduced  obligations,  or  in  various  other  ways.  Inasmuch  as  the 
extent  of  the  gain  is  frequently  difficult  to  measure,  there  is  con- 


Ch.  29]  NET  INCOME  869 

siderable  latitude  for  the  exercise  of  discretion  and  good  faith  on 
the  pa:rt  of  officials  in  estimating  income.  It  is  therefore  possible 
for  them,  if  they  are  not  governed  by  the  strictest  integrity,  to 
enlarge  or  reduce  the  statement  of  income  which  they  give  to  their 
stockholders  and  to  the  public  to  such  an  extent  that  these 
statements  become  dangerously  unreliable. 

§  308.     Gross  Earnings — Appreciation  in  Value 

Under  such  conditions  the  greatest  conservatism  and  honesty 
should  obtain  all  through  a  financial  statement.  If  it  does  not, 
the  statement  is  not  only  a  fictitious  presentation  in  itself,  but  is 
an  absolutely  unsafe  basis  for  future  action. 

A  typical  lack  of  conservatism  in  the  matter  of  earnings  is 
found  in  the  early  history  of  the  United  States  Realty  and  Con- 
struction Company.  In  its  first  report,  earnings  for  the  first 
nine  months  of  the  company's  existence  were  given  as  $1,417,000; 
but  it  later  appeared  that  $487,000  of  these  earnings  consisted 
of  "profits  from  estimated  increase  in  the  value  of  investments 
still  held."  This  item  is  characteristic  of  a  procedure  frequently 
advocated  by  corporate  officials  who  desire  to  make  a  showing 
of  profits  that  have  not  been  earned  through  operation.  Real 
estate,  securities,  stocks  of  merchandise,  and  the  like  are  con- 
stantly fluctuating  in  value.  If  any  of  these  properties  are 
actually  sold  and  a  profit  is  realized,  it  is  entirely  proper  that  this 
profit  should  be  credited  to  surplus,  but  to  credit  it  to  the  surplus 
arising  out  of  operations  during  a  given  period  is  to  give  a  dis- 
torted view  of  the  operations  for  that  period.  Beyond  this,  so 
long  as  the  profit  is  not  realized,  but  exists  simply  on  paper,  it  is 
a  rule  of  accounting  practice  that  it  should  not  be  credited  at  all. 
Officers  who  advocate  marking  up  profits  on  account  of  fluctua- 
tions in  value  of  permanent  holdings  are  frequently  the  first  ones 
to  find  some  plausible  reason  for  declining  to  mark  down  profits 
when  these  same  holdings  decline  in  value.  If  a  company  is 
engaged  in  the  business  of  buying  and  selling  real  estate  or 
securities,  the  case  may  be  different  and  may  be  woi'thy  of  further 


870  CORPORATE  FINANCE  [Bk.  II- 

consideration,  but  in  other  cases  such  profits  should  not  be 
credited  unless  realized. 

§  309.     Cost  or  Market  as  a  Basis  of  Valuation 

Before  the  Great  War,  the  accounting  rule  that  valuations 
should  be  "at  cost  or  market,  whichever  is  lower,"  was  almost 
invariably  adhered  to  in  conservative  practice.  The  wide 
variations  of  costs  and  values  resulting  from  war  and  postwar 
conditions  have,  however,  brought  about  some'  changes  in  the 
application  of  this  rule,  and  the  general  principle  that  incre- 
ments in  values  of  assets  should  not  be  brought  on  the  books 
until  the  profit  has  been  actually  realized  by  the  sale  of  the  assets 
has  been  liberalized.  For  instance,  in  1920  the  Consolidation 
Coal  Company  by  revaluations  of  its  coal  lands  brought  into 
its  income  statement  and  added  to  surplus  an  amount  of  over 
$33,000,000.1  In  the  192 1  income  statement  of  this  company 
shown  earlier  in  the  chapter,  a  similar  addition  to  surplus  is 
shown  of  almost  a  million  dollars. 

The  following  opinion  on  this  subject  is  interesting:  2 

My  suggestion  is  that  when  reappraisals  or  inventories  at 
market  indicate  higher  values  than  cost,  the  appreciation  may  be 
expressed  in  the  balance  sheet  provided  the  increment  is  not  set  up 
as  realized.  I  am  not  sanctioning  the  practice  of  anticipating 
profits,  for  that  is  vicious.  Let  me  illustrate.  If  a  concern  buys  or 
produces  copper  at  10  cents  a  pound,  which  at  the  date  of  inventory 
is  freely  selling  at  15  cents  a  pound,  and  the  market  continues  to 
rise  after  thedateof  the  balance  sheet,  surely  no  sound  accounting 
or  economic  principle  is  being  violated  if  the  market  value  as  well 
as  cost  is  shown  in  the  balance  sheet.  To  carry  copper  at  10  cents 
because  cost  is  lower  than  market,  would  be  positively  misleading 
unless  the  additional  financial  resources  of  the  concern  are  dis- 
closed somewhere  on  the  statement.  Likewise,  when  copper  costs 
20  cents  and  at  the  date  of  balance  sheet  is  selling  for  18  cents,  and 
after  the  date  of  the  balance  sheet  has  declined  still  further,  it  is 
equally  deceptive  to  value  the  copper  at  18  cents  merely  because 
that  happened  to  be  the  market  price  on  one  day. 

"v'O  

>  See  Book  III,  5§  26.  27. 
-;;■),!'  Montgomen''s  Auditing,  Vol.  I,  p.  $.  ijl^;  iJch'J  JlU  .Ji JLTIU.'.-  • 


Ch.  29]  NET  INCOME  871 

§  310.     Gross  Earnings — Profits  on  Work  in  Progress 

Another  doubtful  item  from  the  standpoint  of  conservative 
practice  is  found  in  the  first  report  of  the  United  States  Realty 
and  Construction  Company  referred  to  in  the  preceding  section. 
It  includes  among  the  earnings  of  the  period  the  sum  of  $577,000, 
for  "profit  on  buildings  in  progress,  estimated  proportion 
accrued."  Here,  however,  there  is  more  room  for  debate  It 
would  seem  unfair  that  companies  which  customarily  engage  in 
long-time  contracts,  such  as  the  construction  of  buildings  and 
the  like,  should  credit  no  profits  to  the  period  in  which  the  con- 
struction work  is  going  on.  On  the  other  hand,  it  was  found  in 
the  case  of  the  United  States  Shipbuilding  Company  that  the 
anticipated  profits  on  large  contracts,  which  had  been  counted 
in  the  millions  of  dollars,  were  never  realized,  but  actually  turned 
•into  a  loss  at  the  completion  of  the  contracts.  Estimates  of 
profits  on  uncompleted  contracts  are  likely  to  be  made  by  officers 
whose  judgment  may  be  warped  by  their  own  interests.  Such 
items  are  to  be  considered,  therefore,  with  some  degree  of  skep- 
ticism. 

Another  fruitful  source  of  error  in  stating  gross  earnings  is 
over-optimism  in  the  valuation  of  finished  and  partly  finished 
products  and  raw  materials  on  hand.  Sometimes  balance  sheets 
are  found  in  which  inventories  amount  to  several  times  the 
aggregate  of  gross  sales.  In  such  cases  it  is  clear  that  even  a 
slight  excess  valuation  of  the  inventories  may  be  the  real  source 
of  a  considerable  proportion  of  the  alleged  profits.  Where  the 
item  of  inventories  appears  to  be  constantly  growing,  from  year 
to  year,  more  rapidly  than  sales  and  profits,  the  estimate  of 
gross  earnings  should  certainly  be  subjected  to  close  examination. 
Particularly  is  this  true  in  a  period  of  deflating  values  such  as 
existed  in  1920  and  1921,  when  many  inventories  were  reduced 
one-half  or  more  by  falling  values. 

It  should  never  be  forgotten  that,  by  reason  of  the  discretion 
which  is  necessarily  accorded  to  them  in  estimating  gross  earn- 
ings, corporate  ofl&cials  ought  to  be  exceptionally  cautious,  and 


872  CORPORATE  FINANCE  (Bk.  II- 

for  their  own  protection  should  rely  to  a  great  extent  upon  the 
judgment  of  impartial  accountants  and  other  outside  advisers. 
Misstatements  of  gross  earnings  are  not  made  necessarily  with 
dishonest  intentions;  the  men  who  are  most  interested  in  the 
business  are  frequently  the  very  ones  who  are  most  easily  per- 
suaded that  an  exaggerated  estimate  of  unrealized  earnings  is 
sound  and  reliable. 

§  311.     Operating  Expenses  and  Reductions 

There  is  usually  little  question  as  to  the  actual  outgo  for  raw 
materials  or  other  purchases,  labor,  selling  expenses,  salaries  of 
officers  and  other  administrative  overhead,  etc.,  all  of  which  are 
directly  chargeable  to  the  various  accounts  that  are  grouped 
under  the  general  heading  of  "Operating  Expenses."  Even 
here,  claims  are  sometimes  advanced  in  favor  of  charging  such 
expenditures  as  those  for  advertising  and  for  training  employees, 
to  capital  accounts  rather  than  to  operating  expenses,  on  the 
theory  that  such  expenditures  are  a  permanent  benefit  to  the 
business.  If  such  claims  are  to  be  allowed  at  all,  which  is  usually 
doubtful,  it  is  regarded  as  correct  practice  to  charge  them  to  some 
such  account  as  "Deferred  Expenses,"  which  is  carried  on  the 
balance  sheet  for  the  time  being  as  a  capital  account  but  is 
intended  to  be  written  off  within  a  brief  period. 

There  is  little,  if  any,  question  also  as  to  most  expenditures 
for  repair  and  maintenance  of  the  permanent  property  of  the 
business.  This  property  must  be  kept  up  as  nearly  as  possible 
to  its  original  standard  of  efficiency,  and  the  expense  of  so  doing 
can  scarcely  be  regarded  otherwise  than  as  a  portion  of  the  total 
expense  of  operation.  Going  a  step  farther,  it  is  well  to  point  out 
that  many  new  companies  make  a  serious  error  in  not  beginning 
at  once  to  charge  against  profits  a  fair  allowance  which  will  take 
care  of  a  portion  at  least  of  the  repairs  and  other  maintenance 
expenses  that  are  to  be  expected  in  the  course  of  a  few  years. 
Owners  of  apartment  houses  and  other  city  real  estate  are  fre- 
quently negligent  in  this  respect.     A  building  of  this  character 


Ch.  29]  NET  INCOME  873 

may  run  for  some  years  with  comparatively  slight  outlay  for 
repairs;  then  all  at  once  everything  is  out  of  order.  Either 
large  sums  must  be  expended  and  charged  against  operating 
expenses,  or  the  character  of  the  building  will  change  for  the 
worse  and  a  lower  income  will  be  obtained.  The  same  line  of 
reasoning  applies  to  many  manufacturing  establishments. 

§  312.    Reserves 

Nearly  all  well-managed  corporations  charge  against  the 
profits  of  each  year  an  estimated  sum,  or  a^  number  of  distinct 
estimated  sums,  which  are  intended  to  provide  for  losses  and 
expenses  likely  to  arise  in  the  future  but  which  are  incident  to 
the  operations  of  the  current  period.  The  sums  so  charged 
are  credited  to  reserve  accounts,  which  are  carried  on  the  balance 
sheet  of  the  company. 

As  to  the  nature  and  use  of  these  reserve  accounts,  there  is 
much  misunderstanding.  They  do  not  consist,  as  people  seem 
sometimes  to  imagine,  of  funds  of  cash  or  property  set  aside  for 
the  purpose  of  meeting  future  expenses.  It  is,  in  fact,  easily 
possible  that  a  company  may  accumulate  large  reserve  accounts 
and  yet  be  quite  unable  to  meet  the  anticipated  expenses  when 
they  actually  arise.  This  is  due  to  the  fact  that  the  reserved 
profits  are  tied  up  in  stock  or  equipment  or  in  other  ways  and  the 
company  is  short  on  cash  and  free  credit. 

The  essential  character  of  all  such  reserves  lies  in  the  fact 
that  they  constitute  a  deduction  from  profits.  They  exist  only 
in  the  form  of  entries  and  figures  in  the  company's  books  of 
account.  It  is  quite  possible  that  a  firm  which  carries  no 
reserves  on  its  balance  sheet  may  be  just  as  conservatively 
managed  as  the  one  which  has  large  reserves.  But  the  proba- 
bilities are  the  other  way,  for  the  reason  that  proper  estimates  in 
favor  of  reserve  accounts  assist  the  officers  and  stockholders  of  a 
company  in  gauging  the  true  status  of  the  business  and  tend  to 
prevent  over-optimism  and  dividends  that  should  not  be  paid.' 

»  See  Book  III,  Ch.  Ill,  "Reserve  Accounts." 


874  CORPORATE  FINANCE  [Bk.  II- 

§  313.    Depreciation 

The  most  common  form  of  reserve  is  that  for  depreciation 
in  the  value  of  fixed  assets,  due  to  wear  and  tear,  obsolescence, 
etc.  Depreciation  on  account  of  wear  and  tear  may  be  estimated 
in  advance  with  some  accuracy,  but  depreciation  for  obsolescence 
is  always  of  uncertain  amount.  No  one  can  foresee  what  changes 
in  taste  or  fashion,  what  unthought-of  inventions,  or  what  im- 
provements in  organization  may  take  place,  which  will  perhaps 
render  useless,  or  partly  useless,  much  of  the  company's  plant, 
machinery,  or  other  assets.  The  best  that  can  be  done  is  to 
make  a  fairly  liberal  estimate,  based  on  the  experience  of  the  past 
and  trust  that  it  will  be  sufficient  to  keep  the  book  value  of  fixed 
assets  always  well  within  the  limits  of  actual  value.  If  this 
result  is  not  accomplished,  then  the  depreciation  reserve  is  in- 
sufficient and  net  income  is  overstated.  ^.tuvria 

§  314.    Fallacious  Depreciation  Offsets 

Although  the  presence  of  depreciation  as  an  actual  factor  in 
every  business  can  scarcely  be  denied,  yet  the  absence  of  any 
depreciation  charges  and  reserve  accounts  on  the  books  of  cer- 
tain corporations  is  defended  by  fallacious  arguments.  For 
example,  many  street  railway  companies  and  other  public  utility 
corporations  decline  to  make  any  deduction  for  depreciation 
charges  from  gross  income.  The  claim  which  many  of  them 
advance  is  that  the  value  of  their  franchises  is  constantly  in- 
creasing and  is  sufficient  to  offset  the  admitted  decline  in  value 
of  their  road-bed  and  equipment. 

Much  the  same  argument  is  advanced  by  some  of  the  large 
oil  companies  which  claim  that  appreciation  in  the  values  of 
some  of  their  properties  is  a  proper  offset  against  the  depletion 
of  others.  This  kind  of  argument  is  apparently  advanced  simply 
to  justify  a  line  of  action  previously  determined  upon.  It  is 
based  on  a  twofold  fallacy.  First  of  all,  granting  that  there  is 
a  steady  rise  in  the  value  of  franchises  or  a  marked  increase  in  the 
value  of  certain  oil  land,  and  that  this  increment  should  be  taken 


Ch.  29]  NET  INCOME     '  '  '  87 j; 

into  the  income  account,  it  should  be  then  valued  by  itself  and 
shown  as  a  source  of  income,  while  depreciation  or  depletion 
charges  should  be  shown  as  a  deduction  from  income;  otherwise 
there  is  not  even  an  attempt  to  make  up  a  fair  and  reUable  income 
statement.  In  the  second  place,  in  the  case  of  the  street  railway, 
experience  has  shown  that  the  alleged  increase  in  the  value  of 
franchises  is  a  highly  uncertain  factor.  Most  public  utility 
enterprises  are  subject  in  a  peculiar  degree  to  legislative  control 
and  the  legislature  usually  takes  care  that  franchise  values  are 
not  permitted  to  increase  with  excessive  rapidity.  Even  if  this 
were  not  the  case  the  present-day  swarm  of  jitneys  and  auto- 
buses can  be  depended  upon  to  take  care  of  the  matter. 

§  315.    Insufficient  Depreciation 

Another  fallacy  is  clearly  shown  in  a  report  of  the  Canadian 
Locomotive  Company,  which  includes  this  remarkable  assertion : 
"We  have  not  added  anything  to  depreciation  reserve  account 
as  we  feel  that,  our  plant  being  new,  the  $75,000  already  at  the 
credit  of  this  account  is  sufficient." 

Following  out  this  line  of  reasoning,  it  is  evident  that  depre- 
ciation reserves  are  to  be  set  aside  only  when  the  period  has 
arrived  in  which  they  are  actually  needed.  This  makes  the  so- 
called  depreciation  reserve  and  the  account  for  repairs  and 
maintenance,  practically  identical,  and  does  away  with  the  only 
genuine  reason  for  the  creation  of  a  depreciation  reserve.  Com- 
panies that  have  new  plants  and  are  enjoying  prosperity  are  the 
very  ones  which  should  be  setting  aside  liberal  reserves  for  de- 
preciation. In  contrast  to  this  position  is  the  action  of  the 
Baldwin  Locomotive  Works  which  wrote  off  from  surplus  the 
entire  cost  of  the  munition  plants  constructed  by  it  at  the  time 
of  the  Great  War. 

It  is  particularly  necessary  to  set  aside  liberal  reserves  and 
write  down  severely  in  time  of  inflation.  The  London  Economist 
has  put  the  truth  of  the  situation  clearly  in  the  following  words: 
"Depreciation  allowances  are  all  the  more  necessary  in  a  boom 


876  CORPORATE  FINANCE  [Bk.  II- 

period,  because  there  is  always  the  practical  certainty  that  the 
boom  will  decline  more  or  less  suddenly  and  will  leave  over- 
valued stock  on  hand."  Many  companies  of  high  standing  are 
at  the  present  time  embarrassed  and  in  some  cases  on  the  verge 
of  bankruptcy  because  sufficient  reserves  were  not  set  aside 
during  the  inflated  period  that  came  with  the  Great  War. 

§  316.    Arbitrary  Depreciation  Allowances 

The  practice  sometimes  followed  of  arbitrarily  setting  aside 
for  depreciation  such  sums  as  can  conveniently  be  spared  out  of 
the  annual  surplus  regardless  of  the  amount  actually  required, 
is  not  one  to  be  encouraged.  This  practice  is  followed,  it  is 
true,  by  some  of  the  greatest  and  best-managed  concerns  of  the 
country.  But  it  is  essentially  unsound.  Depreciation  is  not  a 
theory  or  a  vague  notion  in  someone's  head ;  it  is  an  actual  ele- 
ment in  the  operation  of  every  business;  it  is  going  on  night  and 
day,  through  all  seasons,  year  after  year,  in  periods  of  depression 
as  well  as  in  periods  of  prosperity.  The  provision  against  de- 
preciation should  constitute,  therefore,  a  regular  charge  against 
gross  income.  The  amount  of  that  charge  should  be  estimated 
as  accurately  as  possible  and  should  be  adhered  to  year  after 
year;  otherwise  we  get  a  purely  fictitious  showing  of  net  profits. 
If  large  sums  are  charged  off  in  one  year  and  nothing  is  charged  off 
the  next  year,  the  final  showing  of  profits  in  the  two  years  may  be 
about  uniform,  whereas  the  business  has  perhaps  really  suffered 
an  enormous  fluctuation.  The  purpose  of  accounting  should 
be,  not  to  conceal  such  facts,  but  faithfully  and  clearly  to  set 
them  forth. 

§  317.    Depreciation  of  Intangible  Assets 

Depreciation  of  intangible  assets  should  be  liberally  estimated 
and  provided  for.  In  fact,  it  is  generally  agreed  that  intangible 
assets  should  be  written  off  at  an  especially  rapid  rate,  even 
though  their  real  value  may  not  be  decreasing.  Many  bankers 
and  other  financial  men  have  a  very  high  regard  for  what  is 


Ch.  29]  NET  INCOME  877 

called  a  "clean"  balance  sheet,  that  is  to  say,  one  which  includes 
only  tangible  assets  at  a  conservative  value  with  ample  reserves 
to  cover  all  possible  losses.  This  preference  seems  to  be  in  many 
cases  little  more  than  a  prejudice,  inasmuch  as  such  assets  as 
patents,  copyrights,  good-will,  and  the  like  may  be  permanent 
and  constitute  the  greatest  value  of  a  valuable  business.  Under 
such  conditions  they  may  properly  be  carried  as  real  assets. 
Nevertheless,  even  where  this  is  the  case,  it  is  often  advisable  to 
defer  to  prejudice  that  has  been  created  through  the  unscrupu- 
lous and  reckless  valuation  sometimes  placed  on  intangible 
assets,  and  to  carry  out  the  poUcy  of  "writing  off"  with  consid- 
erable rigor.< 

§  318.    General  Reserves 

There  are  many  other  kinds  of  reserves  which  should  be 
carried  if  the  business  of  a  company  is  to  be  based  on  sound 
accounting  and  finance.  The  business  of  many  companies,  for 
example,  requires  them  to  enter  into  contracts  which  involve 
immediate  payment  on  the  part  of  the  purchaser  of  their  prod- 
ucts, combined  with  a  liability  assumed  by  the  company  to 
render  future  service.  A  company  publishing  a  magazine 
usually  collects  subscription  payments  in  advance  and  contracts 
to  deliver  the  magazine  over  a  twelve  months'  period.  This 
being  the  case,  it  is  clear  that  the  company  actually  earns  the 
subscription  payment  only  as  it  proceeds  through  the  year  with 
the  delivery  of  its  magazine,  and  that  it  would  be  improper  to 
credit  the  subscription  payment  as  income  of  the  week  or  month 
in  which  it  is  received.  The  modern  custom  among  magazine 
publishers  is  to  credit  an  account  called  "Unearned  Subscrip.. 
tions"  for  payments  sent  in  by  subscribers,  and  at  the  close  of 
each  month  to  debit  this  account  and  credit  another  account 
called  "Subscriptions  Earned,"  or  some  similar  title,  for  tiie 
proportion  actually  earned  by  sending  out  magazines  during 
that  month. 


*  See  Book  III,  ii  144-146. 


878  CORPORATE  FINANCE  [Bk.  II- 

Any  future  outgo  on  contracts  that  are  taken  into  current 
income  account  should  be  watched  and  provided  for  with  the 
greatest  oare.  Companies  that  are  conservatively  managed  will 
always  provide  for  future  or  contingent  expenses  of  this  kind. 
In  the  1920  balance  sheet  of  Babcock  and  Wilcox,  for  example, 
one  item  consists  of  "Reserve  for  completion  of  contracts, 
$2,316,038." 

"  Another  instance  of  commendable  conservatism  is  given  in 
the  following  quotation  from  the  192 1  report  of  the  president 
of  the  International  Harvester  Company: 

In  the  early  years  of  the  war,  the  officers  and  directors  realized 
that  the  advance  in  prices  of  raw  materials  would  affect  this  in- 
dustry in  a  peculiar  way.  It  was  evident  that  if  the  inventory 
were  valued  according  to  high  war-time  prices,  the  profits  would  be 
"-"  materially  increased,  and  when,  after  the  war,  the  inevitable  decline 
in  prices  occurred,  the  company  would  be  confronted  with  large 
losses  due  to  such  declines.  The  company  is  compelled  to  have  on 
hand  constantly  an  inventory  of  raw  materials,  work  in  process, 
and  finished  machines  of  at  least  50%  of  the  gross  sales  of  a  normal 
year.  The  turnover  in  this  business,  that  is,  the  period  between 
the  purchase  of  raw  materials  and  the  sale  of  the  manufactured 
product,  averages  about  twelve  months,  whereas  in  some  lines  of 
production  the  turnover  is  made  in  a  much  shorter  time. 

In  view  of  these  facts  it  was  decided  that  so  much  of  the  inven- 
I  tory  as  represented  the  portion  constantly  on  hand  (termed  the 
basic  inventory)  should 'be  valued  at  prewar  (19 16)  prices  and 
carried  on  the  balance  sheet  at  those  prices;  and  that  fluctuations 
in  values  should  be  reflected  only  in  the  amount  of  the  inventory 
carried  in  excess  of  the  base  inventory.  This  policy  was  adhered 
to  even  though  the  United  States  government  for  taxation  purposes 
valued  the  entire  inventory  at  cost  or  market  prices,  thus  resulting 
in  the  payment  of  taxes  on  profits  never  realized. 

The  inventory  at  the  close  of  1920  was  valued  at  the  then  cost 
'•'  or  market,  whichever  was  lower,  and  is  so  valued  in  this  balance 
sheet.  The  company  shows  a  net  profit  for  the  year  1921,  not- 
withstanding the  decline  in  value  of  the  inventory.  Had  not  the 
company  adopted  conservative  methods  in  valuing  inventories 
during  the  past  few  years  the  balance  sheet  for  192 1  would  have 
shown  a  net  loss  in  excess  of  $20,000,000. 


Ch.  29]  NET  INCOME  ^'j  879 

Another  instance  of  cautious  financing  is  explained  in  a 
letter  from  President  Mitchell  of  the  National  City  Bank  to  its 
stockholders.     This  letter  referring  to  the  192 1  operations  says: 

During  the  past  year,  in  addition  to  writing  off  from  undivided! 
profits  the  good-will  cost  represented  in  the  acquisition  of  the 
Second  National  Bank,  the  Commercial  Exchange  Bank,  and  the 
Paris  branch  of  the  Farmers  Loan  &  Trust  Co.,  we  have,  from  time 
to  time,  charged  current  earnings  and  undivided  profits,  crediting 
reserves  and  allocating  to  specific  accounts  sums  which  cover,  with 
the  exception  noted  below,  every  probable  loss  disclosed  by  careful 
analysis  of  the  accounts  of  our  head  office  and  all  of  our  branches. 
The  exception  is  some  probable  loss  in  a  group  of  loans  to  sugar 
estates  in  Cuba  and  a  single  loan  in  South  America,  the  liquidation 
of  which  will  in  some  degree  depend  on  future  trade  conditions. 
These  accounts  have  been  the  subject  of  special  study  by  the 
management  and  by  committees  of  our  board  of  directors,  and 
plans  have  been  laid  for  working  them  out  as  rapidly  as  possible. 

We  anticipate  that  the  ultimate  loss  on  these  items  will  not  be 
serious.  In  order,  however,  to  amply  provide  for  such  shrinkage  as 
may  occur  in  these  accounts,  and  to  take  up  any  other  possible 
losses  that  careful  scrutiny  has  not  at  this  time  revealed,  the  board 
of  directors  has  deemed  it  conservative  to  establish  a  reserve  for 
contingencies  in  the  amount  of  $10,000,000  by  a  direct  charge  to 
undivided  profits  in  that  amount.  Further,  the  board  has  ap- 
proved a  policy  of  maintaining  this  reserve  for  contingencies  at 
all  times  at  not  less  than  $5,000,000. 

§  319.    Concealment  of  Profits 

We  have  spoken  above  of  charges  for  repairs,  renewals,  main- 
tenance, and  depreciation  as  being  properly  included  in  operating 
expenses  or  in  deductions  from  gross  income,  and  have  empha- 
sized the  necessity  for  liberal  allowances.  There  is,  however,  a 
possible,  although  not  so  frequent  danger  of  going  to  the  opposite 
extreme.  Depreciation  charges  may  be  too  high,  and  thus  the 
showing  of  earnings  may  be  unduly  depressed. 

Again  the  various  accounts  included  under  the  general 
headings  of  "Repairs,"  "Renewals,"  and  "Maintenance"  may 
be  stretched  so  as  to  include  outlays  for  betterments.     In  this 


88o  CORPORATE  FINANCE  [Bk.  II- 

case  earnings  on  the  income  statement  are  decreased  and  the 
capital  assets  are  at  the  same  time  built  up  but  without  any 
corresponding  increase  in  their  valuation  on  the  balance  sheet. 
Something  of  this  kind  has  happened  frequently  in  the  manage- 
melit  of  railroad  companies  in  the  United  States.  Conservative 
companies  will  include  in  their  "Maintenance"  accounts,  ex- 
penditures for  reballasting,  for  laying  heavier  rails,  for  putting 
in  permanent  culverts  and  even  bridges  and  for  purchasing  new 
locomotives  and  cars.  After  this  practice  has  been  carried  on 
over  a  period  of  years  and  the  property  has  been  put  into  excel- 
lent condition,  the  profits  are  no  longer  diverted  into  and  appar- 
ently lost  in  capital  expenditures,  the  statements  of  earnings  are 
allowed  to  expand  to  their  correct  proportion,  and  the  stockhold- 
ers of  the  second  period  are  perhaps  given  enlarged  dividends  or 
a  "melon"  of  some  kind. 

A  notable  instance  of  this  procedure  was  afforded  by  the 
Lehigh  Valley  Railroad  Company  under  the  management  of 
President  Walter  from  1898  to  1904.  During  these  six  years  the 
stockholders  noted  in  each  year's  accounts  that  the  charges  for 
maintenance,  repairs,  etc.,  were  reaching  unprecedented  heights 
and  that  the  net  profits  were  correspondingly  reduced.  They 
suspected  the  truth — that  expenditures  for  betterments  were 
being  charged  into  maintenance  accounts — and  many  of  them 
protested,  but  without  effect. 

§  320.    Is  Concealment  of  Betterment  Expenditures  Justifiable? 

The  management  in  the  Lehigh  Valley  case,  as  in  many  other 
similar  cases,  took  the  attitude  that  they  were  the  ones  best 
acquainted  with  the  needs  of  the  corporation  and  were  better 
entitled  than  were  the  stockholders  to  judge  as  to  the  necessity 
for  betterment  expenditures.  They  took,  therefore,  the  course 
which  seemed  to  them  proper,  and  in  order  to  avoid  objection 
and  interference,  concealed — or  partially  concealed — the  ex- 
penditures for  betterments,  thus  improving  the  property  of  the 
corporation  without  the  stockholders'  knowledge  or  consent. 


Ch.  29I  NET  INCOME  881 

The  motives  of  the  management  in  this  case  were  unim- 
peachable, and  there  can  be  no  doubt,  as  we  look  back,  that  the 
Lehigh  Valley  and  its  stockholders  as  a  body  have  been  greatly 
benefited  by  the  policy  that  was  followed.  And  other  corpora- 
tions have  done  the  same  thing  with  advantage  to  their  stock- 
holders. The  question  is,  however,  not  whether  accumulation 
of  surplus  out  of  earnings  is  wise,  but  whether  concealment  of 
the  accumulating  surplus  is  right.  Concealment  makes  it 
easier  for  the  directors  to  reserve  profits.  But  it  also  offers  a 
wide  opportunity  for  fraud.  And,  speaking  generally,  the  owners 
of  property  have  a  right  to  know  its  true  status.  Therefore, 
while  recognizing  the  force  of  the  arguments  in  favor  of  secrecy 
when  a  diversion  or  accumulation  of  surplus  or  profits  is  under 
way,  the  reply  to  the  question  must  be  in  the  negative. 

§  321.    Two  Classes  of  Betterments 

Before  leaving  this  subject,  it  may  be  well  to  call  attention  to 
the  two  different  classes  of  betterment  expenses  which  are  gen- 
erally regarded  as  being  properly  financed  in  two  different  ways. 
One  class  consists  of  betterments  which  are  certain  to  yield  a 
definite,  traceable  return,  either  in  the  form  of  enlarged  revenue 
or  in  the  form  of  savings  in  outgo,  as,  in  a  factory,  a  better  engine 
that  will  develop  more  power  from  the  same  amount  of  fuel. 

The  second  class  of  betterments  consists  of  those  which  are 
considered  desirable  and  well  worth  the  expense  involved,  but 
which  will  not  yield  direct  and  traceable  profits,  as  in  the  same 
factory,  a  reading-room,  or  lunchroom  for  the  employees. 

By  general  consent  among  the  officers  and  directors  of  great 
corporations,  it  is  agreed  that  the  first  class  of  betterments  may 
properly  be  financed  by  the  issuance  of  fresh  securities,  if  it  can 
clearly  be  shown  that  the  interest  or  dividends  on  these  securities 
will  be  provided  out  of  the  enlarged  income  or  the  savings  made 
possible  by  the  betterment.  The  second  class  of  betterments, 
however,  should  be  provided  for  out  of  surplus.  They  may 
prove  to  be  highly  profitable,  but  there  is  no  certainty  on  that 


882  CORPORATE  FINANCE  [Bk.  II- 

point.  The  only  money  that  should  be  spent  on  them,  there- 
fore, should  be  money  that  has  been  accumulated  out  of  the 
profits  of  the  preceding  years  or  that  is  currently  accumulating. 
In  case  the  judgment  of  the  directors  should  be  wrong,  and  the 
betterments  should  not  make  for  enlarged  profits,  the  corporation 
would  at  least  escape  a  loss  that  would  be  damaging  to  its  credit. 
The  Pennsylvania  Railroad  Company  has,  perhaps,  been 
the  most  consistent  follower  of  the  principle  that  has  just  been 
presented.  In  financing  $150,000,000  of  improvements  of  the 
company  in  New  York  City  terminals,  including  tunnels  under 
the  North  and  East  rivers  and  the  magnificent  terminal  building, 
approximately  one-half  the  investment  was  provided  by  fresh 
issues  of  securities;  the  other  half  was  provided  by  charges 
against  the  surplus  of  the  Pennsylvania  Railroad  and  allied 
companies. 


CHAPTER  XXX 
DIVIDENDS  1 

§322.    Fixed  Charges  i;i,oiuofei4J     .fs:t  ?? 

After  a  corporation's  net  income  has  been  determined,' it  is 
in  order  for  the  directors  to  consider  how  it  shall  be  distributed. 
Normally  net  income  is  distributed  through  three  channels: 
fixed  charges,  dividends,  and  additions  to  surplus. 

As  to  "Fixed  Charges"  there  is  little  that  needs  to  be  said  at 
this  point.  They  consist  of  taxes,  payments  on  leases  and 
rentals,  and  interest  payments  on  the  funded  obligations.  The 
amount  of  fixed  charges  (except  for  taxes)  is  determined  by  the 
amount  and  form  of  the  company's  capitalization  and  of  its  long- 
term  contracts.  At  the  time  when  net  income  for  a  given  period 
has  been  determined  and  its  distribution  is  under  advisement, 
the  payments  for  fixed  charges  are  no  longer  questions  within 
the  discretion  of  the  directors  or  of  anyone  else  connected  with 
the  company.  Unless  they  are  paid  as  they  become  due,  the 
company  ceases  to  be  solvent.  Such  charges  might,  of  course, 
and  frequently  have  been  in  the  past  year,  paid  from  surplus,  but 
for  the  present  purposes  we  will  assume  that  net  income  is  more 
than  sufficient  to  meet  fixed  charges,  and  that  there  is  remaining 
a  balance  available  for  dividends  and  surplus. 

§  323.    Dividends  and  Surplus 

As  to  the  distribution  of  the  available  balance  of  net  income 
between  dividends  and  surplus,  the  board  of  directors  is  the  sole 
authority.  Neither  officers  nor  stockholders,  as  such,  have  any 
voice  in  the  matter  and  there  are  few  effective  legal  restrictions. 


»  See  also  Book  I,  Chs.  LII.  LIII  "Dividends";  also  Book  III.  Oh.  XIV,  "Dividends." 

883 


884  CORPORATE  FINANCE  [Bk.  II- 

We  have  before  us,  then,  for  treatment  in  this  and  in  the  following 
chapters,  the  two  closely  related  questions: 

What  principles  should  guide  the  directors  in  fixing  divi- 
dends? 

What  principles  should  guide  the  directors  in  accumulating 
and  in  using  surplus? 

§  324.    Classification  of  Dividends 

Two  classes  of  dividends  are  to  be  considered:  those  which 
are  preferred  and  cumulative  (with  which  may  be  included  the 
so-called  interest  on  income  bonds),  and  those  which  are  common 
or  ordinary  and  have  no  special  priorities. 

As  to  preferred  dividends,  much  the  same  reasoning  applies 
as  has  just  been  stated  with  regard  to  fixed  charges.  There  is 
left,  to  be  sure,  a  much  larger  measure  of  discretion  to  the  direc- 
tors, who  may,  at  their  option,  decide  to  defer  the  payment. 
But  there  is  a  corresponding  penalty  in  the  fact  that  the 
accumulated  dividends  constitute  a  growing  barrier  in  the  way 
of  common  dividends,  and  that  the  credit  of  a  corporation  is 
adversely  affected  by  piling  up  large  arrears  of  preferred  divi- 
dends. For  these  reasons  corporations  that  are  earning  sufficient 
profits  and  are  in  strong  enough  financial  condition,  usually  pay 
their  preferred  dividends  without  much  argument.  There  are, 
to  be  sure,  some  exceptions,  but  the  pressure  in  favor  of  payment 
of  preferred  dividends,  when  possible,  is  effective  in  the  great 
majority  of  cases. 

Preferred  dividends  which  are  not  cumulative  belong  in  a 
different  class.  The  interests  of  the  common  stockholders, 
whom  the  directors  usually  represent,  require  that  non-cumula- 
tive preferred  dividends  be  passed  until  common  dividends  can 
also  be  paid.  Hence  we  may  include  all  dividend  charges  which 
have  priority,  but  are  not  cumulative,  under  our  consideration 
of  common  or  ordinary  dividends. 2 


'For  detailed  discussion  of  cumulative  and  non-cumulative  dividends,  see  §S  60-62;  also 
Book  I,  {{  109,  no. 


Ch.  30] 


DIVIDENDS 


88s 


§  325.    Average  Rates  of  Dividends 

A  valuable  compilation  showing  the  amount  of  railway  stock 
in  the  United  States  which  pays  dividends,  the  percentage  of 
this  dividend-paying  stock  to  all  outstanding  railway  stock,  and 
the  average  dividends  over  a  period  of  years,  is  reprinted  below.s 


Year  Ended 

Amount  of 

Stock  Yielding 

Dividends 

Per  Cent 
of  Stock 
Yielding 
Dividends 

Amount  of 
Dividends 
Declared 

Average 
Rate  on 
Dividend 
Yielding 
stock 

June  30,  1908 

$4,843,370,740 

65.69 

$390,695,351 

8.07 

1909 

4,920,174,118 

64.01 

321,071,626 

6.53 

1910 

5,412,578,457 

66.71 

405,771,416 

7-50 

1911 

5,730,250,326 

67.65 

460,195,376 

8.03 

1912 

5,581,289,249 

64-73 

400,315,313 

7.17 

1913 

5,730,982,416 

66.14 

369,077.546 

6.37 

1914 

5,667,072,956 

64-39 

451,653,346 

7-97 

191S 

5,219,846,562 

60.45 

328,477,938 

6.29 

1916 

5,279,427,954 

60.38 

342,109.396 

6.48 

Dec.  31,  1916 

5,430,123,235 

62  02 

366,561,494 

6.75 

1917 

5,610,774,033 

62.32 

381,851,548 

6.81 

1918 

5,138,851,230 

58.09 

339,185,658 

6.60 

1919 

5,298,320,617 

59-64 

335,241,935 

6.33 

1920 

5,056,814,549 

57-24 

328,989,492 

6.51 

It  is  of  especial  interest  to  note  that  over  one-half  of  the 
railway  stock  outstanding  in  the  United  States  during  recent 
years  has  been  paying  dividends. 

Some  interesting  figures  as  to  the  invested  capital  of  the  cor- 
porations of  the  country  and  the  dividends  paid  thereon  are 
contained  in  the  1922  "Statistics  of  Income"  issued  by  the 
Treasury  Department.  For  the  year  1919,  according  to  these 
statistics,  102,037  corporations  reported  the  amount  of  their 
invested  capital.  The  grand  total  was  $66,130,351,148.  The 
net  income  of  these  same  corporations  for  1919  before  payment 
of  taxes  was  $9,305,769,954.  Income  and  excess  profits  taxes 
amounted  to  $2,162,260,244,  leaving  net  income  available  for 
dividends  of  $7,143,509,710. 


•  By  courtesy  of  the  Bureau  of  Railway  Economics. 


886  CORPORATE  FINANCE  [Bk.  II- 

The  statistics  do  not  give  directly  the  amount  paid  out  by 
these  corporations  in  dividends,  but  the  individual  returns  for 
the  same  year  show  total  receipts  from  dividends  of  $2,453,774,- 
825.  Ignoring  dividends  received  by  corporations  holding 
securities  of  other  companies,  which  it  is  presumable  would 
eventually  come  into  the  hands  of  the  individuals,  this  gives  us 
a  rough  basis  for  calculation,  and  from  this  we  find  that  the  per- 
centage of  net  income  to  invested  capital  is  approximately 
10.96%,  and  that  the  dividends  actually  paid  were  approximately 
3.767%  on  the  total  corporate  capital. 

§  326.    Percentages  of  Earnings  Devoted  to  Dividends 

An  instructive  tabulation  of  the  income  statements  of  about 
900  English  companies  for  the  year  ended  July  31,  1914,  before 
the  economic  conditions  of  the  country  had  been  disturbed  by 
the  Great  War,  shows  the  following  distribution  of  profits : 

Net  Preferred  Ordinary  Surplus, 

Profits  Dixadend  Dividend  Reserves,  etc. 

£  £%£%£% 

Breweries 2,409,759  486,255  20.2  1,312,820  54.4  610,684  25.4 

Gas 856,541  1391729  16.3  887,953  103-7  *i7iii4i  *i9-8 

Iron,  Coal  &  Steel.  1,533,761  275,244  17.9  669,196  43.5  589,321  38.S 

Shipping 770,861  104,89s  13.6  326,952  42.2  339.014  44-2 

Teas,  Rubber,  etc.  535,699  31,247  5.7  400,384  75.0  104,068  19.3 

Trusts 160,725  25,663  16.0  109,220  67.9  25,842  16. 1 

Waterworks 62,727  9,357  14.9  45,3i5  72-3  8,055  12.8 

Miscellaneous....  3,160,147  945,715  29.9  1,473,991  46.5  740,441  23.6 

9,490,220    2,018,105    21.3    5,225,831      55.2    2,246,284     23.5 
*  Deficit. 

It  appears  from  the  above  table  that  preferred  dividends 
received  21.3%  of  the  net  profits  of  these  900  companies;  ordi- 
nary dividends  received  44.2%;  and  the  balance  added  to 
surplus  was  23.5%. 

It  should  be  noted  in  passing  that  the  gas  companies  paid 
out  in  ordinary  and  preferred  dividends,  considerably  more  than 


Ch.  30]  DIVIDENDS  887 

their  net  profits,  showing  that  they  drew  in  this  year  upon  the 
surplus  accumulated  in  previous  years. 

The  London  Economist  comments  on  the  above  table  as 
follows : 

As  usual  the  iron  and  steel  and  shipping  companies  have 
adopted  a  conservative  policy  with  regard  to  the  distribution  of 
profits  to  their  shareholders.  Most  of  the  rubber  companies  have 
no  preference  shares,  and  prefer  to  maintain  their  high  dividends 
at  the  expense  of  the  reserve  funds.  A  very  high  percentage  of 
the  profits  of  the  water  and  gas  companies  goes  to  the  ordinary 
shareholders,  and  in  the  case  of  the  latter  large  reductions  have 
been  made  in  the  amounts  carried  forward  for  this  purpose. 

Similar  compilations  for  companies  in  the  United  States  are 
not  available.  Returning,  however,  to  the  "Statistics  of  In- 
come" issued  by  the  Treasury  Department,  we  find  that  in  191 9 
the  net  income  of  192,037  companies  reporting  definite  invested 
capital  was,  after  payment  of  taxes,  $7,143,509,710,  and  that  the 
dividends  paid  to  individual  stockholders  was  $2,453,774,825. 
This  gives  a  little  over  34%  of  the  net  corporate  income  paid  out 
in  dividends,  and  between  65%  and  66%  retained  for  surplus 
and  reserves.  As  will  be  noted,  the  tendency  in  European  coun- 
tries is  much  more  strongly  in  favor  of  paying  out  the  greater 
portion  of  earnings  in  the  form  of  dividends  than  it  is  in  the 
United  States.  Doubtless  this  is  due  in  large  part  to  the  com- 
parative instability  of  economic  conditions  in  a  newer  and 
rapidly  growing  country.  It  is  due  also  to  different  and  in  some 
respects  more  conservative  standards  of  capitalization. 

It  is  obvious  that  the  statistics  given,  although  interesting 
and  of  some  value  as  furnishing  a  standard  of  comparison,  are 
not  hkely  to  prove  of  much  assistance  to  directors  in  solving  the 
dividend  problem  for  their  own  company.  There  are,  however, 
principles  which  have  been  almost  unconsciously  worked  out 
through  the  experience  of  thousands  of  corporations,  and  which 
are  now  accepted  as  sound  by  most  conservative  business  men. 
These  principles  furnish  the  safest  and  most  satisfactory  guide. 


888  CORPORATE  FINANCE  [Bk.  II- 

§  327.    Regularity  of  Dividends 

It  is  a  matter  of  the  greatest  practical  importance  that 
dividends  should  as  far  as  possible  be  regular  in  both  payment 
and  rate.  This  somewhat  obvious  fact  must  be  regarded  as 
almost  a  discovery  of  the  last  generation  or  two.  Formerly  the 
unquestioned  practice  was  to  regard  shareholders  as  standing  in 
substantially  the  same  relation  as  partners.  They 'were  sup- 
posed to  be  familiar  with  the  status  and  fluctuations  of  the  busi- 
ness and  were  expected  to  share  in  its  ups  and  downs.  If  the 
enterprise  enjoyed  an  exceptionally  good  year,  it  was  accepted 
as  a  matter  of  course  that  the  dividend  rate  would  be  correspond- 
ingly increased.  If  in  the  following  year  there  was  a  sharp 
decline  in  profits,  the  dividend  rate  should  be  correspondingly 
cut. 

As  a  matter  of  fact,  this  is  today  the  practice  of  a  great 
number — perhaps  the  majority — of  corporations.  In  so  far  as 
it  is  followed  by  close  corporations,  all  the  stock  of  which  is  held 
by  men  who  are  themselves  active  in  the  business  and  familiar 
with  its  every  phase,  it  is  probably  unobjectionable.  It  is  a 
matter  of  personal  preference  in  many  cases,  and  has  the  advan- 
tage of  stimulating  the  interest  of  those  shareholders  who  are 
active  in  the  business  to  the  highest  degree. 

But  the  corporation  which  has  shareholders  who  are  not 
active  in  the  business  or  famiHar  with  it  is  in  a  different  situation. 
This  remark  applies  with  especial  force  to  the  great  corporations 
that  number  their  shareholders  in  the  thousands  or  tens  of  thous- 
ands. The  vast  majority  of  these  shareholders  have  only  the 
barest  information  as  to  the  manner  in  which  the  business  is 
handled  and  as  to  the  results  that  are  being  achieved,  and  are  not 
sufficiently  familiar  with  the  business  or  sufficiently  interested  in 
it  to  absorb  more  detailed  information  if  it  were  given  to  them. 
They  regard  their  ownership  of  a  company's  stock  purely  as  an 
investment  of  capital  that  will  bring  them  an  income.  They 
buy  a  railroad  or  an  industrial  stock  much  as  they  would  buy  a 
real  estate  mortgage — the  only  purpose  being  that  of  securing 


Ch.  3ol  DIVIDENDS  889 

a  dependable  income  with  a  ghance  at  profits.  The  object  that 
is  actually  in  their  minds  in  making  the  purchase  is  not  a  partner- 
ship interest  in  a  going  enterprise,  but  certain  pieces  of  paper 
called  "certificates  of  stock"  which  at  regular  intervals  will 
bring  them  dividend  checks. 

To  shareholders  of  this  type,  regularity  in  their  dividend 
returns  is  of  the  highest  importance.  They  count  upon  these 
returns  as  a  fixed  portion  of  their  income — indeed,  in  thousands 
of  instances  the  living  expenses  of  dependents  are  provided  out 
of  these  dividends.  The  American  Telephone  and  Telegraph 
Company  has  more  women  shareholders  than  men.  The  same 
thing  is  true  of  other  corporations,  and  all  of  the  large  corpora- 
tions number  many  women  among  their  shareholders.  The 
effort  of  the  directors  of  a  corporation  which  includes  a  large 
proportion  of  shareholders  of  this  type  should  clearly  be  to  meet 
their  needs  by  paying  a  permanent  rate  of  dividends  with  the 
fewest  possible  fluctuations.  This  dividend  rate  in  a  really 
stable  and  conservatively  managed  corporation  seldom  varies 
to  any  considerable  degree  except  when  it  is  increased.  And  it 
is  not  increased  until  after  the  directors  have  assured  themselves 
that  in  all  human  probability  a  later  decrease  will  not  become 
necessary.  If  there  are  unusual,  or  possibly  temporary  profits 
which  it  is  thought  wise  to  distribute,  the  directors  of  such  cor- 
porations will  ordinarily  announce  an  ''extra"  dividend  or  once 
in  a  while  will  cut  a  "melon"  in  the  form  of  a  stock  dividend  or  a 
subscription  privilege.  These  extras,  however,  are  to  be  re- 
garded only  as  incidents  which  should  not  be  allowed  to  disturb 
the  regular  and  uninterrupted  flow  of  dividends. 

§  328.    Advantages  of  Dividend  Regularity 

The  desirability  of  maintaining  regularity  of  dividend  rates 
rests  not  merely  upon  the  duty  of  the  corporation  to  its  share- 
holders, but  also  upon  the  substantial  gain  for  the  corporation 
itself.  By  reason  of  the  fact  that  shares  which  yield  regular 
dividends  are  in  demand  by  so  large  a  body  of  owners  of  capital 


Sgo  CORPORATE  FINANCE  [Bk.  11- 

who  are  not  engaged  in  active  business,  there  is  a  much  stronger 
demand  for  these  shares  than  for  those  which  are  paying  irregular 
dividends.  Out  of  two  issues  of  common  stock  otherwise  equiva- 
lent, one  of  which  is  paying  a  permanent  dividend  rate  year 
after  year  and  the  other  of  which  is  paying  dividends  irregularly 
but  averaging  at  least  as  high  as  the  regular  payer,  the  first- 
named  issue  will  always  sell  at  a  substantially  higher  price.  For 
this  reason,  the  corporation  which  has  succeeded  over  a  period 
of  years  in  maintaining  a  record  of  dividend  stability,  and  which 
has  not  changed  and  is  not  likely  to  change  its  dividend  except 
to  raise  it  to  a  permanently  higher  level,  enjoys  the  benefit  of  a 
credit  and  of  a  demand  for  its  securities  which  is  worth  a  large 
amount  of  money. 

For  both  these  reasons,  even  the  smaller  corporations  are 
tending  more  and  more  strongly  toward  so  adjusting  their  affairs 
that  regularity — or  at  least  approximate  regularity — of  their 
dividend  rates  can  be  attained.  It  is  coming  to  be  more  and 
more  widely  recognized  by  bankers,  investors,  and  the  public  at 
large,  that  the  ability  of  a  company  to  maintain  regular  rates  is 
a  better  test  of  its  soundness  than  is  its  ability  to  pay  high  but 
irregular  dividends. 

§  329.    Regular  Dividends  vs.  Irregular  Profits 

In  sharp  contrast  to  the  desired  regularity  of  dividend  pay- 
ments is  the  wide  fluctuation  in  profits  that  is  characteristic  of 
the  majority  of  corporations.  Business  does  not  move  on  a 
regular  and  even  keel.  Economic  and  financial  conditions  vary; 
changes  in  management  occur;  difficulties  with  employees  arise; 
changes  in  taste  may  suddenly  create  new  markets  or  wipe  out 
markets — all  these  and  many  other  factors  which  are  constantly 
at  work  bring  about  kaleidoscopic  changes  which  often  come  as 
great  surprises  even  to  people  who  are  intimately  acquainted 
with  the  business.  The  sudden  outbreak  of  the  Great  War  in 
1 914,  followed  by  an  intense  depreciation  in  iron  and  steel  and 
machinery  industries,  was  an  unexpected  variation  of  this  kind. 


Ch.  30]  DIVIDENDS  891 

Within  a  few  months  it  was  followed  by  an  unprecedented  de- 
mand from  the  European  nations  at  war  for  the  products  of 
American  farms  and  factories,  stimulating  production  and  prices 
to  an  unheard-of  extent;  this  was  a  variation  no  less  surprising. 
Then  came  the  deflation  following  the  close  of  the  war.  This 
was  the  expected  happening  but  none  the  less,  many  of  the  great 
corporations  were  caught  unawares.  Thus  the  Central  Leather 
Company  showed  a  net  income  for  1919  of  $16,126,689,  and  in 
1920  a  net  deficit  of  $20,590,006. 

Also  rapid  fluctuations  are  constantly  taking  place  even 
under  normal  conditions.  Certain  Hues  of  business,  such  as 
building  construction,  ship  construction,  iron  and  steel  manu- 
facturing, and  manufacturing  of  novelties  and  articles  of  fashion 
or  luxury,  are  peculiarly  subject  to  great  fluctuations.  In 
Andrew  Carnegie's  famous  phrase  these  industries  are  either 
"prince  or  pauper."  For  instance,  during  the  fiscal  year  1913 
the  Lackawanna  Steel  Company  earned  over  $3,000,000  available 
for  dividends  on  its  common  stock,  equal  to  8.3%;  in  the  fiscal 
year  19 14,  prior  to  the  outbreak  of  the  Great  War,  the  same 
company  showed  a  deficit,  after  payment  of  fixed  charges, 
amounting  to  $1,500,000.  Again  in  1918,  profits  available 
for  dividends  were  over  $8,000,000,  while  the  company's  profits 
for  1919  were  but  $356,863,  and  it  "dipped"  into  surplus  to  pay 
dividends  to  the  extent  of  $1,749,152.  In  1920  this  deficit 
was  easily  covered  by  the  net  profits,  and  this  after  payment  of 
dividends. 

On  the  other  hand,  industries  which  sell  small  articles  for 
personal  use,  such  as  cigars  or  household  sundries,  are  likely 
to  avoid  fluctuation.  The  business  of  the  large  five-and-ten- 
cent  stores  is  especially  stable;  owing  to  the  fact  that  they  are 
operated  on  a  strictly  cash  basis,  there  is  usually  little  difficulty 
in  adjusting  expenditures  to  sales.  During  August  and  Sep- 
tember of  19 14,  when  almost  all  other  lines  of  business  were 
suffering,  the  business  of  F.  W.  Wool  worth  Company  and  S. 
S.  Kjresge  Company  both  showed  very  satisfactory  increases 


892  CORPORATE  FINANCE  [Bk.  II- 

over  the  business  of  preceding  years.  In  191 9  the  Wool  worth 
net  prci&ts  were  $10,361,557;  in  the  disastrous  year  that  followed 
they  were  $9,775,252.  The  Kresge  net  for  1919  was  $3,505,201, 
for  1920  $3,678,506.  Contrast  these  figures  with  those  of  the 
Central  Leather  Company's  loss  for  the  same  year  of  over 
$20,000,000. 

Companies  which  follow  the  policy  of  protecting  their  cus- 
tomers and  of  charging  prices  that  yield  them  only  a  moderate 
rate  of  profit  are  likely  to  be  rewarded  by  being  able  to  maintain 
a  fairly  steady  volume  of  sales  and  of  profits.  If  this  policy 
results  in  stabilizing  dividends,  the  credit  of  the  company  may 
be  so  much  enhanced  as  to  be  of  much  greater  value  than  any 
excessive  profits  it  might  have  extracted  from  its  customers. 

§  330.    Rule  for  Maintaining  Regularity  of  Dividend  Rate 

Although  companies  differ  widely  among  themselves,  they 
are  all  subject  to  a  greater  or  less  degree  of  fluctuation  in  their 
profits  and  at  the  same  time  (with  the  exception  of  the  closely 
held  corporations)  they  are  all  under  pressure  to  maintain  regu- 
lar rates  of  dividends.  How  are  these  two  conditions  to  be 
reconciled? 

There  is  obviously  only  one  satisfactory  answer — dividends 
must  not  be  allowed  to  rise,  even  in  the  most  prosperous  periods, 
above  a  conservative  estimate  of  the  minimum  earnings  of  the 
company.  Those  concerns  which  suffer  from  great  fluctuations 
find  this  to  be  a  harsh  rule.  It  means  that,  so  long  as  there 
remains  even  a  reasonable  possibility  that  earnings  may  sink 
close  to  or  below  the  level  of  fixed  and  contingent  charges,  no 
dividends  whatever  should  be  paid.  This  has,  in  fact,  been  the 
rule  followed  by  all  really  successful  corporations  the  nature  of 
the  business  of  which  involves  unavoidable  fluctuations.  The 
Carnegie  Steel  Company  ran  as  a  highly  successful  corporation 
for  many  years  without  paying  dividends.  When  Charles  M. 
Schwab  took  control  of  the  Bethlehem  Steel  Corporation  in  1902 
and  started  to  build  it  up,  it  was  on  the  basis  of  devoting  all  the 


Ch.  30]  DIVIDENDS  893 

earnings  to  upbuilding  without  paying  a  cent  of  dividends — 
and  the  policy  was  rigorously  followed  until  recent  years. 
Even  after  a  corporation  of  this  nature  begins  to  pay  dividends, 
it  is  not  to  be  expected,  if  the  management  is  conservative,  that 
they  will  rise  anywhere  near  the  level  of  the  average  earnings. 
The  rule  of  keeping  dividend  payments  below  the  level  of 
minimum  earnings  must  strictly  be  adhered  to. 

§  331.    Results  of  Conservative  Dividend  Policy 

Possibly  the  net  result  of  such  conservation  as  to  dividends 
may,  at  first  glance,  seem  to  be  a  permanent  loss  to  the  share- 
holder, who  can  never  expect  on  this  principle  to  receive  in 
dividends  any  large  proportion  of  the  actual  earnings  of  their 
corporation.  However,  this  loss  is  apparent,  not  real,  for  two 
reasons : 

1.  The  proportion  of  earnings  paid  out  in  dividends  being 
small,  there  is  a  rapid  increase  in  the  productive  capacity  of  the 
company,  due  to  betterments  provided  out  of  surplus,  and  this 
increase  may  in  the  course  of  a  few  years  raise  even  the  minimum 
net  earnings  far  above  the  average  earnings  that  would  otherwise 
have  been  received. 

2.  The  very  fact  that  lines  of  busine^  in  which  great  fluctua- 
tions occur  call  for  extreme  patience  and  self-denial  on  the  part 
of  shareholders,  means  that  comparatively  few  men  are  willing 
to  put  their  capital  and  energy  into  getting  a  business  of  this 
nature  thoroughly  well  established  and  that  opportunities  for 
exceptionally  large  profits  are,  for  this  reason,  left  open. 

It  is  partly  owing  to  this  condition  that  Andrew  Carnegie 
and  his  partners  built  up  their  wonderfully  profitable  iron  and 
steel  business.  Their  earnings  year  after  year  went  back 
into  the  business,  and  they  did  not  themselves  realize  the  full 
value  of  the  property  they  had  created.  But  when  the  time 
arrived  for  the  formation  of  the  United  States  Steel  Corporation, 
the  market  value  of  the  securities  that  went  to  the  Carnegie 
Company  was  well  over  $500,000,000. 


894 


CORPORATE  FINANCE 


[Bk.  II- 


The  same  rule  could  be  applied  with  even  less  question  and 
more  rigor  to  those  corporations  which  conduct  a  comparatively 
stable  business.  For  them  it  is  only  a  minor  hardship  to  keep 
dividend  payments  below  the  level  of  minimum  earnings.  This 
regularity  of  dividend  payments  results  in  a  gain  in  credit  that 
is  secured  with  relatively  little  sacrifice. 

.0)  b^f3ii\y&'jiiwiy 
§  332.    Dividend  Practice — ^Regular  Dividends 

Taking  a  few  examples  first  .of  regularity  of  dividends,  we 
have  such  records  as  that  of  the  American  Sugar  Refining 
Company,  which  paid  regular  dividends  every  year  from  1901 
to  July  1921  of  7%  per  annum,  and  an  extra  dividend  of  ^% 
each  quarter  from  July  2,  1918,  to  October  2,  1920.  The 
Mergenthaler  Linotype  Company,  during  the  ten  years  1902  to 
191 2,  paid  10%  regular  dividends  plus  a  5%  extra  dividend  each 
year,  making  15%  annually.  Since  then  its  dividends  have 
ranged  between  10%  and  15%. 

iff  The  dividend  record  of  the  John  B.  Stetson  Company, 
which  follows,  is  an  excellent  example  of  stability  combined 
with  liberal  distribution  of  large  profits  accumulated  during 
the  earlier  years  of  the  company's  existence.  It  will  be  noted 
that  after  1893  dividen^Js  were  decreased  slightly,  but  this  is  to 
be  explained  by  reason  of  the  great  depression  which  existed 
from  1893  to  1896  and  which  could  not  reasonably  have  been 
foreseen: 


John 

B. 

Stetson  Co. 

Common  Dividend  Record 

1892-1893 

6%  (per  annum) 

190S-1907 

20%  and    5%  extra 

I894-I896 

4%  (per  annum) 

(per  annum) 

1897 

5% 

1908 

25%     "    25%      " 

1898 

8% 

1909 

25% 

1899 

12% 

1910 

25%    "    25%      " 

1900 

15% 

191 1 

25% 

I 901 -I 902 

17%  (per  annum) 

1912 

25%      "     25%        " 

I903-I904 

20%  (per  annum) 

1913-1920 

25%  (per  annum) 

The  dividend  record  on  the  common  stock  of  the  National 


Ch.  30]  DIVIDENDS  895 

Biscuit  Company  is  an  excellent  example  of  conservative  and 
well-sustained  dividends.     It  is  as  follows: 


1899 

1% 

1909 

sK% 

1900-1905 

4%  (per  annum) 

1910 

6% 

1906 

S% 

1911 

8K% 

1907 

1908 

6% 

1912-1921 

7%  (per  annum) 

An  even  better  record  is  that  of  the  Delaware  and  Hudson 
Company  which  since  1897  has  paid  dividends  as  follows: 

1897-1900  5%  (per  annum) 

1901-1906  7%  (per  annum) 

1907-1921  9%  (per  annum) 

The  Eastman  Kodak  Company  has  paid  regular  10% 
dividends  since  1902,  but  with  extra  dividends  in  most  years 
running  from  as  low  as  93^%  to  as  high  as  50%.  These  extra 
dividends  are  so  high  that  they  overshadow  the  regular  dividends, 
and  if  any  criticism  of  so  successful  an  enterprise  is  permissible, 
it  may  be  based  on  the  desirability  of  attaining  a  greater  degree 
of  regularity  in  the  extra  as  well  as  in  the  so-called  "regular" 
disbursements. 

§  333*    Dividend  Practice — Irregular  Dividends 

On  the  other  hand,  concerns  engaged  in  fluctuating  lines  of 
business,  frequently  decline  to  restrict  themselves  to  the  pay- 
ment of  a  fixed  dividend  rate.  The  dividends  of  the  Anaconda 
Copper  Company  ranged  from  3%  in  1913,  to  26%  in  1907, 
and  then  down  until  they  were  suspended  entirely  in  1920. 
There  is  less  excuse  for  such  fluctuations  in  the  case  of  the 
American  Thread  Company,  the  business  of  which  is  relatively 
stable;  nevertheless  from  1902  to  192 1  dividends  varied  from  as 
low  as  4%  to  as  high  as  18%.  The  Bourne  Mills,  manufacturing 
textiles,  paid  dividends  between  1897  and  192 1,  fluctuating  from 
as  low  as  3%,  to  as  high  as  49^^%,  this  "peak"  dividend  being 
followed  in  the  next  year  by  a  dividend  of  sl4%. 


896  CORPORATE  FINANCE  [Bk.  II- 

Following  is  the  record  of  the  Porto  Rican  American  Tobacco 
Company,  which  is  even  more  remarkable  for  the  extent  and 
rapidity  of  its  fluctuations: 

1904  8%  1913  20%  (scrip) 

1905  3iK%  1914  20%  (scrip) 

1906  84%  1915  4%  and  5%  (scrip) 

1907  ioK%  1916  4%  and  10%  (stock) 

1908  5%  -  1917  4%  and  8%  (scrip) 

1909  9%  1918  9%  (scrip),  4%  (stock) 

1910  14%  ■  1919  6%  (scrip) 

1911  16%  1920  12%  (scrip) 

1912  16%  and  20%  (scrip)  1921  3%  (scrip) 

The  Atlantic  Refining  Company,  like  various  companies  of 
the  oil  and  other  extractive  industries,  prefers  to  allow  its 
dividends  to  fluctuate  with  its  profits.  Before  the  disintegration 
of  the  Standard  Oil  Company  it  was  customary  for  the  directors 
to  determine  at  the  end  of  each  quarter  what  rate  of  dividend  for 
the  quarter  should  be  declared.  In  this  case  the  fact  that  the 
company,  although  of  enormous  size,  was  comparatively  closely 
held,  was  no  doubt  another  reason  for  the  practice  of  letting 
dividends  follow  profits. 

From  companies  engaged  in  extractive  industries  come  the 
most  remarkable  records  of  enormous  profits,  and  it  is  perhaps 
natural  that  the  desirability  of  stability  in  their  dividend  dis- 
bursements should  not  appeal  to  them  as  of  great  importance. 
The  Calumet  and  Hecla  Mining  Company,  which  has  out- 
standing about  $2,500,000  of  capital  stock  with  a  par  value 
of' $25,  of  which  only  $12  per  share  is  paid  up,  has  paid  out 
total  dividends  from  1871  to  July  i,  1920,  amounting  to  over 
$150,000,000.  The  Koloniale  Bergbau  Gesellschaft  (Colonial 
Mining  Company),  a  German  concern,  which  operated  dia- 
mond mines  in  German  Southwest  Africa,  used  to  be  one  of 
the  large  dividend  payers.     Its  capital  was  only  about  $25,000. 


Ch.  30]  DIVIDENDS  897 

Its  dividend  record  up  to  the  year  of  the  Great  War  was  as  follows : 

1910 2,400% 

1911 2,500% 

1912 3.800% 

1913 2,500% 

Total  for  four  years 11,200% 

It  is  stated  by  financial  writers  that  in  the  period  of  deflation 
existing  in  1920-192 1,  over  100  prominent  companies,  the 
majority  of  which  had  stock  listed  on  the  New  York  Stock 
Exchange,  either  passed  or  curtailed  dividends. 

The  great  advantage  of  prudent  management  in  the  main- 
tenance of  a  comparatively  low  but  regular  rate  of  dividends  is 
shown  in  the  record  of  two  great  railroad  companies.  In  19 13 
the  earnings  of  the  Pennsylvania  Railroad  Company  fell  to  the 
lowest  figures  except  one  in  fifteen  years,  and  in  19 14  there  was 
a  further  sharp  decline.  Nevertheless,  even  at  this  level  the 
company's  regular  6%  dividends  continued  unaffected  until  the 
abnormal  conditions  of  1920  and  192 1  forced  them  down  to 
4%  in  the  latter  year.  Good  as  this  is,  the  record  of  the  Dela- 
ware and  Hudson  Company,  given  on  a  preceding  page,  is 
better,  for  its  dividend  has  been  maintained  steadily  at  9% 
through  all  the  trying  period  from  19 14  to  date. 


CHAPTER  XXXI 

PAYMENT  OF  DIVIDENDS 

§  334.    Dividends  from  Accumulated  Surplus 

Frequently  it  is  a  question,  when  the  net  income  for  a  given 
period  is  not  sufficient  to  pay  dividends,  whether  these  dividends 
should  nevertheless  be  paid  and  charged  against  the  surplus 
that  has  been  accumulated  in  previous  periods.  Ordinarily 
the  answer  that  should  immediately  be  given  is,  no.  It  is 
equivalent  to  an  individual  drawing  unnecessarily  upon  his 
savings,  and  while  conditions  may  exist  which  justify  such  a 
depletion  of  reserves,  it  should  not  ordinarily  be  permitted. 

All  this  refers  to  customary  financial  practice,  and  not  to 
the  legal  view  of  surplus  which  makes  no  distinction  between 
that  which  has  been  accumulated  in  the  past  and  that  which 
is  current.  The  legality  of  paying  dividends  out  of  accumu- 
lated surplus  cannot  be  questioned.  1  The  company  may  if  it 
will,  and  the  only  question  is  as  to  the  wisdom  of  so  doing. 

Granting,  then,  that  accumulated  surplus  is  legally  available 
for  the  payment  of  dividends,  when  will  good  practice  permit 
its  use  for  this  purpose?  In  July,  1914,  the  directors  of  the 
Baltimore  and  Ohio  Railroad  Company  voted  the  usual  semi- 
annual dividend  of  2%  on  the  preferred  and  3%  on  the  common. 
The  required  total  of  dividends  for  the  year,  which  amounted 
to  $11,538,888,  was  greater  than  the  surplus  during  the  year  by 
$2,469,095.  It  was  explained  unofficially  that  the  company  had 
not  exercised  its  privilege  of  prorating  depreciation  charges  over  a 
series  of  years,  but  had  charged  against  current  earnings  over 
$2,000,000  of  losses  incurred  in  the  Central  Western  floods  of 


•  As  to  this  and  the  legal  phase  of  dividends  generally,  see  Book  I,  Chs.  LII,  LIII;  for 
accounting  treatment  of  dividends,  see  Book  III,  Ch.  XIV. 

898 


Ch.  31]  PAYMENT  OF  DIVIDENDS  899 

March,  1913.  The  action  of  the  directors  was  based  on  the  belief 
that  the  decline  in  earnings  was  only  temporary,  and  on  a  pro- 
found desire  to  maintain  an  unblemished  record  of  regular 
dividends.  There  is  no  question  as  to  the  conservatism  and 
ability  of  the  board  and  this  action  was  somewhat  grudgingly 
accepted  by  the  financial  community  as  sound  and  correct. 

In  192 1  the  Louisville  and  Nashville  Railroad  Company  drew 
heavily  on  surplus  for  dividends,  its  income  statement  for  the 
year  showing  a  deficit  of  over  $5,000,000.  This  followed  a 
profit  after  payment  of  dividends  in  the  preceding  year  of 
over  $2,700,000.  As  the  road  has  undivided  profits  of  over 
$70,000,000,  it  could  well  afford  to  draw  on  these  to  keep  up  the 
regularity  of  its  7%  dividend. 

The  objections  to  paying  dividends  out  of  surplus  under  nor- 
mal conditions  are  obvious.  Not  only  is  it  ordinarily  an  im- 
proper use  of  surplus — a  squandering  of  permanent  reserves — 
but  it  is  a  public  exhibition  of  bad  management  and  an  advertise- 
ment of  the  fact  that  the  company  is  not  making  adequate  profits. 

§  335-    Cash  Requirements  for  Dividends 

In  discussing  the  payment  of  dividends  so  far,  it  has  been  as- 
sumed that  adequate  and  regular  profits — provided  they  are 
correctly  estimated — justify  dividends.  But  this  assumption 
cannot  be  permitted  to  stand  unchallenged.  It  is,  in  fact,  the 
direct  source  of  a  large  proportion  of  financial  embarrassments. 
Profits  do  not  necessarily  mean  cash  on  hand,  and  thousands  of 
corporations  which  have  been  able  to  report  highly  satisfactory 
profits  and  which  have  paid  good  dividends  on  the  strength  of 
those  profits,  have  found  themselves  a  short  time  later — to  the 
intense  surprise  and  indignation  of  their  stockholders  and  even 
of  their  directors  and  officers — in  the  hands  of  their  creditors.  It 
is  quite  apparent  that  many  business  men,  even  including  some  of 
unusual  capabilities,  do  not  fully  grasp  the  fact  that  dividend 
payments  should  be  dependent  not  only  upon  profits,  but  also 
upon  the  corporation's  cash  position. 


goo  CORPORATE  FINANCE  [Bk.  II- 

The  point  has  already  been  emphasized  and  will  later  be 
reiterated,  that  many  companies  find  their  chief  financial  diffi- 
culties arising,  not  in  periods  of  depression  and  small  business, 
but  in  their  periods  of  prosperity.  If  more  business  is  to  be  done 
more  working  capital  is  usually  imperative.  To  attempt  to  do 
a  large  volume  of  business  with  a  small  working  capital  is  one  of 
the  quickest  and  surest  methods  of  financial  suicide.  Yet  this  is 
precisely  the  course  that  is  followed  by  those  concerns  whjch, 
on  the  strength  of  a  showing  of  profits,  declare  dividends,  the 
payment  of  which  seriously  depletes  their  working  capital. 
Under  these  conditions  the  only  prudent  course  is  to  withhold 
dividends  until  in  the  normal  course  of  the  company's  business 
cash  is  accumulated  beyond  the  requirements  of  the  business. 
It  is  not  merely  a  book  surplus,  but,  in  addition,  a  satisfactory 
cash  balance,  that  should  furnish  the  basis  for  a  declaration  of 
cash  dividends. 

To  give  a  concrete  illustration  of  a  situation  which  does  not 
justify  cash  dividends,  we  may  take  the  case  of  a  flour  mill 
company  operating  in  Canada  which  has  outstanding  capital 
stock  of  $1 ,000,000.  During  a  recent  year  the  company  reported 
net  profits  available  for  dividends  amounting  to  $91,462,  and 
declared  dividends  of  $30,000,  or  3%,  leaving  an  addition  to  the 
surplus  of  $61,462.  On  the  face  of  it  there  would  seem  to  be  no 
reasonable  question  as  to  the  conservatism  of  this  small  dividend 
declaration.  When  we  come  to  examine  the  company's  balance 
sheet  after  payment  of  the  dividend,  however,  we  find  that  it 
shows  a  secured  overdraft  at  its  bank  of  $191,000.  Its  cash  on 
hand  is  less  than  $6,000,  and  its  cash  and  receivables  together 
are  less  than  its  current  liabilities.  A  glance  at  this  balance 
sheet  is  enough  to  prove  that  the  payment  of  dividends  was 
not  merely  unwise,  but  a  reckless  and  dangerous  proceeding. 

§  336.     Paying  Dividends  with  Borrowed  Cash 

Sometimes  circumstances  arise  which  justify  the  directors 
of  a  corporation,  in  their  opinion,  in  borrowing  the  money 


Ch.  3i]  PAYMENT  OF  DIVIDENDS  goi 

with  which-  to  pay  dividends.  This  is,  in  fact,  quite  frequently 
the  case  with  companies  which  have  to  contend  with  wide  season- 
al fluctuations,  and  with  companies  which  normally  operate  with 
a  small  working  capital.  As  has  previously  been  pointed  out, 
transportation .  and  communication  enterprises  frequently  be- 
long in  this  last-named  group.  Commenting  on  numerous  cuts  in 
the  dividends  of  railway  corporations,  the  London  Financial 
Times  of  October  2,  19 14,  says  editorially: 

It  is  necessary  to  be  guided  by  the  amount  of  cash  actually  in 
the  till.  Borrowing  on  temporary  loans  from  one's  bankers  in 
order  to  make  up  the  heavy  amount  of  ready  cash  required  to  pay 
dividends — a  common  and  perfectly  proper  procedure  in  normal 
times — is  much  less  desirable  under  existing  financial  conditions. 

For  companies  of  the  two  types  just  referred  to,  it  may  be 
sound  policy  at  times  to  pay  dividends  with  the  proceeds  of 
temporary  bank  loans — assuming,  of  course,  that  there  can 
be  no  reasonable  question  as  to  the  company's  ability  to  repay 
these  loans  without  crippling  itself.  There  is  a  great  distinc- 
tion, however,  between  this  situation  and  that  which  exists 
when  a  corporation  issues  long-term  obligations  or  when  it 
sells  additional  stock  in  order  to  obtain  money  with  which 
to  pay  di\'idends.  If  a  corporation  were  to  follow  this  practice 
during  a  period  when  it  was  not  actually  making  a  legitimate 
showing  of  profits,  it  would  be  clearly  engaged  in  a  fraudulent 
transaction.  When  it  issues  long-term  obligations  or  sells 
additional  stock  during  a  period  of  adequate  profits  or  for  the 
purpose  of  paying  dividends  that  are  charged  against  accumu- 
lated surplus,  its  course  of  action  is  not  necessarily  fraudulent, 
but  it  is  certainly  open  to  serious  question  as  to  soundness. 

A  case  which  aroused  a  great  deal  of  discussion  in  financial 
circles  occurred  in  191 3,  when  the  management  of  the  American 
Can  Company  decided  to  pay  up  a  portion  of  the  dividend  claims 
on  its  preferred  stock  issue  which  had  been  accumulating  over 
a  period  of  several  years.  The  company  sold  an  issue  of  $14,- 
000,000  5%  debenture  bonds.     Ostensibly  the  sale  of  the  deben- 


902  CORPORATE  FINANCE  [Bk.  II- 

tures  was  to  recoup  the  treasury  of  the  company  for  capital 
expenditures  from  earnings  and  to  provide  additional  working 
capital.  The  proper  entries  were  made  on  the  books,  of  course, 
but  the  cash  proceeds  from  the  bonds  paid  a  24%  dividend  on 
preferred  stock,  and  the  company's  working  capital  had  no 
more  available  cash  than  before. 

While  it  would  have  been  safer  for  the  company  to  pay  off 
the  arrears  of  preferred  dividends  from  profits  as  they  were  made, 
it  must  be  admitted  that,  as  a  practical  matter,  the  company 
was  not  injured  by  this  somewhat  doubtful  financing.  It  has 
since  then  strengthened  its  financial  position  greatly  and, 
though  no  dividends  have  been  paid  on  its  common  stock,  has 
fully  maintained  its  dividend  on  the  preferred  and  had  built  up 
its  surplus,  at  the  end  of  1920,  to  over  $20,000,000.  It  is 
indicative,  however,  of  its  cash  needs  and  also  o£  the  difference 
between  profits  and  cash,  that  with  over  $20,000,000  of  surplus 
early  in  192 1,  this  same  company  was  forced  to  issue  $12,000,000 
in  short-term  notes  to  secure  funds  with  which  to  purchase  tin 
plate  and  other  necessary  material. 

§  337.    Lack  of  Prudence  in  Paying  Dividends 

It  seems  almost  superfluous,  after  what  has  been  said  above^ 
to  cite  examples  of  financial  difficulties  which  are  traceable  to 
the  payment  of  dividends  which  were  not  earned  or  which 
could  not  be  met  without  reducing  working  capital  below  the 
limits  of  safety.  The  number  of  examples  is  practically  infinite. 
Some  of  the  most  flagrant  are  furnished  by  the  records  of  im- 
portant industrial  combinations.  And,  as  to  this,  we  cannot 
do  better  than  present  the  following  abstract:  2 

Nearly  all  the  large  industrial  combinations  have  been  guilty 
of  distributing  dividends  recklessly.  This  is  due  in  part  to  the 
extravagant  promises  on  the  strength  of  which  securities  have  been 
sold,  in  part  to  the  optimism  of  promoters  and  directors,  in  patt  to 
a  desire  to  unload  on  the  part  of  insiders. 


'  Dewing  on  Corp.  Prom.  &  Reorg.,  p.  549  et  seq. 


Ch.  31]  PAYMENT  OF  DIVIDENDS  903 

The  failures  of  the  Corn  Products  Co.,  The  American  Malting 
Company,  the  U.  S.  Realty  Co.  and  the  New  England  Cotton 
Yarns  Co.  were  the  direct  results  of  unwarranted  payments  of 
dividends.  The  U.  S.  Leather  Co.,  the  National  Cordage  Co.,  the 
National  Salt  Co.,  the  Consolidated  Cotton  Duck  Co.,  and  the 
International  Cotton  MUls  Corporation,  were  all  seriously  weak- 
ened by  payment  of  dividends  at  the  expense  of  their  cash  position. 

In  the  case  of  the  American  Malting  Co.,  it  was  proved  that  the 
directors  must  have  declared  dividends  without  having  before  them 
any  statements  of  earnings.  This  same  thing  probably  is  true  also 
of  other  corporations. 

The  great  fluctuations  in  industrial  earnings  are  the  chief  argu- 
ment against  the  use  of  bonds  by  industrials  and  in  favor  of  con- 
servatism in  paying  dividends.  In  igo8  the  Westinghouse  Co.  had 
gross  sales  of  $20,000,000  and  a  deficit  of  $1,000,000;  in  1909,  gross 
sales  of  $30,000,000  and  a  net  profit  of  $3,000,000. 

These  fluctuations  involve  a  strong  tendency  to  borrow  on 
short-term  notes  or  even  to  use  short-term  notes  as  a  means  of 
raising  money  with  which  to  pay  dividends. 

There  is  sound  reason  for  borrowing  on  short  time  in  order  to 
meet  fixed  charges  inasmuch  as  the  insolvency  and  reorganization 
of  the  company,  even  though  it  be  only  temporary,  involves  a 
severe  blow  to  its  credit  and  trade.  For  instance,  after  the  panic 
of  1907,  the  General  Electric  Co.  had  a  loss  of  25%  in  its  business 
and  the  Westinghouse  Co.  37%.  The  explanation  seems  to  be  in 
the  failure  of  the  Westinghouse  Co. 

The  fact  that  insufiicient  working  capital  exists  at  the  time  of 
the  insolvency  of  a  company  is  not  proof  that  this  is  the  actual 
cause  of  insolvency.  It  is  very  often  true  that  the  lack  of  working 
capital  is  itself  due  to  unwise  payments  on  account  of  fixed  charges 
and  on  account  of  dividends. 

The  only  possible  reasons  which  can  lead  directors  to  pay  out 
dividends  in  the  face  of  falling  earnings  and  increasing  floating 
debt  are: 

1.  Ignorance  of  corporation's  true  financial  position. 

2.  A  belief  that  later  proves  unfounded  in  the  immediate 

return  of  prosperity. 

3.  A  desire  to  give  the  corporation  a  higher  standing  among 

bankers  and  investors  than  its  earnings  warrant. 


904  CORPORATE  FINANCE  [Bk.  II- 

§  338.    Scrip  Dividends 

Scrip  dividends  are  those  which  are  issued  in  the  form  of 
promises  to  pay  on  the  part  of  the  corporation.^  These  promises 
may  or  may  not  bear  interest.  They  usually  mature  at  some 
definite  date,  but  may  be  purely  indefinite  I.  O.  U's,  redeemable 
at  the  oprion  of  the  corporation  or  redeemable  within  a  certain 
limit  of  time.  They  are  intended  usually  to  meet  the  situation 
which  has  been  briefly  described  above — that  of  a  corporation 
which  has  made  a  good  showing  of  profits  during  a  given  period, 
but  is  not  in  sufficiently  strong  financial  position  to  part  with 
cash. 

Payment  of  dividends  in  scrip  is  sometimes  voted  in  order  to 
avoid  spoiling  a  dividend  record  that  would  otherwise  be  un- 
broken, or  as  a  temporary  expedient  to  keep  up  dividends  on 
preferred  stock  issues.  After  the  Westinghouse  reorganization 
in  1 89 1,  the  first  dividend  of  iK%  on  the  preferred  stock  was 
issued  in  scrip,  so  as  not  to  reduce  the  working  capital  im- 
mediately. 

In  the  fall  of  1914,  the  Cambria  Steel  Company  desired  to 
keep  up  its  regular  5%  dividends,  but  on  account  of  war  con- 
ditions inventories  were  larger  than  usual,  and  available  cash 
resources  were  smaller  than  usual,  and  the  directors  did  not  think 
it  wise  to  pay  out  in  cash  the  $562,500  required.  The  difficulty 
was  solved  by  issuing  a  scrip  dividend  bearing  5%  interest. 
The  same  thing  was  done  in  191 5.  Since  then  all  this  scrip  has 
been  paid.  Sears,  Roebuck  and  Company  paid  a  2%  scrip 
dividend  in  the  early  part  of  1921,  but  perceiving  that  the 
crisis  before  the  company  was  more  serious  and  of  longer  dura- 
tion than  at  first  supposed,  suspended  common  stock  dividends 
thereafter.  The  Porto  Rican  Tobacco  Company,  as  noted  in  the 
preceding  chapter,  has  paid  many  of  its  dividends  in  scrip. 

The  payment  of  accumulated  dividends  on  preferred  shares 
has  been,  in  a  number  of  cases,  taken  care  of  in  this  manner. 
The  Trenton  Potteries  Company  has  outstanding  $411,570  of 

>  See  also  Book  I,  §  492. 


Ch.  3i]  PAYMENT  OF  DIVIDENDS  905 

"funding  certificates"  which  were  issued  to  stockholders  who 
exchanged  their  8%  cumulative  preferred  for  a  new  issue  of 
8%  non-cumulative  preferred.  These  stockholders  received 
44%,  being  the  amount  of  their  dividends  in  arrears,  in  the  form 
of  "funding  certificates,"  bearing  interest,  if  earned,  at  the  rate 
of  4%. 

§  339*    Stock  Dividends  * 

A  form  of  dividend  payment  which  appears  to  be  growing 
in  popularity  is  the  issuance  of  stock  representing  profits  not 
otherwise  distributed.  Stock  dividends  are  issued  for  any  of 
three  reasons: 

1.  In  order  to  give  to  stockholders  tangible  evidence  of 

the  increasing  value  of  their  property. 

2.  In  order  to  keep  the  market  price  of  the  stock  at  a  point 

which  will  make  it  more  readily  salable. 

3.  In  order  to  veil  huge  profits  in  prospect  by  making 

it  possible  to  declare  a  small  or  moderate  dividend 
on  a  large  amount  of  stock  instead  of  a  very  high  divi- 
dend on  a  small  amount  of  stock. 

These  three  motives  are  not  always  clearly  distinguished; 
one  of  the  three  is  usually  predominant.  It  will  be  agreed  by 
everyone  that  the  payment  of  a  stock  dividend  does  not  in 
itself  add  anything  to  the  assets  of  the  stockholders  who  receive 
the  dividend.  If  the  owner  of  one  share  of  stock  in  a  cor- 
poration with  $100,000  stock  outstanding,  is  given,  we  will  say 
a  900%  stock  dividend,  so  that  he  becomes  the  owner  of  10 
shares  in  a  $1,000,000  corporation,  his  real  standing  has  not  been 
changed  in  the  slightest.  He  remains,  just  as  he  was  at  the 
beginning,  the  owner  of  1/1,000  interest  in  the  enterprise.  His 
only  real  gain  comes  in  the  mental  satisfaction  that  he  receives 
if  he  continues  to  hold  his  stock  indefinitely  (and  this  is  by  no 
means  a  negligible  factor),  or  in  the  easier  marketability  of  his 


*  See  also  i  133,  and  Book  I,  {  490. 


906  CORPORATE  FINANCE  [Bk.  II 

holdings  if  he  wishes  to  sell  them.  Even  the  third  motive  does 
not  affect  the  shareholder's  income  but  merely  the  nominal  rate 
of  dividend  on  his  holdings. 

,  A  number  of  companies  have  adopted  the  practice  of  paying 
regular  stock  dividends  in  addition  to  cash  dividends.  Annual 
4%  stock  dividends  were  paid  by  the  Proctor  and  Gamble 
Company  from  1913  to  1920.  The  American  Light  and  Trac- 
tion Company  has  for  a  number  of  years  declared  dividends  in 
cash  and  also  in  stock.  The  American  Gas  and  Electric  Com- 
pany has  paid  stock  dividends  in  addition  to  its  cash  dividends 
since  1914.  These  amount  to  4%  per  annum  with  an  extra 
dividend  of  27^^%  in  1919.  It  may  be  assumed  that  the 
practice  in  the  case  of  public  utility  companies  has  in  view  the 
desirability  of  keeping  down  the  rate  of  cash  dividends  to  a 
moderate  amount.  Much  the  same  plan  has  been  followed 
by  some  of  the  English  public  utility  companies. 

The  oil  companies  frequently  pay  stock  dividends.  Sinclair 
Oil  Corporation  paid  4%  in  1920  and  the  same  dividend  in 
192 1  in  no-par- value  stock;  Middle  States  Oil  Corporation  paid 
12%  in  stock  dividends  in  1918,  38%  in  1919,  and  70%  in  1920, 
all  in  no-par- value  stock.  In  1920  the  Continental  Oil  Company 
paid  a  stock  dividend  of  200%;  International  Petroleum,  Ltd., 
paid  100%;  and  the  Standard  Oil  Company  of  Indiana  150%. 
In  192 1  the  Standard  Oil  Company  of  Nebraska  paid  a  stock 
dividend  of  200%, 

§  340.    Stock  Dividends  to  Represent  Surplus 

Stock  dividends  which  are  intended  to  represent  large  ac- 
cumulations of  surplus  that  could  not  be  disbursed  in  cash  are 
frequent.  Some  of  those  mentioned  were  of  this  nature.  Among 
the  automobile  companies,  the  Packard  Motor  Company  paid  a 
40%  stock  dividend  in  191 3,  and  in  19 16  paid  stock  dividends 
aggregating  60%.  The  record  among  motor  companies  up  to 
the  present  time  is,  however,  held  by  the  Chalmers  Company, 
which  in  19 10  paid  a  stock  dividend  of  900%,     The  subsequent 


Ch.  31]  PAYMENT  OF  DIVIDENDS  907 

history  of  the  company  does  not  indicate  any  justification  for 
this  increase  of  outstanding  stock. 

The  record  of  the  Singer  Sewing  Machine  Company  shows 
various  stock  dividends  of  100%  to  200%.  Other  instances 
are  the  Pacific  Mills,  which  increased  its  capital  stock  from 
$3,000,000  to  $12,000,000  in  191 2,  and  declared  a  200%  stock 
dividend,  at  the  same  time  reducing  the  par  value  of  its  shares 
from  $1,000  to  $100,  and  again  in  191 7  increased  its  stock  and 
paid  stockholders  a  25%  stock  dividend;  the  American  Rolling 
Mills  Company,  which  paid  a  stock  dividend  of  Z2MP/0  iii  iQo?? 
and  another  stock  dividend  of  100%  in  1909,  and  additional 
stock  dividends  thereafter  aggregating  to  February  i,  1920, 
over  68%;  the  George  E.  Keith  Company,  which  in  1913  issued 
$4,000,000  7%  cumulative  preferred,  later  designated  "Second 
Preferred,"  as  a  200%  stock  dividend;  and  the  Midvale  Steel 
Company  which  in  1910  declared  a  1,200%  stock  dividend, 
increasing  the  outstanding  issue  from  $750,000  to  $9,750,000, 


CHAPTER  XXXII 

SURPLUS 

§  341.    The  Nature  of  Surplus  ^ 

The  final  item  in  our  formula  for  income  consists  of  "balance 
carried  to  the  permanent  surplus  account."  It  is  sometimes 
labeled  "surplus  for  the  period,"  but  inasmuch  as  this  phrase  is 
applied  also  to  what  we  have  called  "balance  applicable  to 
dividends  and  surplus,"  it  is  somewhat  misleading  and  for  this 
reason  is  not  used.  Much  confusion  of  thought  arises  out  of 
the  continual  inaccuracies  and  variations  in  the  application 
of  such  terms  as  "income,"  "profits,"  "earnings,"  and  "surplus." 
Until  the  general  usage  of  this  and  many  other  business  terms 
becomes  more  clearly  settled,  it  will  be  impossible  wholly  to 
avoid  this  confusion. 

One  term  which  should  be  clearly  distinguished,  however, 
is  "surplus  reserve."  Surplus  reserve,  more  frequently  referred 
to  simply  as  "surplus,"  is  in  effect  simply  an  account  or  a  group 
of  accounts  kept  in  the  company's  books  which  show  the  value 
of  the  equity  belonging  to  stockholders  over  and  above  the  par 
value  of  the  outstanding  shares.  Like  many  other  accounts, 
surplus  is  in  part  the  result  of  valuations,  or  of  a  series  of  val- 
uations. If  the  estimate  of  value  is  judged  by  the  directors  or 
ofiicers  of  the  corporation  to  be  wrong,  it  may  be  changed  by  a 
mere  entry  on  the  company's  books.  An  instance  has  been 
cited  in  the  preceding  chapter  of  a  publishing  company,  which 
increased  its  Good- Will  account  by  $100,000  in  order  to  inflate 
the  Surplus  account  correspondingly  so  that  a  dividend  might  be 
legally  declared.2     In  the  section  following,  the  various  methods 

I  For  a  more  detailed  discussion  of  the  nature  of  surplus,  see  Book  III,  Part  I,  "Surplus 
and  Reserve  Accounts." 
'See  i  128. 

908 


Ch.  32]  SURPLUS  909 

through  which  a  Surplus  account  may  be  built  up  are  reviewed. 
For  the  immediate  purpose,  it  is  sufficient  to  emphasize  the 
point  that  surplus  reserve  is  in  itself  nothing  more  nor  less  than  a 
formal  and  inconclusive  appraisal  of  the  shareholders'  equitable 
interest  in  the  corporation  above  the  par  value  of  their  holdings 
of  stock. 

§  342.    Sources  of  Surplus 

We  have  spoken  of  surplus  in  the  preceding  chapters  as  if 
it  were  always  derived  from  earnings.  Ordinarily  this  is  so, 
but  surplus  may  result  from  other  causes  as  well.  Five  possible 
sources  of  surplus  are  given  below: 

1.  Inheritance  from  previously  absorbed   corporations. 

2.  Sale  of  securities  above  par. 

3    Sale  of  assets  above  their  book  value. 

4.  Revaluation  of  assets. 

5.  Accumulation  of  net  earnings. 

§  343.    Purchased  Surplus 

The  first  source  of  surplus  is  uncommon,  inasmuch  as  most 
new  corporations,  even  those  which  take  over  going  businesses, 
carry  the  assets  which  they  acquire  at  their  full  cost  value — 
no  more  and  no  less — so  that  they  start  with  neither  a  surplus 
nor  a  deficit;  and  this  would  seem  ordinarily  to  be  the  correct 
procedure.  However,  there  are  occasional  exceptions.  Some 
years  ago  the  Dominion  Linens  Company  of  Canada  was 
organized  with  an  issued  capital  stock  of  $250,000.  The  com- 
pany, according  to  a  statement  prepared  by  the  well-known 
accounting  firm  of  Price,  Waterhouse  and  Company,  showed 
assets  of  $267,684.  After  deducting  a  small  amount  of  accounts 
payable,  there  was  left  a  surplus  at  the  outset  of  $14,138.  It 
should  be  remarked,  however,  that  among  the  assets  was  one 
item  of  "Good- Will,  Trade-Marks,  etc.,"  valued  at  $20,000. 
A  surplus  under  such  circumstances  can  hardly  escape  the 
suspicion  of  being  more  or  less  fictitious.     It  is  scarcely  safe  to 


910  CORPORATE  FINANCE  [Bk.  II- 

assume  that  the  assets  acquired  are  worth  more  than  what  was 
paid  for  them.  The  fact  that  these  assets  may  have  been  carried 
on  the  books  of  the  previously  existing  companies  at  a  higher 
book  value  than  was  paid  for  them,  has  no  bearing  on  the 
case  so  far  as  the  new  company  is  concerned. 

§  344.    Surplus  from  Sale  of  Securities  or  Fixed  Assets 

The  second  source  of  surplus  consists  of  the  sale  of  securities 
above  par.  In  such  a  case  the  corporation  receives  a  greater 
sum  than  the  nominal  value  of  the  obligations  or  the  shares  which 
it  issues.  This  additional  sum  may  be  carried  to  an  account 
called  "Premium  on  Securities"  or  some  such  title,  or  it  may 
be  and  frequently  is  credited  direct  to  Surplus.  It  is  clear  that 
a  surplus  which  arises  in  this  form  is  not  to  be  regarded  as  a 
proper  source  of  dividends,  inasmuch  as  the  premium  on  shares 
or  bonds  is  in  reality  a  contribution  to  the  capital  assets  of  the 
company. 

In  this  matter  industrial  and  railroad  corporations  might 
profitably  take  a  leaf  from  the  practice  of  banks.  In  organizing 
new  banks  it  is  frequently  agreed  that  every  $100  share  shall  be 
sold  at  $150  or  $200,  or  some  other  amount  above  its  nominal 
value,  so  as  to  create  a  Surplus  account  at  the  outset.  In  this 
way  the  special  liability  usually  imposed  on  financial  institutions 
by  the  statutory  law  is  provided  for  in  advance  and  the  surplus 
so  created  adds  materially  to  the  stability  of  the  institution. 
As  the  bank  earns  profits,  these  are  carried,  not  to  the  Surplus 
account,  but  to  an  account  entitled  "Undivided  Profits"  out  of 
which  dividends  are  declared.  From  time  to  time  the  directors 
may,  more  or  less  arbitrarily,  transfer  whatever  sums  they 
decide  upon  from  the  Undivided  Profits  account  to  the  Surplus 
account.  It  is  understood  that  credits  to  Surplus  are  not 
intended  to  be  distributed,  but  are  regarded  as  an  integral  part 
of  the  permanent  capital  of  the  institution. 

The  third  source  of  surplus  is  through  the  sale  of  permanent 
assets  which  are  not  intended  for  trading  purposes,  for  a  sum 


Ch.  32]  SURPLUS  ^11 

above  their  book  value.  Frequently  assets  are  written  down 
aver  a  long  period  until  their  book  valuation  becomes  only  a 
small  portion  of  their  real  value.  To  take  an  extreme  and 
notable  instance,  the  immensely  valuable  property  of  the  Bank 
of  England  on  Threadneedle  Street,  London,  does  not  appear  on 
the  balance  sheet  of  the  corporation  at  all. 

§  345*    Surplus  from  Revaluation  of  Assets 

The  fourth  source  of  surplus  is  the  revaluation  of  assets 
which  have  not  been  sold  but  are  intended  to  be  retained.  This 
is  a  tempting  expedient  for  a  company  which  is  running  at  an 
operating  loss  or  with  very  small  profits,  and  yet  is  under 
pressure  to  make  a  satisfactory  showing.  An  extreme  instance 
of  this  was  the  revaluation  of  the  hemlock  bark  land  of  the 
United  States  Leather  Company  in  1902.  This  land  had  been 
bought  at  a  fair  market  valuation  almost  ten  years  before. 
Since  then  prices  of  timber  and  bark  had  gone  up  and  a  com- 
mittee of  directors  reported  that  the  bark  property  was  worth 
about  $14,000,000  more  than  its  book  value.  In  order  to  show 
this  increased  value  on  the  books,  without  such  an  obvious 
write-up,  the  officials  incorporated  the  Central  Pennsylvania 
Lumber  Company  (all  of  the  stock  of  which  was  owned  by  the 
United  States  Leather  Company),  which  bought  the  timber 
(only)  on  the  revalued  bark  land,  giving  in  payment  $16,000,000 
of  first  mortgage  bonds.  .; 

The  handling  of  timber  properties  so  as  to  present  a.  fair 
statement  of  the  results  that  are  actually  achieved,  always 
raises  difficult  questions.  Taxes  assessed  against  timber  lands 
are  frequently  charged  into  an  asset  account  in  order  to  show 
the  total  carrying  charges  of  the  property.  The  continual  rise 
in  land  values,  and  especially  in  the  values  of  timber  properties, 
has  been  so  regular  that  this  method  has  seldom  been  found 
disappointing.  As  to  the  revaluation  of  timber  properties,  it  is 
thought  by  some  authorities  that  there  is  no  special  objection 
in  this  case,  provided  the  surplus  thus  created  is  put  into  a 


912  CORPORATE  FINANCE  [Bk.  II- 

separate  account  and  not  treated  as  a  part  of  the  general  surplus 
available  for  dividends.  Coal  lands  are  not  infrequently 
revalued  and  the  increased  value  added  to  surplus  to  be  used 
for  dividends  if  so  desired.  An  instance  of  this  is  shown  in  the 
income  statement  of  the  ConsoUdation  Coal  Company  in  the 
preceding  chapter. 

The  question  as  to  whether  assets  should  be  revalued  or 
not,  frequently  arises  also  in  the  cases  of  banks  and  other  finan- 
cial institutions  which  own  large  amounts  of  securities.  On  a 
rising  market  these  securities  may  frequently  have  a  market 
value  much  higher  than  their  original  cost,  and  the  officers  or 
directors  of  the  company  may  desire  that  this  extra  value  should 
be  shown  on  the  books  and  credited  to  Surplus.  Independent 
accountants  are  usually  strongly  averse  to  this  practice,  on  the 
ground  that  it  makes  a  fictitious  showing  of  profits.  If  the 
securities  are  actually  sold  and  a  profit  is  reahzed,  then  this 
profit  will  naturally  go  into  a  surplus  account.  Otherwise 
it  is  regarded  as  sound  and  correct  to  carry  them  at  their  cost 
valuation.  It  is  not,  however,  inconsistent  with  this  principle 
to  insist  that  declinations  in  market  value  should  be  written 
off  against  surplus. 

It  must  be  remembered  that  the  Surplus  account  is  at  best 
only  an  estimate  and  that  it  is  highly  desirable  to  keep  this 
estimate  always  well  within  conservative  limits.  In  operating 
an  enterprise  and  selling  its  products,  a  valuable  trait  is  the 
optimism  that  will  carry  a  man  forward  through  discouragements 
and  temporary  defeats.  But  in  estimating  the  results  and 
forecasting  the  future,  it  is  necessary  above  all  to  be  cautious 
and  even  skeptical. 

In  general  it  is  safe  to  say  that  the  instances,  in  which  an 
upward  revaluation  of  the  permanent  assets  of  a  company  is 
permissible,  are  highly  exceptional  and  that  in  these  exceptional 
cases  the  surplus  thus  created  should  always  be  plainly  ear- 
marked so  that  there  will  be  no  mistaking  its  source. 3 

•  For  further  discussion  of  this  subject,  see  Oh.  XXIX,  "Net  Income." 


Ch.  32]  SURPLUS  913 

§  346     Surplus  from  Earnings 

The  fifth  and  most  important  source  of  surplus  consists 
of  savings  out  of  the  company's  earnings.  We  have  already 
seen  that  every  year  should  yield  a  balance  of  profits  above  all 
fixed  charges  and  above  all  dividends.  This  balance,  if  credited 
to  Surplus  year  after  year,  will  in  time  build  up  a  large  Surplus 
account.  If  the  building  up  of  this  account  is  accompanied 
by  consistent  writing  down  of  all  assets  of  doubtful  value,  the 
balance  sheet  of  the  company  will  in  time  show  an  increasing 
and  very  substantial  equity  on  the  part  of  the  shareholders. 
If  surplus  were  only  built  up  out  of  conservatively  estimated 
earnings,  it  could  be  safely  accepted  as  a  fairly  accurate  measure 
of  the  real  prosperity  and  sohdity  of  the  business.  But  surplus 
which  comes  from  the  other  sources  that  have  been  named — 
even  though  it  may  be  a  genuine  surplus  which  has  been  realized 
— gives  no  convincing  evidence  of  earning  power  or  of  con- 
servative and  able  management. 

JU  The  term  "surplus,"  therefore,  in  itself  means  little.  It 
is  merely  the  valuation  the  officials  of  the  company  put  upon 
the  corporate  business  and  property  in  excess  of  the  par  value  of 
the  capital  stock — or  book  value  if  the  capital  stock  has  no 
par  value — plus  any  unencumbered  reserves.  It  should  always 
be  examined  with  care,  and  its  origin  and  its  supporting  assets 
should  be  determined  before  basing  upon  it  any  judgment  as  to  the 
prosperity  or  good  management  of  the  company  which  shows  it. 

§  347.    Policy  as  to  Income  and  Surplus 

In  discussing  the  desirability  of  establishing  and  maintaining 
a  regular  rate  of  dividends,  it  has  been  suggested  that  the 
only  safe  principle  to  follow  is  to  fix  the  dividend  rate  below 
the  estimated  minimum  earnings,  thus  making  sure  that  it  will 
be  kept  up  year  after  year.  This  leaves  all  the  extra  profits 
of  good  years  to  go  into  surplus.  If  the  company's  business 
is  of  a  highly  stable  nature  so  that  the  fluctuations  in  earnings 
are  slight,  it  follows  that  the  extra  earnings  of  the  good  years 


914  CORPORATE  FINANCE  [Bk.  II- 

will  be  relatively  small  and  surplus  will  accumulate  slowly.  If 
the  business,  on  the  other  hand,  fluctuates  a  great  deal,  these 
dividends  will  absorb  only  a  small  proportion  of  average  earnings, 
and  the  greater  portion  will  remain  as  a  credit  to  the  Surplus 
account. 

This  principle,  therefore,  automatically  results  in  piling 
up  a  surplus  almost  in  direct  proportion  to  the  degree  of  fluc- 
tuation of  earnings.  And  this  is  as  it  should  be.  A  company 
engaged  in  a  business  which  enjoys  steady  earnings  will  have 
no  trouble  in  raising  fresh  capital  for  any  extensions  that  may 
be  required  and  which  can  be  shown  to  be  clearly  profitable. 
It  is  not  necessary,  therefore,  that  new  capital  should  be  pro- 
vided by  savings  out  of  earnings.  On  the  other  hand,  a  company 
the  earnings  of  which  fluctuate  widely  is,  on  the  face  of  it, 
engaged  in  a  speculative  business  and  cannot  easily  secure 
fresh  capital  on  favorable  terms.  Only  through  accumulations 
out  of  earnings  can  the  business  be  extended  and  stabilized. 

The  principle  that  has  just  been  stated  is  of  course  put 
forward  only  as  a  general  rule  which  is  subject  to  innumerable 
qualifications  and  exceptions.  First  of  all,  it  may  be  impossible 
to  determine  in  advance  what  the  minimum  earnings  are  likely 
to  be.  Second,  it  may  be  desirable  to  use  some  discretion  and 
diplomacy  in  dealing  with  stockholders  and  to  satisfy  their 
wishes  from  time  to  time  by  distributing  a  portion  of  the  extra 
earnings  of  prosperous  years,  as  extra  or  special  dividends.  For 
both  these  reasons  the  strict  and  inflexible  application  of  the 
rule  that  has  been  stated  is  not  always  to  be  insisted  upon. 
Most  well-managed  companies  are  satisfied  if  they  reach  some 
reasonable  approximation  in  applying  the  rule. 

There  is  another  qualification  of  still  greater  importance. 
In  all  that  has  been  said  as  to  this  rule,  it  has  been  taken  for 
granted  that  fresh  capital  can  be  taken  into  any  business  enter- 
prise and  used  as  profitably  as  the  original  capital.  In  a  great 
many  cases  this  is  true,  especially  if  the  fresh  capital  is  not 
dumped  upon  the  company  in  one  or  two  big  lots  secured  through 


Ch.  32]  SURPLUS  915 

the  sale  of  securities,  but  is  gradually  added  year  after  year  and 
thus  made  available  for  betterments  and  extensions  that  are 
actually  needed.  However,  even  in  those  cases  there  may- 
after  a  time,  come  a  Umit  to  the  development  of  the  company 
beyond  which  fresh  capital  cannot  be  profitably  applied.  When 
this  limit  is  reached,  it  is  no  longer  desirable  to  accumulate 
surplus  with  rapidity.  If  earnings  have  not  at  that  time  been 
stabilized,  it  may  be  good  policy  to  pay  out  most  of  the  income 
year  after  year  in  dividends,  allowing  the  dividends  to  fluctuate 
in  close  relation  to  the  income.  Or  it  may  be  adjudged  better  to 
fix  the  dividend  rate  at  about  the  average  anticipated  income,  in 
which  case  extra  profits  of  the  good  years  will  be  invested  outside 
the  company  in  short-term  securities  which  will  be  sold  when 
necessary  in  order  to  provide  cash  or  dividends  during  the 
lean  years.  It  is  perhaps  due  to  the  fact  that  opportunities  for 
expansion  of  successful  enterprises  in  the  United  States  are 
almost  unHmited,  that  so  much  emphasis  has  been  laid  in  our 
financial  practice  on  the  necessity  of  making  large  savings  out  of 
annual  profits;  whereas  in  European  countries,  where  the  oppor- 
tunities for  expansion  are  more  limited,  the  custom  prevails 
of  paying  out  most  of  the  annual  earnings  in  dividends  and  of 
relying  upon  fresh  issues  of  securities  to  provide  whatever  new 
capital  is  needed. 

§  348.    Policies  of  Various  Companies 

.yj  Sometimes  the  American  policy  of  conservatism  in  dividends 
is  carried  to  an  extent  which  creates  a  remarkable  disproportion 
between  the  Capital  account  and  the  Surplus  account.  The 
Atlantic  Refining  Company  with  profits  of  over  $10,500,000 
in  1920,  paid  dividends  of  $2,376,851;  and  with  a  total  out- 
standing capital  stock  of  $25,000,000,  had  a  surplus  of  over 
$66,000,000.  The  Ford  Motor  Company  at  the  end  of  the 
fiscal  year,  April  30,  1921,  had  a  capital  stock  of  $17,264,500, 
and  a  surplus  of  over  $182,000,000.  In  addition  to  this  it  had 
reserves   for   depreciation,   amortization,    and    taxes   of   over 


9l6  CORPORATE  FINANCE  (Bk.  II- 

$90,000,000.  However,  these  unusual  relations  are  to  be 
ascribed,  not  so  much  to  an  extraordinary  amount  of  savings  out 
of  income  on  the  part  of  these  two  corporations,  as  to  their  omis- 
sion to  follow  the  usual  practice  of  revising  their  capitalization 
from  time  to  time  to  conform  to  the  increasing  assets  and  earn- 
ings. Most  prosperous  American  industrials  save  the  greater 
part  of  their  earnings,  but  through  stock  dividends  and  other 
processes  of  "watering"  their  prosperity  appears  in  the  form  of 
enlarged  capital  accounts  rather  than  enlarged  surplus  accounts. 
The  Pennsylvania  Railroad  Company,  in  applying  the 
principle  that  has  been  stated  in  the  preceding  section,  endeav- 
ored for  years  to  put  at  least  a  dollar  into  the  Surplus  account 
for  every  dollar  that  was  paid  in  dividends.  In  other  words, 
it  has  aimed  to  divide  its  balance  of  earnings,  after  providing 
for  fixed  charges,  about  evenly  between  dividends  and  surplus. 
During  the  twenty  years  ended  January  i,  192 1,  the  company 
maintained  dividends  at  6%,  with  an  occasional  extra  dividend 
of  >^%  or  1%.  In  spite  of  the  Pennsylvania's  highly  conserva- 
tive policy,  the  critical  railway  year  of  1920  forced  a  reduction 
of  its  annual  dividend  rate  to  4%,  at  which  it  now  stands. 
Its  profit  and  loss  surplus  December  31,  1920,  was  $48,905,393, 
with  outstanding  stock  of  almost  $500,000,000. 

§  349.     "Rainy-Day  Funds" 

Some  companies  make  it  a  practice  to  invest  a  portion  of 
their  saved  earnings  in  securities  or  readily  salable  property, 
and  hold  these  investments  outside  the  business,  as  an  insurance 
that  dividends  will  be  maintained.  This  practice  is  much  more 
common  abroad  than  in  this  country,  although  not  wholly 
unknown  here.  For  instance,  the  American  Car  and  Foundry 
Company  carries  on  its  balance  sheet  a  "Reserve  for  Common 
Dividends"  of  over  $10,000,000.  The  great  English  steamship 
companies,  which  are  peculiarly  subject  to  heavy  losses  through 
the  sinking  of  their  vessels  and  similar  accidents,  have  for  many 
years  made  it  a  practice  to  build  up  surplus  funds  consisting  of 


Ch.  32]  SURPLUS 


917 


outside  investments.     These  funds  are  intended  as  a  kind  of 
insurance  against  marine  losses  that  cannot  otherwise  be  insured 
and  also  for  the  purpose  of  "dividend  equalization."     In  our  own 
country,  the  United   Fruit   Company   carries  investments   in 
securities  of  over  $19,000,000,  presumably  for  the  same  purpose. 

One  trouble  with  this  policy  is  that  it  necessarily  results  in 
tying  up  a  portion  of  the  capital  of  the  company  in  assets  which 
yield  only  a  small  return.  If  the  surplus  fund  is  to  be  of  any 
value  for  the  purpose  intended,  it  can  be  invested  only  in  the 
best  grade  of  marketable  securities.  Most  companies  which 
are  prosperous  and  expanding  do  not  feel  that  they  can  afford 
to  take  cash  away  from  the  business  where  it  would  bring 
profits  of  perhaps  10%,  15%,  20%,  or  more,  in  order  to  put  it 
into  securities  that  will  yield  at  best  4%  or  5%.  Another 
objection  is  the  fact  that  even  this  low  yield  does  not  necessarily 
guarantee  that  the  company's  capital  put  into  investments  will 
remain  intact.  The  officials  of  a  manufacturing  enterprise  are 
not  expected  to  be  investment  specialists. 

A  somewhat  striking  demonstration  of  this  fact  is  given  in 
the  record  of  the  Boston  Belting  Company,  a  long-established 
and  substantial  New  England  institution.  Some  years  ago  the 
company  received  in  settlement  of  a  suit,  a  sum  of  approximately 
$1,000,000.  Inasmuch  as  the  cash  was  not  needed  immediately 
in  the  business,  and  as  it  was  not  thought  best  to  distribute  it  to 
stockholders,  it  was  decided  to  invest  it  in  certain  securities, 
which  were  then  considered  high  grade.  These  securities  in- 
cluded 1,000  shares  each  of  the  stock  of  the  New  Haven  Railroad 
and  of  the  stock  of  the  Boston  and  Albany,  besides  other  shares 
and  bonds.  In  19 14,  as  a  result  of  the  drastic  decline  in  all 
securities,  and  especially  in  those  which  had  been  purchased, 
it  was  necessary  to  charge  off  over  $400,000.  Later  an  addi- 
tional $100,000  was  written  off,  and  half  the  reserve  had  melted 
away.  It  is  true,  of  course,  that  the  stockholders,  if  they  had 
received  the  cash,  might  themselves  have  made  exactly  the  same 
mistake  and  would  today  be  in  no  better  position  financially. 


9l8  CORPORATE  FINANCE  [Bk.  TT- 

But  the  feeling  naturally  exists  that  it  would  have  been  better 
for  the  company  to  distribute  to  the  stockholders  whatever  cash 
yf2i^jrtot  needed  in  the  business  and  to  have  remained  strictly  a 
manufacturing  institution. 

In  general,  American  thought  and  practice  are  not  inclined 
to  favor  the  diversion  of  capital  and  energy  away  from  the 
essential  and  legitimate  business  of  a  company  into  outside 
investments.  It  is  generally  agreed  that  regular  dividends 
combined  with  large — or  at  least  adequate — savings  out  of 
annual  income  should, be  features  of  the  financial  management 
of  most  corporations.  However,  this  belief  is  based  upon  the 
assumption  that  the  surplus  thus  credited  is  needed  for  the 
develpoment  of  the  business  and  should  in  fact  constitute  the 
chief  source  of  new  capital.  Wherever  this  assumption  is 
unjustified,  the  general  opinion  would  probably  favor  distribu- 
tion of  profits  even  though  the  rate  may  be  irregular. 

§  350.    Surplus  as  a  Source  of  Capital 

In  this  country  the  accumulation  of  surplus  out  of  earnings 
is  conceived  almost  wholly  as  a  source  of  fresh  capital.  As 
such  it  is  to  be  contrasted  with  the  policy  of  paying  out  all,  or 
nearly  all,  the  earnings  in  dividends  and  relying  upon  fresh 
issues  of  securities  in  order  to  obtain  new  capital  when  needed. 

The  great  advantage  of  securing  capital  through  issues  of 
securities  is  that  it  may  be  more  quickly  obtained  and  thus 
advantage  may  be  taken  of  conditions  which  favor  rapid  develop- 
ment. Assume  that  two  competitive  corporations  start  to 
do  business  at  about  the  same  time  with  the  same  amount  of 
capital,  and  that  one  corporation  depends  solely  upon  its  ac- 
cumulating surplus  for  the  capital  with  which  to  finance  exten- 
sions, while  the  other  corporation  distributes  most  of  its  earnings 
in  dividends  but  is  successful  in  raising  fresh  capital  by  the 
sale  of  securities.  If  both  corporations  are  able  to  work  peace- 
ably side  by  side,  it  is  probable  that  in  the  long  run  the  first- 
mentioned  policy  will  prove  sounder  and  more  profitable  and  that 


Ch.  32I  SURPLUS 


919 


the  stockholders  in  this  first  corporation  will  eventually  reap  the 
benefits  of  their  self-denial.  But  possibly  both  corporations 
cannot  work  side  by  side.  As  they  expand,  one  or  the  other  is 
certain  to  get  the  mastery,  to  capture  the  market,  and  to  drive 
its  competitor  out  of  business.  Under  these  conditions  it  may 
well  be  that  the  second  corporation,  through  its  policy  of  selling 
securities,  may  be  able  to  raise  needed  capital  more  quickly  and 
thus  secure  the  dominating  position  which  is  the  goal  of  both, 
before  the  first  corporation  has  made  a  good  start. 

Somewhat  similar  conditions  frequently  exist.  A  corpor- 
ation formed  to  manufacture  and  sell  a  new  device  may  find  it 
vitally  necessary  to  cover  its  field  before  some  other  device 
can  be  brought  out  and  introduced  as  an  effective  competitor. 
Or  a  company  may  have  in  hand  a  project  which  is  peculiarly 
timely,  such  as  accepting  a  new  and  profitable  contract.  In 
all  cases  where  the  element  of  time  in  developing  a  business  is 
a  factor  of  great  importance,  the  advantage  as  between  the  two 
methods  rests  with  the  plan  of  issuing  securities. 

The  great  advantage,  on  the  other  hand,  of  securing  capital 
through  savings  consists  of  the  steadiness  and  soundness  with 
which  the  business  may  in  this  way  be  developed.  It  will  not 
suddenly  spurt  ahead — perhaps  before  adequate  preparation 
has  been  made  or  before  an  effective  organization  can  be  brought 
together.  It  will  grow,  year  by  year,  adding  a  new  piece  of 
machinery  here,  erecting  an  addition  to  its  plant  there,  gradually 
increasing  its  organization — until  some  day,  almost  to  the  surprise 
of  its  own  founders,  it  finds  itself  a  leader  among  its  competitors. 
Something  like  this,  as  has  already  been  intimated,  was  the 
history  of  the  Carnegie  Steel  Company;  a  still  more  striking 
instance  of  inside  financing  is  furnished  by  the  history  of  the 
Ford  Motor  Company — in  fact,  this  has  been  the  history  of 
probably  75%  of  the  great  industries  of  the  country.  The 
other  25%  have  been  built  up  chiefly  by  the  more  rapid,  more 
attractive,  and  more  dangerous  process  of  bringing  together 
great  sums  of  capital  through  the  issuance  of  securities. 


920  CORPORATE  FINANCE  [Bk.  II- 

§  351.    Hidden  Surpluses 

The  somewhat  doubtful  sources  of  surplus  discussed  in  the 
earlier  part  of  this  chapter  may  properly  be  taken  to  indicate 
reasons  for  questioning  the  validity  of  the  surplus  accounts 
which  appear  on  the  balance  sheets  of  many  corporations. 
If  these  alleged  surpluses  are  based  on  revaluations  of  the  com- 
pany's assets  or  are  derived  from  statements  of  earnings  that 
have  been  exaggerated  over  a  series  of  years,  it  may  easily 
happen  that  on  searching  analysis  and  examination  they  will 
vanish  into  thin  air.  There  is  plenty  of  reason  for  a  questioning 
attitude  on  the  part  of  purchasers  of  securities  when  they  are 
supplied  with  a  surplus  statement. 

On  the  other  hand,  many  old  and  well-established  corpora- 
tions may  properly  be  said  to  have  "hidden"  or  secret  surpluses. 
The  situation  arises  out  of  the  practice  over  a  series  of  years 
of  understating  net  income;  of  making  larger  provision  than 
is  necessary  for  reserves;  of  writing  down  drastically  the  book 
values  of  assets,  both  tangible  and  intangible.  The  result  ob- 
viously is  that  the  balance  sheet  shows  an  understatement  of 
the  value  of  the  company's  assets;  and  this  understatement 
constitutes  a  hidden  surplus.  If  the  balance  sheet  were  revised 
so  as  to  show  the  true  values  of  the  company's  assets,  the  Surplus 
account  would  be  correspondingly  increased. 

In  theory,  the  practice  of  understating  the  values  of  assets 
and  carrying  hidden  surpluses  is  just  as  objectionable  as  the 
practice  of  overstating  values.  The  real  aim  of  the  accountant 
and  of  the  financial  manager  should  be  to  see  to  it  that  the 
balance  sheet  tells  the  exact  truth — neither  more  nor  less — so 
that  every  creditor,  every  prospective  purchaser  of  securities, 
may  take  action  with  his  eyes  open.  However,  this  ideal  is  not 
attainable,  and  since  there  must  be  an  error  on  one  side  or  the 
other,  it  is  better  to  err  on  the  side  of  understatement  and  over- 
conservatism.  Bankers  and  careful  investors  place  a  high  value 
on  a  balance  sheet  that  gives  evidence  of  having  been  prepared 
with  extreme  caution  or  even  pessimism. 


Ch.  32]  SURPLUS  921 

Banking  houses — and  sometimes  other  firms  as  well — find 
it  useful  to  carry  certain  surpluses  in  the  form  of  undervaluations 
of  securities  and  other  assets  in  order  to  take  care  of  exceptional 
losses  without  disturbing  the  appearance  of  the  balance  sheet. 
If  a  bank  suffers  a  serious  defalcation,  for  example,  it  may  be 
highly  injurious  to  its  credit  to  charge  the  whole  amount  directly 
against  surplus,  thus  advertising  to  its  customers  and  the  world 
at  large  that  it  has  met  with  a  set-back.  In  case  the  bank  has 
been  carrying  assets  at  an  undervaluation,  it  may  resort  in  such 
a  case  to  a  revaluation  of  these  assets  so  as  to  increase  them  by 
approximately  the  same  amount  as  the  loss  that  is  to  be  written 
off.  When  the  next  balance  sheet  appears  it  shows  no  difference 
except  that  the  skilled  analyst  might  be  able  to  detect  changes  in 
the  valuations  of  assets;  but  this  is  not  usually  possible. 


•ui 


./(i 


-V 


CHAPTER  XXXITI 
BUDGETARY  CONTROL 

§  352.    Nature  and  Types  of  Budgets 

In  handling  governmental  business  in  nearly  all  civilized 
countries,  it  is  customary  for  the  executive  power  to  submit 
to  the  legislative  power  a  detailed  estimate  of  the  prospective 
revenue  and  outgo  for  the  succeeding  fiscal  year.  This  esti 
mate  is  know  as  a  budget.  It  may  be  described  as  a  detailed 
income  and  expenditure  statement  made  out  in  advance  of  the 
period  which  it  covers;  it  is  a  prediction  or  a  guide,  not  a  record 
of  results.  In  governmental  practice  it  is  customary  to  secure 
the  approval  of  the  legislative  power,  and  thereupon  the  adopted 
budget  becomes  an  appropriation  of  the  expected  revenue.  The 
various  departments  of  the  government  are  not  authorized  to  go 
beyond  the  budget  sums  for  their  departments  in  their  expendi- 
tures for  the  fiscal  year. 

In  private  corporations  the  budget,  except  in  rough  and  frag- 
mentary form,  has  not  been  generally  used.  There  is  a  growing 
interest,  however,  in  the  application  of  the  principle  of  the 
budget  with  a  view  to  forestalling  the  serious  financial  errors  and 
miscalculations  that  so  frequently  wreck  the  careers  of  otherwise 
successful  corporations.  It  should  be  possible  to  make  detailed 
financial  plans  and  schedules  for  a  year  or  more  ahead,  just  as  it 
is  possible  for  many  companies  to  make  detailed  operating  plans 
and  schedules. 

Budgets  are  divisible  into  two  classes :  those  which  are  merely 
estimates  for  the  benefit  of  the  active  financial  managers,  and 
those  which  are  adopted  and  definitely  determine  appropriations. 
When  the  budget  plan  is  to  be  introduced,  it  is  usually  best  to 
start  with  the  first  class — unless  there  is  some  emergency  which 

922 


Ch.  33I  BUDGETARY  CONTROL  923 

demands  that  a  definite  financial  plan  be  at  once  adopted  and 
adhered  to — always  having  in  mind  the  expectation  that  the 
budget  will  in  time  reach  the  stage  of  being  either  formally- 
adopted  or  accepted  by  general  agreement  as  stating  the  limit 
for  the  year's  expenditures. 

§  353'    Need  of  Budgetary  Control 

In  spite  of  the  obvious  advantages  of  making  a  forecast  of 
financial  operations  each  year,  the  budget  plan,  as  stated  above, 
has  not  yet  been  generally  adopted.  It  is  true,  however,  that 
estimates  for  a  year  or  more  in  advance  (which  are  a  crude  form 
of  budget)  are  customarily  made  by  careful  financial  managers. 
When  the  budget  is  not  used  in  a  more  or  less  complete  form,  it 
is  usually  (i)  because  its  advantages  are  not  appreciated,  or 
(2)  because  of  the  inability  of  the  management  to  install  and 
operate  it. 

The  budget  in  some  form  is  almost  essential  to  proper  admin- 
strative  control.     It  operates  in  two  ways: 

I.  To  co-ordinate  the  activities  of  the  various  functional 

departments. 
3.  To  serve  as  a  basis  for  centralized  executive  control. 

§  354*    Working  up  a  Budget 

The  following  outline  of  the  procedure  to  be  followed  in 
the  installation  and  operation  of  a  budget  gives  an  excellent 
idea  of  the  requirements  and  the  successive  steps  to  be  taken.i 
This  procedure  will  of  course  be  varied  according  to  the  organi- 
zation of  the  business  and  the  nature  of  its  operations. 

I.  Estimate  of  Activities 

Each  department  prepares  an  estimate  of  its  activities  for  the 
budget  period.  The  method  of  stating  these  activities  depends 
on  the  nature  of  the  operations  of  the  department.  The  sales 
department  states  the  sales  it  expects  to  make  and  the  estimated 


>  By  permission  from  "Budgetary  Control,"  by  J.  O.  McKinsey. 


924  CORPORATE  FINANCE  [Bk.  II- 

expenses  it  will  incur  in  making  these  sales.  The  production  de- 
partment states  the  estimated  production  for  the  period  and  the 
requirements  in  material,  labor,  and  manufacturing  expenses  to 
meet  this  estimate.  The  service  departments,  such  as  the  per-  j 
sonnel  department,  the  traffic  department,  the  accounting  depart- 
ment, and  the  office  manager's  department,  state  the  estimated 
expenditures  of  their  departments.  Because  of  the  interdepen- 
dence of  these  departments,  some  will  need  to  use  the  estimates'  ^'  '• 
of  other  departments  in  making  their  own  estimates.  For  instance, 
the  production  department  must  know  the  estimated  sales  before  it 
can  estimate  the  production  necessary  to  meet  the  sales  demands; 
the  treasurer  must  know  the  plans  of  all  the  departments  before  he 
can  estimate  his  cash  receipts  and  cash  disbursements.  Con- 
sequently a  procedure  must  be  set  up  which  provides  for  a  proper 
scheduling  of  the  estimated  with  reference  to  preparation  and 
distribution. 

2.  Combining  the  Estimates 

The  departmental  heads  will  transmit  the  departmental  es- 
timates to  an  executive  who  has  supervision  of  the  budgetary 
procedure.  Sometimes  the  comptroller  acts  in  this  capacity,  while 
in  many  cases  the  duty  is  delegated  to  a  member  of  the  staff  of  the 
general  manager  or  president.  Since  many  businesses  do  not  have 
a  comptroller,  it  will  be  assumed  during  the  present  discussion  that 
an  assistant  to  the  president  acts  in  this  capacity.  This  official 
combines  the  estimates  of  aU  the  departments  into  a  proposed 
financial  budget  for  the  business.  In  preparing  this  estimate  he 
will  be  assisted  by  the  treasurer,  though  in  some  cases  this  budget 
is  prepared  by  the  treasurer  alone.  The  proposed  financial  budge! 
should  show  the  estimated  receipts  from  all  sources  and  the 
estimated  expenditures  by  aU  departments  of  the  business. 

3.  Adjusting  Receipts  and  Expenditures 

The  executive  in  charge  of  the  budget  procedure  makes  a  com- 
parison between  the  estimated  receipts  and  the  estimated  expen- 
ditures as  shown  by  the  proposed  budget.  If  the  estimated  expen- 
ditures exceed  the  estimated  receipts,  one  of  the  following  courses 
of  action  must  be  taken: 

(a)  The  departmental  expenditures  may  be  reduced.  In  mak- 
ing such  reductions  a  problem  arises  due  to  the  fact  that  the  reduc- 
tion of  expenditures  may  result  in  a  reduction  of  receipts.     For 


Ch.  33]  BUDGETARY  CONTROL  925 

instance,  if  the  expenditures  of  the  advertising  department  are 
reduced,  this  may  result  in  a  reduction  of  sales,  with  a  consequent 
reduction  of  receipts  from  collections.  In  the  same  manner,  a 
reduction  of  the  expenditures  of  the  production  department  may 
result  in  a  reduction  of  production  with  a  consequent  lack  of  goods 
to  meet  sales  demands  which  will  result  in  a  reduction  of  receipts 
from  sales.  Care  must  be  taken,  therefore,  in  the  reduction  of 
expenditures  to  see  that  receipts  are  not  reduced  more  than 
proportionately. 

(b)  Additional  receipts  may  be  secured.  It  may  be  possible  by 
speeding  up  operations  and  securing  more  efficient  administration, 
to  secure  additional  receipts  without  incurring  a  proportionate 
increase  of  expenditures. 

(c)  Additional  capital  may  be  secured.  If  it  is  not  deemed  wise 
to  reduce  expenditures,  plans  must  be  made  to  secure  additional 
capital  with  which  to  finance  the  excess  of  expenditures  over  re- 
ceipts. It  is  understood,  of  course,  that  this  condition  cannot 
continue  long,  otherwise  the  business  wUl  find  it  necessary  to 
liquidate.  i"^ 

The  executive  in  charge  of  the  budgetary  procedure  may  make 
recommendations  with  reference  to  possible  procedures,  but  he  is      H 
usually  not  invested  with  authority  to  determine  the  plans  to  be 
followed. 

4.  Preparing  the  Financial  Statements 

The  executive  in  charge  of  the  budgetary  procedure  prepares 
from  the  departmental  estimates  an  estimated  balance  sheet  and 
an  estimated  statement  of  profit  and  loss,  showing  respectively 
the  anticipated  financial  condition  at  the  end  of  the  budget  pferiod 
and  the  anticipated  result  of  the  operations  of  the  period. 

5.  Adopting  the  Budget — Its  Effect 

The  departmental  estimates,  together  with  the  proposed  finan- 
cial budget  and  the  estimated  financial  statements,  are  submitted 
by  the  executive  in  charge  of  the  budgetary  procedure  to  a  budget 
committee,  composed  of  the  principal  executives  of  the  company 
and  presided  over  by  the  president.  This  committee  considers 
the  proposed  estimates  and  makes  such  revisions  as  it  thinks 
necessary.  In  case*  the  proposed  budgets  involve  important 
changes  in  the  company's  policy  or  require  the  securing  of  addi- 
tional capital  for  a  material  amount,  it  may  be  necessary  to  submit 


926  CORPORATE  FINANCE  [Bk.  II- 

them  to  the  board  of  directors  for  approval.  After  the  proposed 
estimates  have  been  approved  they  constitute  the  working  program 
for  the  budget  period.  The  budgets  as  adopted  set  Umits  upon  the 
expenditures  of  all  tne  departments,  and  these  limits  cannot  be 
exceeded  without  the  permission  of  the  budget  committee.  The 
budgets  also  set  up  standards  of  performance  for  certain  depart- 
ments. For  instance,  the  sales  budget  states  the  sales  that  are  to 
be  made  by  the  sales  department,  and  the  production  budget  states 
the  estimated  production  of  the  production  department. 

There  is  no  particular  secret  or  trick  about  the  making  of  a 
budget.  All  that  is  necessary  is  to  marshal  the  facts  of  past 
experience  in  orderly  array,  combine  them  and  use  them  with 
care  and  common  sense  as  a  guide  to  the  activities  of  the  business. 
While  it  may  not  be  possible  to  accomplish  the  estimated  results, 
it  will  certainly  be  a  source  of  satisfaction  to  approach  them  as 
closely  as  possible.  With  each  succeeding  effort  the  margin  of 
error  should  be  decreased, 

§  355.    Sales  Estimates  as  a  Basis  for  Budget-Making        m 

A  constantly  recurring  objection,  not  only  to  formal  budgets, 
but  even  to  advance  estimates,  is  that  the  volume  of  sales  of  most 
corporations  is  not  under  control,  nor  can  it  be  foreseen.  There 
is  undoubtedly  truth  in  this  assertion.  Yet  in  the  great  majority 
of  cases  this  difficulty  is  exaggerated.  As  a  matter  of  fact,  the 
manufacturer  or  trader  should  be  able,  within  reasonable  limits, 
to  exercise  a  fairly  close  control  over  the  volume  of  his  sales; 
if  not,  his  business  is  clearly  on  an  extremely  unsound  basis.  His 
percentage  of  sales  expense  to  gross  profits  has  presumably  been 
definitely  determined  by  past  experience,  or  at  least  the  normal 
percentage  in  his  line  of  business  must  be  known.  While  it  is 
true  that  he  cannot  abruptly  increase  his  business  by  the  mere 
process  of  increasing  his  selling  expenditures,  he  should  be  able  to 
count,  with  some  definiteness,  upon  certain  steps  looking  toward 
the  building  up  of  his  selling  organization  which  should  result  in 
a  proportionate  increase  in  volume  of  business. 

It  is,  of  course,  further  true  that  in  many  lines  of  business 


Ch.  33l  BUDGETARY  CONTROL  07 

extreme  fluctuations  take  place  from  year  to  year,  due  to  causes 
over  which  the  industrial  or  trading  corporation  has  no  control. 
Manufacturers  of  railway  supplies,  for  example,  are  able  to  sell 
more  of  their  product  when  the  railroads  are  prosperous;  and  no 
amount  of  extra  selling  effort  will  prevent  sales  from  falling  off 
when  business  conditions  are  at  a  low  point.  To  say,  however, 
that  these  fluctuations  will  necessarily  take  place  is  not  equiva- 
lent to  saying  that  they  cannot  be  foreseen.  The  budget-maker 
is  not  primarily  engaged  in  planning  to  build  up  sales  or  regulate 
operations;  it  is  his  main  business  only  to  form  a  careful  estimate 
of  what  the  results  of  the  company's  expenditures  are  likely  to 
be.  In  determining  these  results,  he  may  give  proper  weight  to 
all  of  the  unfavorable,  as  well  as  the  favorable  factors.  If  he  is 
a  really  capable  financial  man,  he  will  look  forward  to  the  prob- 
able economic  conditions  of  the  coming  year  and  determine  with 
some  degree  of  accuracy  whether  they  are  likely  to  be  favorable 
or  unfavorable  to  his  company. 

Having  in  view,  then,  these  three  factors:  (i)  estimated  ex- 
penditures during  the  coming  year  directed  toward  building  up 
sales;  (2)  normal  percentage  of  sales  expense  to  volume  of  sales; 
and  (3)  probable  effect  of  general  business  and  financial  condi- 
tions and  other  external  forces  on  his  line  of  business — the 
budget-maker  should  be  able  to  form  a  much  clearer  estimate  of 
the  volume  of  business  than  would  at  first  seem  possible. 

Once  the  anticipated  volume  of  business  is  calculated,  it  is 
comparatively  simple  to  calculate  the  expenses  that  are  necessary 
in  order  to  handle  the  estimated  volume.  The  uncertainty  as  to 
the  result  of  selling  effort  is  the  crucial  difficulty  to  be  overcome. 

§  356.    Effect  on  Budget  of  Fluctuations  of  Business 

A  related  objection  to  budget-making  sometimes  raised,  is  to 
the  effect  that  the  business  cannot  be  expected  to  run  in  a  uni- 
form channel  month  after  month,  but  will  fluctuate  widely, 
whereas  the  budget  is  usually  based  on  the  assumption  of  some 
degree  of  uniformity;  consequently,  it  is  said,  the  budget  gives 


928  CORPORATE  FINANCE  [Bk.  II- 

a  false  notion  of  the  actual  course  of  affairs,  even  though  it  should 
by  chance  be  fairly  accurate  in  its  prevision  of  total  business  for 
the  year.  This  objection  is  of  no  vital  importance.  It  tends 
simply  to  show  that  the  budget  should,  in  the  first  place,  be  made 
on  a  monthly  rather  than  on  a  yearly  basis,  with  a  view  to 
increasing  its  accuracy,  and  in  the  second  place,  should  allow  a 
reasonable  margin  for  errors  and  unforeseeable  fluctuations. 

i-Vjl 

§  357-    Budgetary  Red  Tape 

A  third  objection  to  all  Lu.'gets  is  the  restrictions  they  im- 
pose upon  the  free  ju  Igment  an  J  action  of  operating  officials, 
wh  ch  are  so  essential  to  an  energetic  and  grow"ng  enterprise. 

The  obvious  answer  to  this  objection  is  that  the  free,  un- 
trammeled  and  unco-ordinated  activities  of  sales  managers, 
buyers,  superintendents  of  factories,  and  other  operating  officials, 
has  been  probably  the  most  prevalent  single  cauSe  of  financial 
embarrassments.  One  of  the  main  purposes  of  the  budget  is 
to  bring  the  various  official  activities  into  harmonious  relation, 
not  only  with  each  other,  but  also  with  the  financial  policies  and 
the  financial  resources  of  the  business.  If  the  establishment  of 
a  necessary  and  proper  relation,  and  the  insistence  upon  it 
irritates  operating  officials  and  makes  them  feel  that  they  are 
unduly  restricted,  it  is  only  because  their  interests  are  too  nar- 
row. They  are  attending  to  the  up-building  of  their  own  de- 
partments without  having  a  real  understanding  of  the  situation 
and  the  needs  of  the  business  as  a  whole. 

As  a  matter  of  fact,  a  definite  and  binding  budget,  which 
can  be  debated  and  settled  by  all  the  responsible  officials  and  the 
directors  of  a  company  at  the  beginning  of  a  fiscal  year,  is  a  highly 
effective  method  of  securing  the  singleness  of  purpose  which  is 
an  essential  factor  in  every  efficient  organization. 

§  358.     Flexibility  of  the  Budget 

The  objections  to  the  budget  and  budgetary  control  are 
largely  based  on  the  assumption  that  a  budget  once  adopted  is  an 


Ch.  33l  BUDGETARY  CONTROL  929 

absolutely  inflexible  and  unchangeable  strait-jacket  from  which 
no  relief  can  be  obtained  until  after  the  expiration  of  the  fiscal 
year  in  which  it  holds  good.  If  this  were  actually  the  state  of 
affairs,  the  objections  would  have  weight.  But  the  efficient 
budget,  as  used  by  some  corporations,  is  subject  to  continual 
revision. 

First  of  all,  it  may  be  made  both  on  a  yearly  basis  and  on  a 
monthly  basis.  The  yearly  budget  enters  into  few  details,  but 
gives  a  comprehensive  view  of  the  anticipated  income  from 
various  sources  and  the  anticipated  expenditures  of  this  estimated 
income,  together  with  the  approximate  result  of  the  whole 
year's  business. 

Supplementing  the  yearly  budget  and  controlled  by  it,  are 
the  monthly  budgets,  which  enter  into  as  much  detail  as  may  be 
required  by  the  nature  of  the  business,  and  make  due  allowances, 
so  far  as  they  can  be  foreseen,  for  the  seasonal  and  month-by- 
month  fluctuations  which  occur  in  every  business.  The  month- 
by-month  budget  may  be  checked  up  at  the  end  of  each  month 
against  the  actual  results  of  that  month ;  the  causes  of  discrep- 
ancies may  be  noted;  new  contracts  or  prospects  for  enlarging 
or  reducing  business  during  the  months  immediately  following 
may  be  taken  into  consideration.  With  all  these  and  other 
similar  factors  in  full  view,  such  revisions  of  the  budget  as  are  at 
the  time  required  may  readily  be  agreed  upon. 

It  is  quite  probable  that  during  the  year  wholly  unexpected 
circumstances  may  arise  which  may  make  it  necessary  to  discard 
the  previous  estimates  and  to  make  entirely  new  estimates.  The 
point  toward  which  the  business  vessel  is  being  steered  may  for 
such  reasons  be  altered.  It  goes  without  saying  that  no  budget 
cr  any  other  arbitrary  set  of  figures  should  be  permitted  to  stand 
in  the  way.  But  the  fact  remains  that  the  vessel  is  actually 
being  steered  and  is  not  merely  drifting.  The  budget  is  the 
chart  which  the  financial  manager  is  expected  to  follow  until  he 
finds  that  new  circumstances  make  a  new  or  revised  chart 
essential. 


930  CORPORATE  FINANCE  jBk.  II- 

§  359.    Income  vs.  Cash  as  a  Basis  for  the  Budget 

A  practical  question  that  must  be  answered  before  the  budget 
can  be  prepared,  is  whether  it  should  be  based  upon  income  and 
expenditures  or  upon  cash  receipts  and  cash  disbursements. 
Income  and  expenditure  constitute  the  correct  measure  of  profits, 
and  therefore  should  be  used  whenever  the  prime  purpose  of  the 
budget  is  to  control  expenditure  and  to  insure  a  satisfactory 
showing  of  profits  during  the  ensuing  year.  Cash  receipts  and 
cash  disbursements,  on  the  other  hand,  measure  the  financial 
status  and  financial  prospects  of  the  business  and  should  be 
used  whenever  the  prime  purpose  is  to  make  sure  that  the 
business  will  run  on  a  basis  that  is  financially  sound,  i^'^^^'-yf 

In  many  lines  of  business  the  distinction  is  not  of  great  im- 
portance, for  the  reason  that  the  income  and  expenditure  ot  «ach 
month  tally  closely  with  the  receipts  and  disbursements  of  the 
month.  But  in  other  lines  it  would  be  disastrous  to  overlook  the 
distinction.  In  reply  to  an  inquiry  on  this  point,  a  certified 
public  accountant  of  high  standing  writes : 

It  seems  to  me  that  all  successful  plans  for  business  must  con- 
template both  prospective  income  and  expenditure  and  prospective 
receipts  and  disbursements,  and  that  emphasis  as  to  which  of  the 
two  is  more  important  depends  to  a  considerable  extent  upon  the 
business. 

For  example,  ....  in  the  business  of  making  fertilizers, 
probably  85%  of  the  business  is  done  on  long  terms  and  the  realized 
income  receipts  at  the  time  of  the  greatest  manufacturing  activity 
are  comparatively  small.  In  such  a  case  the  income  and  expen- 
diture features  are  those  which  are  mainly  considered.  These  same 
facts  apply  to  a  considerable  extent  to  the  conduct  of  the  farm 
implement  business. 

On  the  other  hand,  any  concern  doing  a  strictly  trading  busi- .  .^ 
ness,  with  little  or  no  manufacturing,  looks  more  to  the  expected 
receipts  from  current  sales  than  to  the  anticipated  income  arising 
through  a  longer  period.  Nevertheless,  even  in  such  cases,  es- 
pecially where  goods  are  bought  on  time,  the  anticipated  income  has 
to  be  considered  in  determining  the  amount  of  obligations  which 
are  incurred.    For  these  reasons  I  am  led  to  think,  speaking 


Ch.  33I  BUDGETARY  CONTROL  931 

broadly,  that  in  the  cases  where  a  considerable  part  of  the  business, 
whether  of  sales  or  purchases,  is  done  within  a  short  period,  the 
income  and  expenditure  features  demand  the  larger  consideration, 
for  broad  plans  must  be  devised  for  the  whole  year's  business. 
Where  the  business,  however,  approaches  more  nearly  to  regular 
periodical  turnovers,  the  receipts  and  payments  become  more  *-  '' 
important. 

§  360.    Cash  and  Income  Budgets  >^j; 

The  best  answer  to  our  question  would  seem  to  be  that  in  all 
cases  except  those  in  which  income  and  expenditure  and  receipts 
and  disbursements  are  practically  identical,  there  should  be  two 
separate  budgets.  The  income  and  expenditure  budget  should 
be  for  the  guidance  of  all  the  operating  officials  of  the  company; 
it  should  show  in  some  detail  the  amounts  that  may  be  expended 
and  the  results  that  are  expected  in  each  department.  This  is 
the  budget  that  serves  the  purpose  of  facilitating  control. 

The  receipts  and  disbursements  budget  may  be  only  for  the 
private  information  and  guidance  of  the  treasurer  or  of  those  who 
are  responsible  for  the  financial  management  of  the  company. 
It  will  indicate  just  where  the  actual  cash  receipts  of  each  month 
are  to  come  from  and  through  what  channels  the  cash  is  to 
flow  out. 

The  budget  of  cash  receipts  and  expenditures  may  itself  be 
divided  into  two  parts,  the  first  part  including  only  those  trans- 
actions which  have  to  do  with  current  operations,  and  the  second 
part  including  only  capital  transactions.  By  combining  the  two 
parts  the  financial  management  may  look  ahead  and  make  cer- 
tain that  ample  bank  balances  will  be  maintained;  calculate  to 
what  extent  they  will  be  dependent  upon  bank  and  other  loans; 
determine  exactly  how  far  they  should  go  in  taking  advantage 
of  cash  discounts;  and  otherwise  guide  the  financial  course  of  the 
company  with  skill  and  accuracy. 

The  blundering  and  indecision  which  so  often  mark  the 
relations,  between  business  enterprises  and  their  banks,  and 
which  so  often  lead  to  impetuous  and  urgent  demands  for  fresh 


932  CORPORATE  FINANCE  [Bk.  H- 

capital  in  order  to  avert  serious  embarrassment,  could  for  the 
most  part  be  avoided  through  the  use  of  careful  budgets  of 
forthcoming  receipts  and  disbursements. 

§  361.    Calculating  the  Income 

Taking  up  now  in  more  detail  the  procedure  in  forming  a 
budget,  first  on  the  income  and  expenditure  basis,  and  second  on 
the  receipts  and  disbursements  basis,  we  have  to  consider  the 
extent  of  the  income  for  the  period  (whether  it  be  monthly,  half- 
yearly,  or  yearly)  which  may  fairly  be  regarded  as  assured 
Manufacturing  companies  are  likely  to  have  certain  regular 
customers  on  whom  they  may  safely  count,  unless  extraordinary 
conditions  prevail,  for  a  given  amount  of  business.  The  same 
thing  is  true  of  wholesale  trading  companies.  The  companies, 
both  manufacturing  and  trading,  which  are  selling  at  retail,  can 
at  least  work  out  from  their  own  records  the  minimum  limits  of 
their  sales.  The  same  thing  may  be  done  by  public  service  and 
transportation  companies.  Companies  which  operate  on  long- 
term  contracts  extending  over  two  or  three  years  or  more  may 
conceivably  be  in  the  position  of  having  all  their  capacity  occu- 
pied with  work  giving  them  an  assured  income. 

Most  companies  have  in  addition  certain  possibilities  which 
require  careful  study  and  good  judgment  in  order  to  make  a 
reasonably  accurate  estimate  of  earnings  which  are  not  assured 
but  are  probable.  In  these  estimates,  the  financial  manager  will 
naturally  be  guided  to  a  great  extent  by  the  views  of  the  sales 
manager  and  other  operating  officials  who  are  probably  in  closer 
touch  than  he  is  with  the  company's  sources  of  income.  It  is 
well  to  state  separately  the  amount  of  gross  earnings  which  may 
be  regarded  as  probable  but  is  not  assured. 

It  may  or  may  not  be  advisable  to  make  still  a  third  classifica- 
tion which  will  include  the  additional  earnings  that  are  within 
the  range  of  possibility,  but  cannot  conservatively  be  called 
"probable."  Naturally  the  form  in  which  these  earnings  appear 
in  the  budget  will  depend  upon  the  business.  .j^g^Q^jip  oa^ikji  ' 


Ch.  33)  BUDGETARY  CONTROL  933 

In  given  instances  it  may  be  well  to  show  considerable  detail 
as  to  the  exact  basis  of  the  estimates  of  earnings.  However,  if 
sufficient  detail  is  not  given  in  the  budget  itself,  it  should  be  at 
hand  and  should  be  subject  to  the  criticism  of  the  operating 
officials,  with  a  view  to  making  it  as  complete  and  accurate  as 
possible. 

§  362.     Calculating  the  Expenses 

The  classification  of  expenses  should  follow  the  same  lines  of 
division.  It  is  well  to  estimate,  first  of  all,  what  may  be  called 
the  fixed  and  necessary  expenses  of  the  business,  assuming  usually 
that  it  is  intended  to  hold  intact  the  organization  that  has  been 
built  up.  These  necessary  expenses  will  include,  therefore,  the 
salaries  of  officers  and  their  assistants,  of  salesmen,  clerks,  and 
working  men,  the  purchases  of  raw  materials  necessary  for  pro- 
duction up  to  the  amount  that  is  assured,  the  up-keep  of  the 
plant,  and  other  necessary  expenses.  'f\n 

A  second  section  will  show  the  increase  in  expenses  necessary 
in  case  the  probable  volume  of  business,  as  previously  estimated, 
is  secured.  A  third  section  will  show  further  increases  necessary 
in  case  the  possible  volume  of  business  is  attained. 

An  income  and  expenditure  budget  made  up  in  these  three 
divisions  will  prove,  it  may  safely  be  said,  a  remarkably  inter- 
esting and  helpful  guide.  Possibly  the  threefold  division  may 
be  necessary  only  for  the  annual  budget,  while  the  month-to- 
month  budget  may  relate  wholly  to  probable  earnings.  These 
are  matters  of  detail.  The  important  point  is  to  get  the  budget 
so  arranged  and  in  sufficient  detail  to  show  what  may  reasonably 
be  anticipated  without  incurring  the  danger  of  imposing  undue 
or  arbitrary  restrictions  on  the  initiative  of  the  various  officials 
and  department  heads,  >v/  I'l  .hviiupm  ytvN  f-o  .  o) 

§  363.    The  Cash  Budget 

>i    The  receipts  and  disbursements  budget  may  be  arranged  in 
three  divisions  to  correspond;  or  it  may  be  necessary  to  base  it 


934  CORPORATE  FINANCE  [Bk.  II- 

wholly  upon  the  estimate  of  possible  earnings.  In  those  lines  of 
business,  however,  in  which  sales  are  made  on  a  long-term  or 
instalment  basis,  it  will  be  found  of  the  highest  importance  to 
make  the  receipts  and  disbursements  budget  in  considerable 
detail  and  with  a  view  to  all  possible  contingencies.  Not  to  do 
so  is  to  invite  serious  trouble,  for  an  enlarged  volume  of  business 
in  such  industries  necessarily  means  a  proportionate,  or  more 
than  proportionate,  tying  up  of  cash  resources.  A  budget  may 
even  indicate  that  for  this  reason  it  is  unwise  to  attempt  to 
handle  the  volume  of  business  which  the  sales  manager  and 
operating  officials  would  like  to  secure.  The  making  of  a  receipts 
and  disbursements  budget  may  be  sufficient  in  itself  to  reveal  the 
breakers  ahead  and  to  inspire  caution. 

§  364.    Where  a  Budget  Might  Have  Prevented  Failure 

A  remarkable  example  of  lack  of  foresight  in  handling  the 
affairs  of  a  prosperous  business  is  to  be  found  in  the  record  of  the 
M.  Rumely  Company,  large  manufacturers  of  farm  machinery, 
which  became  embarrassed  in  the  spring  of  19 13  and  was  reor- 
ganized a  few  months  later.  The  first  report  of  the  president  of 
the  reorganized  company,  C.  S.  Funk,  which  covers  the  fiscal 
year  ended  December  31,  19 13,  is  remarkable  in  its  clear-cut 
analysis  of  a  bad  financial  situation. 

The  business  of  the  company  was  transacted  by  selling  agri- 
cultural implements,  through  agents,  to  farmers  and  accepting 
instalment  notes  from  the  farmers  in  payment.  The  company 
in  turn  issued  commission  certificates  to  the  agents,  which  were 
due  and  payable  when  the  notes  for  the  sale  on  which  the  com- 
mission was  paid  matured.  As  a  certain  percentage  of  these 
notes  were  not  paid  promptly  at  maturity  and  considerable 
collection  expenses  were  required,  it  was  necessary  to  carry  a 
reserve  against  them. 

The  heavy  loss  during  the  year  preceding  reorganization, 
which  amounted  to  $1,407,000,  was  explained  in  part  by  the  lack 
of  co-ordination  between  the  sales  and  manufacturing  depart- 


Ch.  33]  BUDGETARY  CONTROL  $35 

ments.  During  the  eariy  months  of  the  year,  owing  to  the 
forcing  of  sales,  the  factory  had  to  run  night  and  day,  which 
involved  excessive  piece  rates,  unskilled  help,  and  waste  at  every 
point.  On  the  other  hand,  during  the  latter  part  of  the  year,  the 
factory  was  shut  down,  the  loss  from  manufacturing  alone 
approximating  $i,icx5,ooo.     The  report  says: 

In  the  Sales  Department  a  fundamental  mistake  was  made  in   •  5 
complete  misjudgment  of  the  market  for  Rumely  products  and  the 
rate  of  gross  which  could  be  safely  attained.    The  reduced  volume 

"      of  business  should  have  shown  a  reduction  of  sales  expense  of      ''' 
$600,000,  to  maintain  the  same  ratio  which  held  in  191 2,  but  there 
was  an  actual  increase  of  $600,000,  thus  making  a  relative  increase 
of  $1,200,000. 

i  Interest  charges  were  increased  by  over  $800,000,  due  to  an 

excessive  inventory  and  the  high  interest  necessitated  by  the 
company's  condition. 

ftl  The  company's  embarrassment  was  directly  due  to  the  ac- 
cumulation of  a  large  inventory  of  raw  material,  goods  in  process, 
and  finished  products,  to  the  amount  of  $16,500,000.  The 
expected  increase  in  the  company's  business  failed  to  materialize 
and  the  sales  expense  was  greatly  increased  "in  an  ill-advised 
effort  to  dispose  of  this  product." 

Surely  a  little  foresight  and  care  in  drawing  up  a  cash  budget 
prior  to  the  beginning  of  the  year  1913  would  have  been  sufficient 
in  itself  to  assure  a  reasonable  degree  of  co-operation  between  the 
sales  and  manufacturing  departments  during  the  year,  and  such 
foresight  would  have  prevented  the  extraordinary  absorption  of 
cash  reserves  in  running  expenses  and  inventories  which  in- 
evitably culminated  in  receivership. 

Alii 
•'  If,' 

n>  ' 


CHAPTER  XXXIV  ,. 

EXPANSION 

§  365.    Capital  Requirements 

At  the  inception  of  an  enterprise  provision  must  be  made  for 
both  fixed  and  working  capital — working  capital  for  the  active 
current  operations  of  the  business,  and  fixed  capital  for  invest- 
ment in  its  plant,  equipment,  and  other  more  permanent  re- 
quirements. 

After  a  business  is  organized  its  operations  may  increase,  and 
demand  larger  amounts  of  working  capital,  and  these  same  en- 
larged operations  may  require  larger  investments  of  fixed  capital. 
This  additional  fixed  capital  may  be  provided  from  outside 
sources,  or  the  business  may  have  been  so  profitable  that  its  own 
surplus  supplies  the  fund  for  extension.  In  any  event,  if  addi- 
tional fixed  capital  is  to  be  invested  in  an  extension  of  the  busi- 
ness, it  will  usually  be  expended  along  one  of  the  following  lines : 

1.  Extensions  of  the  original  plant. 

2.  Increases  or  changes  in  equipment. 

3.  Additions  of  side  lines. 

These  three  lines  of  extension  are  considered  in  the  present 
chapter  iii  the  order  given. 

§  366.    Expansion  as  a  Cause  of  Disaster 

Expansion  is  the  natural  outgrowth  of  any  active,  aggressive 
business.  Instances  are  seen  on  every  side,  and  if  undertaken 
with  discretion  and  good  judgment,  such  expansion  is  com- 
mendable and  usually  successful.  Unless,  however,  expansion 
is  wise,  it  is  not  only  injurious  to  the  business,  dissipating  its 
energies  and  resources,  but  frequently  leads  to  disaster. 

936 


Ch.  34]  EXPANSION  937 

One  of  the  most  curious  Instances  on  record  of  a  disastrous 
investment  on  the  part  of  a  corporation  in  extending  its  own 
business,  is  that  of  the  Assets  Realization  Company.  This 
company  was  organized  for  the  specific  purpose  of  giving  financial 
relief  to  embarrassed  concerns,  by  taking  over  the  assets  which 
they  could  not  otherwise  dispose  of.  It  is  frequently  possible 
to  purchase  from  such  concerns  plants,  machinery,  securities, 
and  other  assets  of  great  value,  at  bargain  prices.  It  was  the 
expectation  of  the  organizers  of  the  Assets  Realization  Company 
that  they  could  take  their  choice  among  properties  thrown  on  the 
market  in  this  way,  and  could  rehabilitate  them  or  adapt  them 
to  other  uses  or  see  to  it  that  they  were  managed  in  a  more 
efl&cient  manner,  and  in  this  way  realize  large  profits  for  them- 
selves. The  plan  seemed  fundamentally  sound,  and  for  some 
years  the  Assets  Realization  Company  was  successful.  As  it 
proceeded,  however,  the  company  gradually  extended  its  opera- 
tions into  the  underwriting  of  securities  of  new  corporations 
which  for  one  reason  or  another  could  not  be  marketed.  Further- 
more, it  is  stated  that  some  of  the  assets  which  had  been  taken 
over  from  insolvent  corporations  could  neither  be  utilized  nor 
resold,  and  remained  as  a  dead  weight  on  their  hands.  Eventu- 
ally the  company  became  afflicted  with  the  same  disease  which 
it  had  undertaken  to  cure,  and  was  itself  so  loaded  down  with 
unreahzable  assets  that  it  was  finally  compelled  to  go  into  the 
hands  of  receivers.  It  had  extended  its  business  beyond  the 
limits  of  prudence. 

§  367.    Unwise  Expansion 

A  somewhat  similar  experience,  though  not  with  the  same 
disastrous  ending,  was  that  of  the  United  Retail  Stores  Corpora- 
tion. It  is  an  interesting  retrospect  of  what  seems  to  have  been 
an  unwise  expansion.     As  given  in  the  Wall  Street  Journal 'A 

At  the  outset  organizers  of  United  Retail  Stores  Corp.  an- 
nounced plans  for  the  extension  of  a  manufacturing  business  and 

1  March  i,  1922. 


938  CORPORATE  FINANCE  [Bk.  II- 

retaii  chain  of  stores  throughout  the  world.  This  was  started  with 
the  acquisition  of  United  Cigar  Stores  Co.  of  America  as  nucleus 
and  it  was  planned  to  apply  on  a  larger  scale  the  principles  of  retail- 
ing which  has  been  developed  and  proved  successful  in  that  chain. 

Founders'  Shares  Issued  at  $5  -,-  ,„ 

•;  There  were  160,000  founders'  shares  issued  to  those  identified 
with  the  management  at  $5  a  share,  to  rank  equally  with  the  class 
"A"  shares  in  dividend  distributions.  These  dividends  were  to  be 
accepted  in  lieu  of  salary  or  other  compensation  by  ofiicers  and 
directors. 

Organizers  subscribed  for  50,000  class  "A"  shares  of  no  par  at  :' 
$70  a  share  and  approximately  508,000  shares  additional  were 
issued  in  exchange  for  254,000  shares  of  United  Cigar  Stores  com- 
mon at  ratio  of  two  for  one.  This  made  a  total  of  558,000  class  .^ 
"A"  shares  outstanding  and  160,000  founders'  shares.  Thus  the 
founders  increased  capitalization  immediately  by  28%  and  placed 
the  holders  of  these  shares  in  a  position  to  receive  22%  of  the 
dividends  paid  by  United  Retail. 

Investments  Unproductive  '^^^^ 

The  $3,500,000  received  in  subscriptions  for  stock  sold  has  gone 
into  investments  which  thus  far  have  been  unproductive.  In  the 
reorganization  of  Montgomery  Ward  &  Co.,  United  Retail  pur- 
chased half  of  the  issue  of  850,000  shares  of  no  par  common  at  $30 
a  share.  It  sold  part  of  these  to  an  underwriting  syndicate  at  $40 
and  when  the  transaction  was  completed  Retail  had  left  170,000 
shares  at  an  outlay  of  $2,550,000  or  an  average  of  $15  a  share. 
Then  400,000  founders'  shares  of  United  Retail  Candy  were  pur- 
chased at  $1  a  share.  This  placed  Retail  in  a  position  to  share 
approximately  40%  of  the  candy  company's  profits,  and  involved 
an  investment  of  $400,000.  Then  Retail  acquired  at  an  expen- 
diture of  approximately  $1,500,000  an  interest  in  Gilmer,  Inc., 
operating  a  chain  of  cash  retail  stores  in  the  South.  These  invest- 
ments involved  $4,450,000,  which  not  only  absorbed  the  $3,500,000 
realized  on  the  sale  of  the  50,000  class  "A"  shares,  but  left  it  with 
obligations  at  the  banks  December  31  last  totaling  $1,61 1,000. 

Montgomery  Ward's  Losses 

Montgomery  Ward  &  Co.  in  the  two  years  following  the  invest- 
ment by  Retail  lost  $20,000,000.  Retail  Candy  thus  far  has  shown 
substantial  losses.     During  the  period  of  readjustment,  Gilmer 


Ch.  34J  EXPANSION  935 

found  it  necessary  to  take  inventory  losses,  and  though  its  business 
13  .  appears  to  have  turned  the  corner,  it  is  not  yet  yielding  Retail  an 
income. 

With  stock  dividends,  Retail's  holdings  of  United  Cigar  Stores 
have  been  brought  up  to  308,000  shares.  Retail  has  paid  two 
stock  dividends  of  5%  each,  in  which  the  founders'  shares  par- 
ticipated, bringing  total  class  "A"  outstanding  up  to  633,100 
shares. 

Other  Companies  Organized 

In  connection  with  the  proposed  worldwide  retail-manufactur- 
ing scheme,  A.  T.  Securities  Corp.  was  formed  and  acquired,  by 
exchange  of  stock,  common  shares  of  American  Tobacco  Co.  This 
was  subsequently  dissolved.  Another  company  of  which  little  has 
been  heard.  International  Trademark  Corp.,  made  its  appearance 
on  the  New  York  Curb  rtiarket,  but  no  detailed  announcement  was 
made  in  this  connection.  Efforts  were  also  made  to  acquire  foreign 
tobacco  monopolies. 

United  Retail  was  organized  in  the  peak  of  wartime  inflation 

and  its  investments  were  made  under  these  unfavorable  conditions. 

The  net  result  has  been  $4,450,000  of  unproductive  investments, 

a  bank  debt  of  over  $1,600,000  and  United  Cigar  Stores  left  to  carry 

the  load  with  633,100  class  "A"  shares  and  160,000  founders'  shares, 

a  total  of  793,100  shares  compared  with  Cigar  Stores'  actual 

capitalization  of  328,653  common  shares.     Shareholders  of  United 

81    Retail  who  exchanged  their  United  Cigar  Stores  common  find 

f^p  holders  of  founders'  shares  receive  approximately   20%  of  the 

dividends  paid  out  of  the  Retail's  earnings  from  disbursements  on 

United  Cigar  Stores  common.    At  the  same  time  United  Cigar 

Stores  Co.  has  its  usual  overhead,  while  a  shareholder  in  United 

'     Retail  has  to  carry  the  additional  overhead  of  the  founders'  shares. 

Of 

§  368.    A  Sound  Expansion  Policy 

Many  large  corporations  have  been  led  astray  by  the  idea 
that  it  was  necessary  for  them  to  extend  their  business  by 
attempting  to  buy  up  all  competitors.  The  chief  result  has  been 
that  they  have  "held  the  bag"  for  all  kinds  of  trouble-makihg 
schemes.  The  contrary  policy  is  ably  set  forth  by  A.  W.  Green, 
then  chairman  of  the  company,  in  the  annual  report  of  the 
National  Biscuit  Company  for  1901 .    The  fact  that  the  company 


940  CORPORATE  FINANCE  [Bk.  II- 

has  paid  regular  dividends  of  7%  on  both  its  common  and  pre- 
ferred stock  for  many  years  past  and  now  has  a  surplus  of  over 
$20,000,000,  indicates  the  wisdom  of  the  policy.  Mr.  Green 
says : 

When  the  Company  started  it  was  believed  that  we  must 
control  competition,  and  to  do  this  we  must  either  fight  it  or  buy 
it.  The  first  meant  ruinous  war  of  prices,  the  second  constantly 
increasing  capitalization.  Experience  soon  proved  to  us  that 
instead  of  bringing  success,  either  of  these  courses,  if  per- 
severed in,  must  bring  disaster.  This  led  us  to  ask  ourselves 
whether  the  Company,  to  succeed,  must  not  be  managed  like  any 
other  large  mercantile  business.  We  soon  decided  that  within  the 
Company  itself  we  must  look  for  success. 

We  turned  our  attention  and  bent  our  energies  to  improving 
the  internal  management,  to  getting  the  full  benefit  from  purchas- 
ing our  raw  materials  in  large  quantities,  to  economizing  the  ex- 
pense of  manufacture,  to  systematizing  our  selling  department,  and 
above  all  things  to  improving  the  quality  of  our  goods.  It  became 
the  settled  policy  of  this  Company  to  buy  out  no  competition,  and 
to  that  policy,  since  it  was  adopted,  we  have  steadfastly  adhered 
and  expect  to  adhere  to  the  end. 

§  369.    The  Chain  Store  Plan  of  Expansion 

Another  very  common  fallacy  on  the  part  of  manufacturers 
is  the  notion  that  they  must  handle  their  own  retail  outlets,  and 
to  do  so  must  build  up  a  group  of  chain  stores.  This  policy  has 
in  fact  been  successfully  followed  by  many  important  companies, 
such  as  the  George  E.  Keith  Company,  manufacturers  of  "Walk- 
Over"  shoes,  the  Regal  Shoe  Company,  the  W.  L.  Douglas  Shoe 
Company,  Huyler's,  Page  and  Shaw,  etc.  In  practically  every 
such  instance,  however,  it  will  be  found  that  the  policy  has  been 
followed  as  a  means  of  protection,  not  as  a  profit-maker  in  itself. 
The  dangers  of  extension  along  this  line  are  not  to  be  minimized. 
The  manufacturer,  in  the  first  place,  is  going  into  a  line  of  busi- 
ness with  which  he  is  not  familiar  and  where  it  is  difficult  to 
avoid  numerous  pitfalls.  In  the  second  place,  he  is  likely  to  find 
that  the  move  brings  him  the  active  hostility  of  the  retailers  who 


Ch.  34]  EXPANSION  941 

have  previously  served  as  his  agencies,  thus  making  it  necessary 
for  him  to  develop  his  chain  of  stores  more  rapidly  than  he  had 
anticipated  and  to  invest  more  money  than  he  had  originally 
counted  upon. 

It  is  a  fact  often  commented  upon  that  successful  corpora- 
tions, as  they  expand,  ordinarily  tend  to  earn  smaller  and  smaller 
returns  on  the  actual  value  of  their  property.  One  common 
explanation  is  that  at  the  beginning  one  or  two  managers  exercise 
close  personal  supervision  over  the  whole  enterprise,  and  direct 
it  by  their  insight  and  wisdom  into  the  most  profitable  channels; 
whereas  later  their  duties  are  necessarily  delegated  in  part  to 
men  of  less  ability. 

The  economist  offers  in  explanation  of  this  falling  off  in  the 
percentage  of  return,  the  "law  of  diminishing  returns" — which 
is  simply  the  principle  that  the  most  advantageous  opportunities 
for  utilizing  capital  and  energy  are  taken  at  the  beginning,  and 
the  less  advantageous  opportunities  are  left  for  future  develop- 
ment. Yet  neither  one  of  these  explanations  applies  in  the  case 
of  many  corporations  which  are  ably  managed  and  which  con- 
tinually raise  and  invest  fresh  capital  without  decreasing  the 
average  rate  of  return.  Modern  methods  of  organization  and 
management  and  the  advantage  of  being  able  to  employ  special- 
ized talent  go  far  toward  offsetting  the  first  difficulty  above 
named. 

As  to  the  economic  principle,  it  applies,  to  be  sure,  but  only 
after  the  industry  has  been  so  far  developed  that  all  its  highly 
advantageous  opportunities  have  been  sought  out  and  utilized — 
a  condition  which  obtains  in  very  few  lines  of  business.  We  may 
safely  infer  that  one  important  cause  for  a  decline  in  the  rate  of 
return  is  to  be  found  in  the  strong  tendency  to  make  extensions 
of  original  businesses  along  lines  that  are  not  wisely  chosen.  The 
results  of  each  move  are  not  foreseen  and  calculated  with  suf- 
ficient care. 

As  an  example  of  profitable  extension  on  a  great  scale,  we 
may  take  the  case  of  the  General  Electric  Company.     During 


^2  CORPORATE  FIN.\NCE  [Bk.  li- 

the nine  years,  1905-19 13,  the  capital  stock  Increased  from 
$48,000,000  to  $101,000,000.  However,  $23,000,000  of  this 
increase  represented  a  stock  dividend  in  191 2,  which  left  only 
$20,000,000,  or  slightly  over  40%,  as  an  actual  increase  of  in- 
vested capital.  During  these  nine  years,  the  profits  applicable  to 
dividends  doubled  and  the  gross  sales  nearly  tripled.  Since  then 
the  capital  stock  has  been  increased  to  $139,026,900.  At  the  end 
of  1920  the  company  had  a  working  capital  of  over  $145,000,000 
and  a  surplus  of  over  $70,000,000.  Its  profits  for  that  year 
available  for  dividends  were  over  $22,000,000.  All  this  has  been 
accomplished  by  steady  progress  in  extending  the  business  along 
lines  that  had  previously  been  mapped  out.  It  is  an  inspiring 
record  of  what  may  be  accomplished  by  persistent  and  consistent 
effort. 

§370.  a  Investing  Capital  in  Betterments 

One  of  the  frequent  causes  of  embarrassment  to  corporations 
which  take  over  going  concerns,  or  which  are  formed  in  order  to 
combine  previously  existing  concerns,  is  the  discovery  that  the 
supposed  net  earnings  of  the  acquired  concern  have  been  achieved 
through  failure  to  maintain  the  property  in  first-class  condition. 
Of  course,  if  the  investigation  has  been  sufficiently  thorough,  this 
fact  will  be  discovered  before  any  entangling  alliances  have  been 
formed.  However,  the  truth  is  that  such  investigations  fre- 
quently are  carried  on  in  sKpshod  fashion,  or  may  even  be  omitted 
altogether.  Cases  are  not  uncommon  where  important  com- 
binations have  been  formed  on  the  strength  of  the  unsupported 
statements  of  earnings  submitted  by  each  of  the  constituent 
companies. 

Even  within  a  going  and  apparently  successful  corporation 
the  same  condition,  may  exist.  If  the  direction  of  affairs  is  left 
wholly  in  the  hands  of  the  active  officers,  they  will  net  be  over- 
anxious to  disturb  their  showing  of  profits  by  setting  aside  ample 
sums  to  offset  depreciation  and  to  maintain  the  property  ^at  its 
full  value. 


Ch.  34]  EXPANSION  943 

It  must  be  borne  in  mind  in  this  connection  that  making 
repairs  from  time  to  time  is  not  enough.  If  competitors  are 
installing  new  and  more  efficient  machinery,  it  is  not  sufficient 
for  the  company  to  keep  its  old  machinery  in  good  repair.  The 
more  efficient  machinery  must  be  installed  if  its  position  is  to 
be  maintained.  At  some  later  date,  when  the  fact  becomes 
known  that  large  amounts  are  urgently  required  to  bring  the 
property  back  into  first-class  condition,  both  the  stockholders 
and  the  directors  are  loath  to  give  up  or  even  reduce  their  divi- 
dends to  atone  for  the  errors  of  the  past.  Instead,  the  idea  of 
raising  new  capital  to  provide  for  betterments  will  meet  with 
favor. 

It  will  be  argued  in  favor  of  this  view,  that  betterments 
represent  a  capital  expenditure  which  may  properly  be  provided 
through  the  issuance  of  fresh  securities.  This  may  be  true,  but 
the  needed  expenditures  now  accumulated  in  a  lump  should 
have  been  met  out  of  profits  over  a  series  of  years.  It  is  also 
probable  that  fresh  capital  invested  in  bringing  the  plant  and 
machinery  up  to  a  reasonable  degree  of  efficiency  will  not  materi- 
ally increase  the  profits,  but  will  merely  have  the  effect  of  pre- 
serving or  restoring  the  profits  the  concern  had  theretofore  been 
earning. 

The  question  as  to  when  betterments  constitute  a  legitimate 
capital  expenditure  and  when  they  should  be  met  out  of  earnings, 
is  naturally  always  debatable.  Conservative  management  tends 
strongly  to  decide  the  question  in  favor  of  the  second  alternative. 
When  it  is  not  so  decided,  there  is  always  a  danger  at  least  of 
investing  fresh  capital  in  a  form  that  will  bring  little  if  any 
returns.  The  statement  is  so  obvious  that  no  illustration  is 
needed  to  enforce  it.  Its  importance,  however,  should  not  be 
overlooked. 

) 
§  371.    Investing  Capital  in  Side  Lines 

As  has  been  remarked,  the  managers  ot  a  corporation  that  has 
proved  successful  are  seldom  willing  to  stop.    They  wish  to  go 


944  CORPORATE  FINANCE  [Bk.  II- 

ahead  and  enlarge  their  profits.  This  statement  applies  noti^bly 
to  the  business  men  of  the  United  States.  In  England  and  other 
countries,  business  customs  favor  building  up  a  sound  business 
and  maintaining  it  rather  than  restlessly  pushing  into  other  fields. 
No  doubt  the  American  practice  makes  for  progressiveness,  yet 
it  also  involves  a  constantly  recurring  danger  of  disaster. 

The  number  of  companies  which  have  taken  on  "side  line" 
enterprises  to  their  sorrow  is  far  beyond  what  would  usually 
be  supposed.  A  conspicuous  example  is  the  American  Locomo- 
tive Company  which  some  years  ago  decided  to  engage  in  the 
business  of  manufacturing  automobiles.  The  plant  was  poorly 
located  and  it  is  to  be  presumed  that  the  officers  had  neither  the 
time  nor  the  special  training  which  would  have  enabled  them  to 
handle  this  business  with  success.  A  few  years  later  internal 
dissension  in  the  company  brought  to  light  the  fact  that  over 
$2,3CHD,ooo  had  been  lost  in  a  single  year  in  the  automobile 
enterprise.  Subsequently  the  directors  decided  to  accept  their 
loss,  dispose  of  the  plant  and  other  assets,  and  close  all  their 
activities  in  this  field. 

In  1914  the  American  Water  Works  and  Guarantee  Company 
became  financially  embarrassed.  This  company  had  been  a 
highly  successful  promoter  of  public  utility  corporations  and  of 
holding  companies  operating  in  the  public  utility  field.  After 
having  succeeded  in  this  line,  it  attempted  to  carry  out  certain 
irrigation  projects  and  invested  in  these  projects  more  than 
$10,000,000.  In  addition  it  eventually  became  necessary  for 
the  company  to  indorse  more  than  $23,000,000  of  the  obligations 
of  its  irrigation  subsidiaries.  The  result  was  that  this  "side  line" 
became  the  most  important  activity  of  the  company  and  was  the 
direct  cause  of  its  difficulties,  which  resulted  in  the  reorganiza- 
tion of  the  company  as  the  American  Water  Works  and  Electric 
Company.  No  dividend  has  ever  been  paid  on  the  common 
stock  of  the  new  company. 

On  the  other  hand,  it  is  sometimes  true  that  a  "side  line" 
may  prove  to  be  the  only  really  profitable  feature  of  a  business. 


Ch.  34]  EXPANSION  945 

For  example,  the  London  Underground  Electric  Railways  Com- 
pany some  years  ago  since  had  investments  of  a  nominal  value  of 
£17,000,000,  of  which  £15,500,000  was  in  the  various  under- 
ground railway  companies,  and  £1,500,000  was  in  the  London 
General  Omnibus  Company.  The  profits  from  the  underground 
railways  were  a  trifle  over  1%,  or  about  £160,800;  the  profits 
of  the  omnibus  service  were  nearly  23%,  or  about  £377,000. 

Some  of  the  great  meat-packing  concerns  such  as  Armour, 
Swift,  and  Morris,  started  a  great  many  years  ago  to  operate 
refrigerator  cars  primarily  for  transporting  their  own  products. 
As  a  "side  line"  they  began  to  run  these  cars  for  the  benefit  of 
producers  of  fruit  and  vegetables,  with  the  result,  as  is  well 
known,  that  operating  car  lines  became,  in  time,  one  of  the  most 
profitable  features  of  their  business.      Other  lines  were  also  added. 

In  the  same  way  the  United  Fruit  Company  was  originally 
designed  merely  to  market  tropical  fruits,  especially  bananas. 
In  the  course  of  time,  however,  the  company  has  taken  over  one 
"side  line"  after  another,  until  at  present  it  conducts  banana 
plantations,  sugar  plantations,  railroads,  tramways,  steam- 
ships, and  refrigerator  car  lines.  It  is  understood  that  these 
developments  have  proved  profitable  and  that  the  company's 
revenue  from  its  transportation  interests  is  almost  as  great  as 
from  its  original  field  of  operation. 

On  the  other  hand,  the  recent  unhappy  experiences  of  the 
United  Retail  Stores  Corporation  with  its  side  lines  has  already 
been  referred  to.  Another  somewhat  similar  experience  is 
referred  to  briefly  in  the  report  of  Armour  and  Company  for 
the  year  192 1,  which  in  explanation  of  the  net  loss  for  that  year 
of  over  $31,700,000,  says: 

The  year  just  passed  was  the  most  disastrous  in  our  business 
history,  as  well  as  in  the  packing  industry  in  general.  A  business 
such  as  ours  must  carry  many  millions  of  pounds  of  products  in 
process  of  cure.  Price  declines,  therefore,  mean  losses  not  only  in 
sales  but  in  inventory  values  as  well.  Extent  of  these  losses  can 
be  visualized  in  price  fluctuation  of  live  hogs,  which  fell  from  a  14- 


946  CORPORATE  FINANCE  [Bk.  II- 

•  •   cent  level  at  the  beginning  of  the  year  to  a  7-cent  level  at  the  end. 
Our  principal  losses  for  the  year  were  incurred  in  fields  of  enterprise 
1  other  than  the  meat  lines. 

In  normal  times  distribution  of  risks  through  further  process- 
"  itig  of  by-products,  cotton  oil  products,  &c.,  is  a  safeguard,  but 
''•  "last  year  it  increased  our  losses  because  after-war  liquidation  was 
more  in  most  of  these  lines  of  business  than  in  our  main  business. 
Armour  Fertilizer  Works,  third  largest  in  the  industry,  suffered  in 
common  with  the  whole  fertilizer  industry  and  lost  $8,250,000. 
Canned  fruit  and  vegetable  business  lost  heavily.  Our  agreement 
with  the  Government  compelled  us  to  take  not  merely  market  losses 
on  these  products,  but  additional  losses  from  forced  sales  to  liqui- 
date within  prescribed  limits.  Big  losses  resulted  from  the  situa- 
tion in  the  tanning  business. 

§  372.    Results  of  Side  Line  Investment 

Perhaps  the  most  definite  conclusion  that  can  be  reached  here 
is  that  the  creation  of  "side  lines"  is  a  dangerous  business  policy. 
It  involves  a  diversion  of  capital,  of  thought,  and  of  creative 
energy  that  would  otherwise  go  into  building  up  the  company's 
own  business.  This  is  especially  the  case  when  a  "side  line"  is 
taken  on,  that  has  no  vital  or  necessary  connection  with  the 
original  and  proper  business  of  the  company.  In  that  case,  it 
calls  for  an  especially  heavy  drain  on  the  talent  and  resources  of 
the  company.  The  "side  line"  that  develops  naturally  and  al- 
most unavoidably  is  of  a  different  type.  It  may  be  considered 
as  rather  in  the  nature  of  an  extension  than  a  "side  line." 

Even  when  a  "side  line"  is  successful,  the  question  still  re- 
mains whether  the  appHcation  of  an  equal  amount  of  capital 
and  of  managerial  abiHty  to  the  company's  own  product  would 
not  have  brought  still  greater  success.  Certain  it  is  that  those 
companies  which  have  achieved  the  greatest  records  of  growth 
are  those  which,  like  the  Ford  Motor  Company,  the  National 
Cash  Register  Company,  the  Curtis  Publishing  Company,  and 
thousands  of  others,  have  devoted  themselves  exclusively  to 
turning  out  one  or  two  cognate  products  and  have  never  allowed 
money  or  energy  to  be  diverted  from  this  main  purpose. 


■fyigh:m)-?  :anir!s}l(ff^?23  "  .hKi 


CHAPTER  XXXV.     h  > 

FINANCIAL  STANDARDS  - 

§'r35l3fw-  Need  for  Standards  ^ 

A  man  who  keeps  all  his  property  in  the  form  of  cash  and 
government  bonds  has,  as  to  this,  but  little  to  worry  or  think 
about;  but  on  the  other  hand  he  is  not  using  his  resources  pro- 
ductively. As  the  same  man  proceeds  with  the  development  of 
some  business  enterprise,  he  puts  more  and  more  of  his  capital 
into  the  various  forms  of  tangible  and  intangible  assets  which  are 
required  for  the  up-building  of  the  business.  Presently,  if  he  is 
not  careful,  he  may  find  himself  short  of  cash  and  unable  to  meet 
his  obligations,  although  he  may  be  earning  good  profits. 

The  same  tendency  is  present  everywhere.  The  executives 
who  are  managing  the  financial  affairs  of  a  company  cannot 
make  the  business  profitable  merely  by  piling  up  cash  resources. 
They  must  be  prepared  to  venture  out  into  the  main  current  of 
business  affairs  along  with  their  associates.  And  as  they  ven- 
ture farther  and  farther,  the  danger  increases  that  their  finan- 
cial craft  may  be  swept  out  of  their  control.  It  requires  constant 
watchfulness  and  sound  knowledge  to  steer  a  middle  course 
between  excessive  caution  on  the  one  side,  and  rashness  in 
financial  management  on  the  other. 

It  would  be  far  easier  to  keep  to  this  middle  course  if  the  safe 
channels  were  more  clearly  marked  out,  A  manufacturer,  for 
example,  takes  on  a  greatly  enlarged  volume  of  business  with 
the  result  that  his  working  capital  is  much  reduced;  he  finds 
it  difficult  to  determine  with  any  accuracy  whether  this  reduc- 
tion is  approaching  the  danger  point  or  not;  he  has  no  definite 
rule  or  standard  by  which  to  guide  his  course,     j^'  Ju-i::;! 'jiir 

947 


948  CORPORATE  FINANCE  [Bk.  II- 

§  374.    Establishing  Standards 

Many  such  standards  of  operating  and  financial  practice  are 
established  for  particular  industries  by  general  consent.  These 
standards  are  in  many  cases  of  doubtful  correctness,  but  they 
serve  to  assist  those  who  are  forming  and  testing  policies.  For 
example,  the  percentage  of  cost  of  carrying  on  various  lines  of 
retail  business,  in  comparison  with  the  gross  sales  of  the  business, 
has  been  studied.  It  is  generally  said  that  the  cost  of  conducting 
a  retail  book  store  is  about  30%  of  the  gross  sales.  Again,  in 
many  lines  of  manufacturing  the  percentages  of  prime  cost,  of 
overhead,  and  of  selling  cost,  to  the  prices  of  the  articles  manu- 
factured, are  quite  definitely  agreed  upon. 

Unfortunately,  general  standards  of  financial  practice  are  not 
worked  out  in  any  detail  or  with  any  approach  to  accuracy.  At 
this  stage  it  would  be  impracticable  for  any  individual  or  private 
enterprise  to  attempt  to  collect  and  collate  all  the  data  required 
to  make  our  knowledge  of  standards  of  safe  financial  practice 
more  complete  and  more  practical.  This  is  work  to  be  done  by 
associations  of  business  men  which  have  authority  or  can  secure 
permission  to  inspect  the  private  records  of  thousands  of  busi- 
ness concerns.  Thus  the  American  Bankers'  Association,  the 
Investment  Bankers'  Association,  the  United  States  Chamber 
of  Commerce,  and  other  bodies  might  properly  co-operate  in 
carrying  through  to  completion  investigations  of  this  character. 
Such  a  fixing  of  standards  might  well  justify  governmental  atten- 
tion. 

. ,  The  result  of  such  a  work  would  be  a  definite  determination  of 
many  standards  which  would  be  of  the  highest  value  to  business 
executives,  to  bankers  and  other  creditors,  and  to  the  whole 
business  community  in  reducing  the  amount  and  seriousness  of 
losses  due  to  errors  in  handling  financial  problems.  It  would  not, 
of  course,  be  feasible  to  establish  inflexible  rules  that  would  be 
binding  alike  on  all  classes  of  business.  There  would  be  ample 
room  left  for  individual  knowledge,  foresight,  and  discretion. 
The  result  would  be  simply  to  establish  certain  normal  or  typical 


Ch.  3S]  FINANCIAL  STANDARDS  949 

relations,  such  as  cash  resources  in  relation  to  current  liabilities, 
total  current  assets  to  current  liabilities,  working  capital  to  total 
capital,  working  capital  to  volume  of  business,  the  operating 
ratio,  the  relation  of  gross  profit  to  sales,  turnover,  the  relation 
of  net  profits  to  fixed  and  to  contingent  charges,  of  capital  stock 
and  of  bond  issues  to  gross  volume  of  business,  and  so  on.  Hav- 
ing these  standards  in  mind,  the  financial  manager  would  diverge 
from  them  in  his  own  practice  only  after  careful  consideration 
and  with  the  full  knowledge  that  he  would  have  to  convince  his 
associates  and  his  bankers  of  the  soundness  of  his  reasons.  There 
would  be  little  danger,  as  at  present,  of  his  taking  chances  in 
mere  recklessness  or  ignorance. 

In  the  absence  of  a  lengthy  and  thorough  investigation  by 
associations  of  business  men  along  the  lines  above  suggested,  it 
is  as  yet  impossible  to  do  more  than  offer  a  few  suggestions  based 
upon  studies  of  published  income  statements  and  balance  sheets. 
These  suggestions  are  obviously  fragmentary,  and  are  subject 
to  the  corrections  and  explanations  that  would  doubtless  be 
discovered  in  many  cases  through  a  detailed  study  of  the  accounts 
that  form  the  basis  of  the  published  statements.  The  purpose 
of  presenting  these  suggestions  is  chiefly  to  indicate  more  defin- 
itely how  the  executive  may  test  the  soundness  of  the  practice 
of  his  own  company  by  making  comparisons  with  similar  com- 
panies. These  informal  tests,  however  inaccurate  and  incon- 
clusive they  may  be,  are  often  found  to  be  a  fertile  source  of 
suggestions. 

§  375*    Relation  of  Working  Capital  to  Total  Capital 

Following  are  the  percentages  of  working  capital  to  total 
capital  as  shown  in  the  published  balance  sheets  of  a  considerable 
number  of  prominent  American  industrial  corporations,  which 
have  been  selected  practically  at  random.  The  figures  given 
are  those  of  the  period  immediately  preceding  the  Great  War,  the 
enormous  inflation  of  the  war  period  rendering  present  figures 
too  erratic  to  afford  any  basis  of  comparison.    As  a  matter  of 


950  CORPORATE  FINANCE  [Bk.  II- 

interest,  however,  the  present-day  figures  are  given  in  parentheses 
immediately  following  the  prewar  figures.  They  show  startling 
increases  in  the  amount  of  working  capital  involved.  A  large 
part  of  this  working  capital  was  tied  up  in  the  enormous  and 
high-priced  inventories  carried  by  all  the  larger  corporations 
towards  the  end  of  the  war  period — an  inventory  condition  out 
of  which  they  are  now  painfully  working  to  more  normal  and 
safer  levels.i 

For  convenience  these  companies  are  divided  into  three 
groups  on  the  basis  of  their  prewar  percentages  of  working  capi- 
tal, those  having  a  proportion  of  working  capital  below  15%  of 
total  capital  being  placed  in  the  first  group,  those  having  between 
15%  and  35%  in  the  second  group,  and  those  having  above  35% 
in  the  third  group. 

Percentage  of  Working  Capital  to  Total  Capital 

I 

Mexican  Petroleum  Company 3-5% 

California  Petroleum  Company 3.9  (  6.4%) 

Sloss-Sheffield  Company 6.1  (10.6) 

Corn  Products  Company 6.7  (30.2) 

Pittsburg  Coal  Company 8.9  (27.5) 

United  Fruit  Company 9.0  (28.2)     * 

Union  Bag  and  Paper  Company 9.4  (25.6) 

Harbison-Walker  Refractories  Company lo.o  (17-2) 

American  Can  Company 11.5  (30.2) 

Railway  Steel  Spring  Company ; 13.0  (48.0) 

International  Paper  Company 14.4  (51.7) 

II 

Sears-Roebuck  Company 151%  (691%) 

Butterick  Company 15.6  (14-6) 

The  National  Enameling  and  Stamping  Company 15.7  (38.5) 

United  States  Food  Products  Corporation 16.0  (17.7)** 

United  States  Steel  Corporation 16.2  (38.3) 

Pressed  Steel  Car  Company 18.3  (32.8) 

Bethlehem  Steel  Company 19.4  (5i.8)t 

*  Does  not  include  current,  stock  distribution. 

**  Name  changed  in  1919  from  Distillers  Securities  Company, 
t  Including  $30,000,000  of  s-year  notes. 

*  For  inventory  losses  of  important  companies,  see  }  381. 


Ch.  35] 


FINANCIAL  STANDARDS 


951 


The  B.  F.  Goodrich  Company-. .-.-.".-» ^.-r.^'Tv.  .-.y^rff.  {« 19-7% 

Republic  Iron  and  Steel  Company 20.2 

May  Department  Stores 20.7 

New  York  Air  Brake  Company 21.0 

American  Steel  Foundry  Company. ; . .  21.3 

Loose-Wiles  Company -tiVsi P^" ^^'^ 

National  Biscuit  Company 22.3 

Lackawanna  Steel  Company 24.4 

Baldwin  Locomotive  Company 28.1 

III 

Studebaker  Company 35-5% 

Crex  Carpet  Company 36.8 

Armour  and  Company 37.0 

American  Woolen  Company ».  ,,j^^^^,. . . . .  37.4 

American  Cotton  Oil  Company 37.7 

American  Sugar  Refining  Company 39.6 

American  Tobacco  Company. 42.8 

Underwood  Typewriter  Company 43.2 

General  Motors  Company 45.0 

Central  Leather  Company ' '  48.6 

Packard  Motor  Car  Company. 51.0 

Swift  and  Company 51.0 

Morris  and  Company 53.0 

Eastman  Kodak  Company 57.0 

Deere  and  Company 70.0 

International  Harvester  Company 81.3 


50-0%) 

37-4) 

.S5-8) 

13-7) 

46.3) 

39-3)     , 

30-4) 

40.1) 

61.9) 


34-o%) 

59-9) 

68.0) 

77.2) 

34-5) 

57-9) 

53-3) 

74-9) 

45-8) 

62.0) 
(102. i) 

84.0) 

46.6) 

(190.5) 

(64.2) 

(103.4) 


§  376.    Comparison  of  Working  Capitals  lunmn 

It  is  interesting  to  observe  that,  with  one  or  two  striking 
exceptions,  companies  which  are  competitive  or  which  do  the 
same  general  class  of  business  had  approximately  the  same  re- 
lations of  working  to  total  capital.  Note,  for  example,  the 
close  correspondence  between  the  California  Petroleum  Company 
and  the  Mexican  Petroleum  Company.  The  only  other  com- 
pany in  the  list  which  is  engaged  in  the  extraction  of  raw  ma- 
terials is  the  Pittsburg  Coal  Company,  which  also  had  a  low 
percentage.  Extractive  companies  have  little  need  for  large 
inventories,  stocks  of  raw  material,  or  other  working  assets, 
except  cash  and  accounts  receivable.  And  their  accounts  re- 
ceivable do  not  run  for  long  periods. 


952  CORPORATE  FINANCE  [Bk.  II- 

The  International  Paper  Company  and  the  Union  Bag  and 
Paper  Company  are  both  in  Group  I;  doubtless,  owing  to  the 
fact  that  both  companies  manufacture  from  wood  pulp,  which  is 
supplied  by  their  own  forests,  they  had  little  occasion  to  carry 
heavy  stocks  of  raw  materials  or  inventories  of  half-finished 
products.  The  American  Can  Company,  the  Corn  Products 
Company,  the  Sloss-Sheffield  Company,  and  the  Harbison- 
Walker  Refractories  Company,  seem-,  on  the  face  of  the  above 
showing,  to  have  working  capital  considerably  below  normal. 
It  is  likely,  however,  that  a  more  thorough  examination  would 
reveal  reasons  which  are  not  now  apparent.  All  these  com- 
panies show  considerable  increases  in  working  capital  for  the 
postwar  period.  The  United  Fruit  Company  is,  to  a  large 
extent,  engaged  in  transportation  rather  than  in  producing  and 
selling.  As  has  been  previously  pointed  out,  transportation 
operations  do  not  call  for  large  amounts  of  working  capital. 

The  various  railway  equipment  companies,  including  the 
Railway  Steel  Spring  Company  in  Group  I  and  the  Baldwin 
Locomotive  Company,  the  New  York  Air  Brake  Company,  and 
the  Pressed  Steel  Car  Company  appearing  in  Group  II,  all  had 
a  low  proportion  of  working  capital  compared  with  other  indus- 
trial companies.  It  may  be. assumed  that  in  railway  equipment 
manufacturing,  comparatively  little  money  is  tied  up  in  accounts 
receivable. 

All  the  steel  manufacturing  companies,  including  the  Ameri- 
can Steel  Foundry,  the  Bethlehem  Steel  Company,  the  Cambria 
Steel  Company,  the  Lackawanna  Steel  Company,  and  the 
United  States  Steel,  are  included  in  the  second  division,  and  all 
had  working  capital  proportions  below  the  average.  We  may 
again  observe  here,  as  in  the  case  of  the  paper  manufacturing 
companies,  that  "integrated"  production  (that  is  to  say,  unified 
control  of  a  complete  series  of  operations  from  extracting  the 
raw  material  to  delivering  the  finished  product)  favors  a  low  pro- 
portion of  working  capital,  as  the  necessity  for  carrying  stocks 
of  raw  materials  is  much  reduced. 


Ch.  35l  FINANCIAL  STANDARDS  953 

The  two  biscuit  manufacturing  companies — Loose- Wiles  and 
the  National  Biscuit  Company — were  approximately  equal  in 
respect  to  proportions  of  working  capital.  The  other  companies 
in  Group  II  call  for  no  special  mention. 

In  Group  III  are  included  a  number  of  important  companies 
which  may  be  subdivided  into  two  classes:  those  which  find  it 
necessary  to  carry  large  inventories  of  materials,  goods  in  pro- 
cess, and  finished  goods,  and  those  which  find  it  necessary  to  sell 
on  an  instalment  or  long-term  basis,  so  that  accounts  receivable 
are  always  heavy.  The  first-mentioned  class  includes  Ameri- 
can Sugar  Refining  Company,  American  Tobacco  Company, 
American  Woolen  Company,  Central  Leather  Company  (the 
length  of  period  of  leather  manufacture  is  exceptionally  long), 
Crex  Carpet  Company,  American  Cotton  Oil  Company,  and 
Eastman  Kodak  Company.  Some  of  the  companies  just  men- 
tioned also  carry  unusually  large  sums  of  cash. 

The  two  agricultural  implement  companies  in  this  group, 
International  Harvester  Company,  and  Deere  and  Company, 
as  well  as  the  Underwood  Typewriter  Company,  belong  in  the 
class  which  sell  their  products  on  long  terms.  Under  the  strict 
definition  of  the  term,  we  should  probably  not  allow  the  agricul- 
tural companies  so  large  a  proportion  of  working  capital ;  for  in 
arriving  at  this  figure  all  accounts  receivable  have  been  listed 
under  "current  assets."  These  accounts,  however,  consist  in 
large  part  of  small  notes  running  for  one,  two,  and  three  years, 
and  are  hardly  to  be  described,  therefore,  as  "current."  If  we 
were  to  include  only  accounts  maturing  within  three  months,  or 
even  six  months,  our  figures  for  working  capital  of  these  com- 
panies would  probably  show  them  in  about  the  same  condition 
as  other  industrial  corporations. 

The  automobile  companies,  Studebaker,  General  Motors,  and 
Packard,  like  other  manufacturers  of  automobiles,  carry  large 
stocks  on  hand,  especially  at  certain  seasons  of  the  year.  So 
long  as  this  practice  remains  a  necessary  feature  of  the  business, 
they  will  be  required  to  carry  large  proportions  of  working  capital. 


954  CORPORATE  FINANCE  [Bk.  H- 

The  meat-packing  companies — Morris,  Swift,  and  Armour — ■ 
find  it  necessary  to  carry  large  inventories  of  live-stock  and  of 
goods  in  process. 

On  the  whole,  in  running  over  the  list  that  has  just  been  given 
and  in  examining  large  numbers  of  other  industrial  balance 
sheets,  it  becomes  fairly  evident  that  well-managed  business 
enterprises  customarily  follow  standards  that  are  more  or  less 
similar  and  that  lead  them  to  establish  similar  proportions  of 
working  to  total  capital.  The  exceptional  cases,  both  above  and 
below  the  normal  proportions,  are  for  the  most  part  readily 
explainable.  Each  financial  manager,  taking  the  published 
statements  of  the  firms  that  are  most  nearly  like  his  own,  will 
find  it  useful  to  make  a  comparison  and,  if  possible,  explain 
the  striking  divergences  either  above  or  below  the  average. 

§  377.    Cash  and  Cash  Resources 

Closely  related  standards  and  tests  apply  to  the  proportions 
of  cash  and  resources  immediately  convertible  into  cash  (prin- 
cipally securities  held  for  sale)  to  gross  volume  of  business,  and 
to  current  liabilities. 

Inasmuch  as  banks  are  devoted  almost  exclusively  to  hand- 
ling cash  and  credit,  we  should  naturally  expect  that  their 
practice  in  respect  to  these  factors  would  be  more  definitely 
standardized  than  the  practice  of  mercantile  manufacturing 
companies,  and  this  is  actually  the  case.  The  experience  of 
financiers  over  many  generations  has  gradually  crystallized  into 
the  conclusion  that  in  an  ordinary  commercial  bank,  which  is 
effectively  using  most  of  its  capital  in  its  own  business,  that 
capital  ought  to  be  invested  chiefly  or  wholly  in  cash,  or  at  least 
in  cash  and  secondary  reserves  immediately  convertible  into 
cash.  The  proportion  of  cash  to  demand  liabilities  has  been 
fixed  by  long  experience  at  from  15%  to  25%. 

In  most  American  industrial  companies,  the  proportion  of 
average  cash  to  gross  sales  is  about  3%  to  6%.  If  the  company 
is  paying  its  bills  promptly  and  is  not  overborrowing,  current 


Ch.  35]  FINANCIAL  STANDARDS  955 

liabilities  should  not  exceed  20%  to  30%  of  annual  sales.  This 
refers,  of  course,  to  the  business  of  manufacturing  a  standard 
article  or  articles  which  can  be  sold  in  fairly  steady  volume.  On 
the  basis  of  these  figures,  cash  and  cash  resources  should  be 
about  12%  to  25%  of  current  liabilities,  and  this  is  not  far  from 
the  customary  showing. 

§  378.    Turnover 

The  definition  of  the  term  and  the  reasons  for  laying  great 
importance  upon  quick  turnover  have  previously  been  dis- 
cussed.2  The  additional  point  that  belongs  in  this  chapter  is 
a  statement  as  to  the  ratio  of  turnover  which  may  be  accepted 
as  standard  in  various  lines  of  business.  This  statement  is  by 
no  means  complete  or  conclusive,  but  is  based  upon  the  frag- 
mentary information  which  it  is  now  possible  to  obtain  from  the 
records  of  business  firms. 

A  cotton  goods  commission  house  which  does  a  little  financing 
of  sales,  employs  some  traveling  salesmen,  and  carries  n'o  stock, 
has  total  working  assets  of  $400,000.  The  annual  sales  of  this 
house  are  about  $3,500,000,  showing  a  turnover  of  nearly  900%. 
This  is  regarded  as  a  good,  though  not  abnormal,  showings,  .i  ..• 

A  large  department  store  is  said  to  carry  an  average  stock 
of  $8,000,000  to  $10,000,000,  and  to  have  average  sales  of  $15,- 
000,000  to  $20,000,000,  showing  a  turnover  of  200%. 

It  is  said,  on  excellent  authority,  that  many  retail  grocers 
make  a  complete  turnover  at  least  once  a  month,  equivalent  to 
1,200%  for  the  year,  while  country  stores,  which  are  forced  to 
carry  a  large  assortment  of  stock,  are  well  satisfied  to  do  300% 
to  400%.  One  small  retail  store  is  recently  reported  to  have 
done  900%,  but  this  is  an  extraordinary  showing. 

In  manufacturing  companies,  turnover  is  an  element  of  so 
much  less  importance  relatively,  that  comparatively  httle  atten- 
tion has  been  paid  to  attempting  to  determine  standards.  It 
would  be  unsafe  to  rely  on  published  balance  sheets  and  income 

"See  ii  150-154. 


Q56  CORPORATE  FINANCE  [Bk.  II- 

atatements  as  the  sole  source  of  information  in  figuring  turnover, 
inasmuch  as  the  working  capital  of  most  concerns  varies  consid- 
erably from  one  season  of  the  year  to  another  and  a  comparatively 
slight  variation  would  make  a  large  difference  in  the  results  of 
the  calculation. 

§  379*     Operating  Ratios 

One  of  the  most  important  standards  or  tests  of  efficiency 
in  all  lines  of  business  is  the  percentage  of  total  expense  of  run- 
ning the  business,  including  manufacturing,  selling,  and  admin- 
istrations, to  the  gross  sales — more  commonly  known  as  the 
"operating  ratio."  It  is  clear  that  the  difference  between  ioo% 
which  represents  gross  sales  and  the  operating  ratio  is  the  per- 
centage of  profit  on  sales.  The  lower  this  percentage  of  profit— 
or,  in  other  words,  the  higher  the  operating  ratio — the  more 
unstable,  other  things  being  equal,  is  the  business  as  a  money 
maker;  for  a  high  operating  ratio  means  that  even  a  slight  varia- 
tion in  the  expenses  which  comprise  it  may  be  sufficient  to  trans- 
form a  profit  into  a  loss. 

On  the  other  hand,  a  phenomenally  low  operating  ratio 
indicates  a  business  which  is  earning  excessive  profits  and  is 
therefore  pecuKarly  subject  to  competitive  attack.  The  oper- 
ating ratio  should  always  be  compared  with  the  capital  invest- 
ment and  the  fixed  charges  of  the  business,  which  should  not, 
however,  be  included  in  calculating  the  ratio.  Although  the 
operating  ratio  may  be  regarded  as  not  primarily  a  financial 
factor,  and  certainly  is  but  partially  subject  to  control  by  the 
financial  management  of  the  company,  yet  it  is  an  element  of 
so  much  importance  that  it  requires  careful  consideration  both 
by  the  operating  officials  and  by  those  who  are  primarily  inter- 
ested in  accounting  and  finance. 

The  term  "operating  ratio"  was  first  applied,  and  is  still  most 
generally  used,  in  connection  with  steam  railroads.  The  ratio 
here  is  low,  usually  not  more  than  70%;  sometimes  it  climbs  to 
80%  and  90%  or  even  more,  and  sometimes  falls  as  low  as  55%. 


Ch.  35] 


FINANCIAL  STANDARDS 


957 


The  operating  ratio  of  the  Chicago,  Rock  Island  and  Pacific 
Railway  for  the  last  ten  years  is  as  follows: 


igii 
1912 

1913 
1914 

191S 


72.80% 

72.33 

74-94 

76.15 

75.19 


1916 
1917 
1918 
1919 
1920 


68.10% 

73.70 

85.87 

87.03 

94.07 


§  380.    Percentage  of  Profit 

When  we  come  to  industrial  and  mercantile  businesses,  the 
same  result  is  perhaps  better  attained  by  taking  at  once  the  per- 
centage of  profit  on  gross  sales.  The  gross  sales,  net  profits, 
and  percentage  of  profits  on  gross  sales  are  given  below  for  three 
typical  concerns.  All  these  have  a  fair  margin  of  profit.  As 
will  be  noticed,  the  percentage  is  very  stable  in  each  case. 


General  Electric  Company 

Gross  Sales 

Net  Prpfits 

Percentage 

1914 

$  90,467,693 

$  8,970,964 

9.9 

1915 

85.552,070 

8,623,887 

lO.I 

1916 

134,242,290 

15,294,091 

11.4 

1917 

196,926,318 

29,004,540 

\tUa 

1918 

216,815,278 

28,375,756 

1919 

229,979,983 

33,124,300 

14.4 

1920 

275,758,4^8 

26,460,058 

9.6* 

F.  W. 

Woolworth  Company 

Gross  Sales 

Net  Profits 

Percentage 

1914 

$69,619,669 

$6,429,896 

9.2 

191S 

75,995,774 

7,548,210 

9.9 

1916 

87,089,271 

8,713,445 

lO.O 

1917 

98,102,857 

9,252,349 

9.4  ^ 

1918 

107,179,411 

7,088,716 

6.6.^ 

1919 

119,496,107 

10,361,557 

8.6 '/ 

1920 

140,918,981 

9,775,252 

6.9  A 

New  York  Telephone  Company 

:-, 

Receipts 

Net  Profits 

Percentage 

1916 

$57,005,565 

$15,002,260 

26.3 

1917 

62,961,006 

14,293.333 

22.7 

1918 

66,691,09s 

12,419,887 

18.6 

1919 

75.065,893 

12,966,125 

17.2 

1920 

87,906,465 

5,483,026 

6.2 

♦$17,800,785  written  off  inventory  in  1920. 

958  CORPORATE  FINANCE  [Bk.  II- 

.  Percentages  for  other  businesses  might  be  given  ad  infinitum, 
but  it  would  be  useless  to  go  farther  here  than  to  indicate  roughly 
some  of  the  considerations  which  enter  into  determining  a  satis- 
factory operating  margin  for  any  one  business. 

As  already  indicated,  a  company  which  requires  a  large 
amount  of  fixed  capital  and  which  has  therefore  heavy  fixed 
charges,  but  light  operating  expenses,  should  normally  have  a 
small  operating  ratio,  as  is  the  case  with  the  New  York  Tele- 
phone  Company. 

Normally,  a  manufacturing  concern  will  have  a  margin  of 
profit  not  far  from  io%,  as  shown  by  the  General  Electric  Com- 
pany. Trading  companies,  such  as  the  F.  W.  Woolworth  Com- 
pany, run  about  the  same. 

The  man  who  is  thoroughly  familiar  with  a  given  line  of 
business  and  who  knows  with  some  definiteness  the  normal  per- 
centage of  profit  that,  is  required  in  order  to  make  the  business 
safe  and  profitable,  will  not  fail  ordinarily  to  look  to  the  operating 
ratio  as  his  first  significant  test  of  any  company's  financial  status. 

§381.    Inventory  Statistics  ?r- ;.i?,, ru- 

in this  general  connection  the  following  tabulation  showing 
the  inventories  carried  by  some  of  the  large  corporations,  and  the 
effect  upon  them  of  the  conditions  following  the  war,  will  be 
found  of  interest.^ 

It  is  the  192 1  balance  sheets  that  tell  the  story  of  the  reaction 
following  the  war  time  prosperity.  Inventory  accounts  mirror  the 
savage  cut  to  even  below  prewar  values  for  many  commodities. 
What  appeared  to  be  huge  profits  built  up  during  war  prosperity 
have  in  many  cases  turned  out  to  be  but  inflated  inventory  values 
and  these  have  been  punctured  by  the  fall  in  prices  of  both  raw  and 
finished  products  during  1921.  To  absorb  these  losses  with  sales 
running  far  below  normal  has  been  the  problem. 

Twenty-three  representative  concerns  show  a  combined  inven- 
tory account  of  $715,091,762,  against  $1,199,330,639  a  year  ago, 
or  a  decline  of  43%.    For  the  prewar  year  1914  these  same  con- 


'  From  Wall  Street  Journal,  March  lo,  1922. 


Ch.  35]  FINANCIAL  STANDARDS  959 

cerns  had  a  combined  inventory  of  $363,147,150,  or  approximately 
one-half  the  present  value.  In  this  connection  it  should  be  remem- 
bered that  many  companies  have  expanded  their  plants  since  1914 
and  would  naturally  be  expected  to  carry  a  larger  supply  of 
materials. 

The  following  table  lists  23  of  the  larger  industrial  concerns 
which  have  reported  for  1921  and  compares  the  192 1  inventory 
account  with  that  of  1920  and  the  prewar  year  1914: 

T       ^  .  QOOBXiii  ni  male   .  .  161 H 

Inventory  account:  1921  1920                 1914          ^  ' 

American  Hide  &  Leather .  $  5,886,096     $       9,289,186    $    9,629,441 

American  Sugar 12,206,239  45i4oS.iSS  iS.43i.o99      ; 

Armour 83,320,641  136,723,528  44,672,448 

American  Locomotive ...  .  4,350,200  8,284,211          3,962,810 

Baldwin  Locomotive 7,000,736  20,182,280          4,029,367 

»; Bethlehem  Steel 41,115,700  73,208,678  111130,734.  rnri; 

,Central  Leather 48,403,924  60,586,898  42,645,904      r^p 

Cudahy 17,177,704  30,648,357  14,079,201 

Cuban -American  Sugar.  . .  12,901,714  15. 593. 934          3,966,453 

B.  F.  Goodrich.  .  ,*.jri«v»iv  29,618,936  72,631,058  11,308,857 

General  Motors.  .  _y^^.  ^,^..,  108,762,625  164,684,679  11,642,370 

Kelly-Springfield.^......'  5.525.730  9.751.388          i,795,36S- ,|^ 

Loose-Wiles.....; '.'7  !'.:^!t  2,936,848  5,230,811          1,981,136 ''•■''^^! 

Lackawanna  J'.'lfJW.fiJdje'  13,304,041  17,723,923          9,139,674 

Midvale ..'.....■  36,319,212  45.393.835  33,422,686 

Montgomery  Ward 16,767,592  30,282,672          6,780,822 

Morris  &  Co 21,548,259  30,624,016  19,297,166 

National  Biscuit.  :QOii'JH\  3,595,327  8,235,341          5,280,844 

Pierce-Arrow 11,246,697  16,470,662  *9,68o,o57 

Sears-Roebuck 46,445,880  105,071,243  13,273,927 

Swift  &  Co 93,771,464  151,305,085  45,899,008 

U.  S.  Rubber 76,691,777  123,503,031  33,606,741 

F.  W.  Woolworth  &  Co. .  .  16,194,461  18,500,668  10,491,040 

Total $715,091,762     $1,199,330,639    $363,147,15?, 


lid  hluode  oJ  b'snahi 

J<:id> 

.^»i  <lii•)r^!^od 

.■].iim<]  JicJvi 

.i>6£ff:>n;(j  ioIIb 


CHAPTER  XXXVI 

ANALYSIS  BASED  ON  FINANCIAL  STANDARDS 

§  382.    A  Problem  in  Finance 

Bankers,  credit  men,  investors,  and  others  who  are  not  in- 
timately acquainted  with  a  given  business,  are  frequently  called 
upon  to  form  tentative  judgments  as  to  the  financial  efficiency  of 
a  business,  based  chiefly  upon  statements  of  account  that  are 
furnished  to  them,  or  even  upon  a  few  unconnected  figures. 
The  process  of  piecing  together  these  fragments  and  from  them 
forming  a  fairly  definite  mental  picture  of  the  status  and  efficiency 
of  the  concern,  is  not  unlike  the  work  of  those  scientists  who  from 
a  few  small  bones  are  able  to  reconstruct  the  skeleton  of  some 
prehistoric  animal.  In  making  an  analysis  and  "reconstruction" 
of  this  kind,  financial  standards,  if  available,  which  apply  to  the 
business  under  consideration  are  of  much  value. 

The  following  problems  from  the  general  manager  of  a  whole- 
sale house  call  for  opinions  on  certain  questions  of  finance : 

The  firm  has  a  paid-in  capital  of  $125,000,  having  been  in 
business  three  years  with  an  approximate  surplus  of  $25,000.  Of 
this  capital,  $35,000  is  invested  in  a  store  building,  warehouses, 
furniture,  drays,  and  general  equipment  necessary  for  the  carrying 
on  of  said  business.  We  have  approximately  $go,ooo  stock  and 
the  surplus  is  working  capital.  The  credit  of  the  firm  is  $25,000 
to  $200,000  high  credit. 

1.  What  is  the  average  stock  of  merchandise  the  business 
referred  to  should  have  at  all  times? 

2.  What  maximum  open  accounts  would  be  conservative  for 
this  business  to  carry?  Goods  sold  at  60  days'  time,  75%  of  the 
business  sold  to  merchants  with  good  credit,  25%  of  the  business 
retail,  principally  city  accounts  collected  on  first  of  each  month 
after  purchase. 


Ch.  36]  FINANCIAL  STANDARDS  961 

3.  What  maximum  amount  of  bills  payable  should  our  books 
show  for  borrowed  money,  goods,  etc.? 

4.  What  amount  in  bills  receivable  would  be  conservative  at 
any  one  time? 

5.  What  would  be  the  maximum  amount  of  yearly  business 
such  a  firm  should  do  for  capital  invested? 

6.  What  amount  of  dividends  should  stockholders  be  paid,  the 
average  net  earnings  of  the  firm  being  25%,  after  all  expenses  and 
losses  are  paid  and  accounted  for? 

§  383.    Analysis  of  Problem 

On  the  basis  of  this  somewhat  scanty  information,  the  reply 
sent  was,  in  effect,  as  follows : 

From  the  information  given,  a  highly  condensed  balance  sheet 
of  your  business  would  read  somewhat  as  follows: 

Assets 

Building,  Furniture,  and  Equipment $  3S,ooo 

Stock 90,000 

Working  Capital 25,000 

Total  Assets $150,000 

Liabilities 

Capital $125,000 

Surplus 25,000 

Total  Liabilities $150,000 

The  $25,000  working  capital  must  consist  partly  of  cash  and 
partly  of  an  excess  of  accounts  receivable  over  accounts  and  other 
obligations  payable. 

In  order  to  prepare  an  opinion  that  would  fit  your  case,  the 
following  additional  information  is  essential  and  should  be  sup- 
plied: 

Normal  amount  of  cash  in  bank. 
Normal  amount  of  accounts  and  bills  payable. 
Normal  amount  of  accounts  and  bills  receivable. 
Average  percentage  of  gross  profits. 
(.  Average  operating  expenses  per  moat^. 


^  CORPORATE  FINANCE  [Bk  II 

As  these  facts  are  not  furnished,  the  following  assumptions  are 
made:  khj^  .•^•jTiorci  Ii.>  vonod  i<">V'«orf^ 

Normal  Cash  Balance $10,000 

Normal  Accounts  and  Bills  Receivable 90,000 

Normal  Accounts  and  Bills  Payable 75iOoo 

Average  Operating  Expenses  per  month 15,000 

Average  Gross  Profits  (on  selling  prices) 25% 

Very  likely  these  assumptions  are  a  long  distance  from  the  facts. 

That,  however,  will  not  affect  the  reasoning;  you  can  readUy  fill  in 

the  right  amounts  and  thus  make  the  figures  suit  your  situation. 

With  these  assumptions,  your  balance  sheet  would  read  as 

.,i     follows: 

Assets 

Building  and  Equipment $  3Si000 

Stock .• 90,000 

Accounts  Receivable 90,000 

Cash , 10,000 

Total  Assets $225,000 

Liabiliiies 

Capital $1 25,000 

Surplus 25,000 

Accounts  Payable 75,ooo 

Total  Liabilities $225,000 

The  above  balance  sheet  on  its  face  would  seem  to  indicate  a 
fairly  strong  financial  position.  Your  quick  liabilities  would  be 
only  75%  of  your  quick  assets,  not  counting  stock  most  of  which  is 
no  doubt  readily  salable.  This  percentage  in  mercantile  com- 
panies and  in  those  manufacturing  companies  that  carry  large  in- 
ventories of  finished  products  is  generally  considered  conservative. 
The  percentage  in  emergencies  or  at  certain  seasons  of  the  year 
might  rise  as  high  as  85%  or  even  90%  without  indicating  reckless- 
ness, but  this  high  ratio  should  be  short-lived. 

Another  ratio  to  consider  is  that  between  quick  liabilities  and 
the  total  of  current  assets,  including  stock.  It  is  safe  to  say  that 
this  percentage  should  not  normally  be  higher  than  50%.  Th6 
balance  sheets  for  a  period  of  years  of  a  large  wholesale  drj'^  goods 
company  showed  a  ratio  of  quick  liabilities  to  total  quick  assets 
at  the  end  of  each  fiscal  year  as  follows:  40%,  55%,  40%,  57%, 
4S%>  40%,  38%.    In  the  above  assumed  balance  sheet,  the  total 


:h.  36]  FINANCIAL  STANDARDS  963 

of  current  assets  is  $190,000,  and  of  quick  liabilities,  $75,000,  or 
less  than  40%.    This  is  conservative  enough. 

Buyers  of  commercial  paper,  especially  large  banks,  sometimes 
make  an  arbitrary  requirement  for  a  definite  ratio.  In  Babson 
and  May's  treatise  on  "Commercial  Paper"  the  following  nde  is 
laid  down: 

"Two  and  a  quarter  of  quick  assets,  that  is,  assets  which  can  be 
converted  readily  into  cash,  to  one  of  debts,  have  been  taken  as  a 
fair  showing  to  be  called  for  on  an  annual  statement  ....  The 
ratio  of  2%  to  i  should  be  regarded  as  a  fair  ratio  to  be  expected 
on  the  statement  of  the  average  mercantile  company,  and  most 
borrowers  of  this  class  in  the  open  market,  under  our  present  sys- 
tem of  commercial  paper,  ought  to  show  this  much." 

Going  back  to  the  hypothetical  balance  sheet,  it  is  obvious  that 
the  gross  volume  of  business  which  can  be  carried  on  with  safety  is 
to  be  determined  only  by  a  study  of  the  proper  relations  of  the 
various  assets  and  liabilities  to  each  other.  To  illustrate:  make 
the  assumption  (which  is,  of  course,  out  of  the  question)  that  the 
gross  sales  in  the  month  following  the  date  of  the  above  balance 
sheet  should  amount  to  $100,000.  What  would  be  the  effect  on 
the  business?  First,  goods  of  a  cost  value  of  $75,000  would  have 
been  sold  and  would  have  to  be  replaced.  In  addition,  with  this 
volume  of  business,  the  stock  on  hand  would  obviously  have  to  be 
increased  to  say  $125,000.  This  would  make  it  necessary  to  buy 
during  the  month  $110,000.  Assume  that  $50,000  of  the  $90,000 
accounts  receivable  fall  due  during  the  month  and  that  $40,000  of 
the  accounts  payable  become  due,  then  the  cash  receipts  would  be 
$50,000  (assuming  that  there  are  no  cash  sales),  $15,000  of  which 
would  go  for  operating  expenses,  leaving  $35,000  to  apply  toward 
the  accounts  payable;  it  would  be  necessary  in  addition  to  draw 
$5,000  from  the  cash  on  hand.  We  must,  of  course,  assume  that 
such  a  volume  of  business  would  require  an  increase  in  equipment 
which  we  may  assume  to  amount  to  $5,000.  The  condensed 
balance  sheet  at  the  end  of  the  month  would  then  be  a9,,fQJio\v?f 

i.  oJ  Toqoiq 

Assets  ,    ,  ,        ,'  , 

Building  and  Equipment ■,  m;*iif  ej^vii^.^rr-  $  40,000 

Stock ,,j, . . , V .s^,,,  .|^nj(vv  -rt'ir.^ -rii iH'/-  •     125,000 

Accounts  Receivable.. .^r,.,,.,,,,,.,.,^^^^^.^,^^,^.^.^^^^^.,,.     140,000 

Total  Assets.* ^.  ....... .,  $305,000 


964  CORPORATE  FINANCE  [Bk.  11- 

Liabilities  ■  ~  ■  - 

Capital '?....  $125,000 

Surplus 35,000 

Accounts  Payable 145,000 

Total  Liabilities $305,000 

Evidently  this  would  be  an  impossible  situation.  It  appears 
absurd  enough  when  put  in  this  exaggerated  form;  yet  business 
concerns  frequently  work  themselves  into  a  situation  somewhat 
like  this  by  trying  to  carry  a  volume  of  business  which  is  far 
beyond  their  capital. 

With  no  more  facts  than  you  have  given  and  with  only  the 
above  assumptions  to  work  on,  it  is  not  possible  to  give  an  intelli- 
gent answer  to  your  questions  as  to  the  amount  of  yearly  business 
a  firm  of  your  size  should  do.  Probably  something  like  $500,000 
a  year,  $40,000  a  month  would  be  somewhere  near  normal,  though 
it  is  unsafe  to  name  that  or  any  other  figure  without  knowing  more 
about  the  situation. 

Your  first  question  as  to  the  average  stock  of  merchandise  can 
be  answered  only  with  relation  to  your  fifth  question  as  to  the 
maximum  amount  of  yearly  business.  Your  stock  must  be  pro- 
portioned to  the  volume  of  your  sales.  Your  sales  must  be  pro- 
portioned to  the  equipment  and  working  capital  of  your  business. 

It  is  not  possible  to  answer  your  questions  2,3,  and  4  by  giving 
definite  figures,  for  the  reason  that  the  right  amounts  of  receivables 
and  payables  are  determined  by  the  relations  of  these  items  to  each 
other  and  to  the  other  assets  and  liabilities  of  the  business.  The 
attempt  has  been  made  to  indicate  above  what  are  generally  con- 
sidered the  right  percentages;  and  also  to  indicate  the  line  of 
reasoning  to  be  followed  in  passing  judgment  on  any  particular 
business,  all  the  essential  facts  being  available. 

In  a  mercantile  business  that  is  running  on  a  sound  basis  and 
that  is  not  increasing  its  volume  of  sales  too  rapidly,  it  is  considered 
proper  to  pay  out  a  fairly  large  proportion  of  its  net  earnings  in 
dividends.  If  your  net  earnings  are  25%  and  the  volume  of  your 
sales  is  some  place  near  the  maximum,  a  dividend  of  15%,  or  pos- 
sibly even  a  little  more,  would  not  be  out  of  place.  The  case  is 
entirely  different  if  your  business  is  growing  rapidly.  In  that  case 
it  is  obviously  necessary  to  reserve  more  cash_  and  thus  build  up 
your  working  capital. 


Ch.  36]  FINANCIAI.  STANDARDS  965 

§  384.    Checking  up  the  Analysis 

In  acknowledging  the  analysis  just  given,  the  manager  of  the 
business  under  consideration  makes  the  following  comment: 

I  notice  in  your  report  that  cash  balance  and  normal  accounts 
and  bills  receivable  should  be  approximately  $100,000.  To  show 
how  near  you  came  to  the  actual  facts,  our  recent  trial  balance 
showed  in  April  $96,000  covering  these  two  accounts,  approxi- 
mately $10,000  cash  balance.  Our  liabilities  at  times  wiU  run  some- 
thing near  $75,000,  though  at  present  they  do  not  show  this  much. 
The  only  figures  I  have  reason  to  challenge  in  your  report  would  be 
your  expense  account  of  $15,000  per  month.  You  no  doubt  have 
in  view  the  handling  of  some  very  profitable  line  of  goods.  Our 
expense  account  showed  in  proportion  to  the  sales  io>^%,  approxi- 
mately $40,000  per  year.  Your  idea  that  a  firm  of  our  capital 
should  do  $500,000  agrees  with  my  own.  In  other  words,  a  whole- 
sale firm  should,  at  least,  turn  its  capital  stock  four  times  during  its 
fiscal  year. 

From  the  above  it  seems  clear  that  through  the  proper  use  of 
accepted  standards  of  financial  practice  it  is  possible  to  arrive  at 
a  fairly  accurate  understanding  of  the  status  of  a  concern  even 
when  the  information  available  is  limited. 


<lfiii<y)'jii  liitmon  hita  •wriKlerf  dssa  JiJtiJ  Ji^k; 


!o  021;  T; 


iJ^^ti^jVI — Financial  Abuses  and  Involvements 


CHAPTER  XXXVII 
EXPLOITATION  BY  OFFICERS 

§  385.    Exploitation 

Any  gross  deception  or  breach  of  trust  which  operates  to  the 
injury  of  an  innocent  party  is  fraud,  and  is  recognized  in  law  as 
sufficient  cause  for  invalidating  a  contract  or  for  bringing  action 
to  recover  damages.  Under  certain  conditions  it  may  constitute 
a  crime.  It  is  often  difficult  to  prove  fraud  in  a  transaction, 
since  evidence  is  usually  required  of  an  intent  to  defraud  or 
mislead. 

Exploitation  differs  from  simple  fraud  in  that  it  is  more 
subtle,  more  difficult  to  trace  and  expose,  and  ordinarily  gives 
no  grounds  for  legal  action.  There  is  no  one  act  or  set  of  acts 
that  can  be  listed  and  definitely  described  as  exploitation,  since 
it  takes  an  infinite  number  of  forms  and  in  many  cases  is  not 
known  or  recognized  even  by  its  victims. 

Nor  is  there  absolute  certainty,  ordinarily,  that  a  company 
has  been  deliberately  exploited,  even  though  it  may  have  been 
wrecked  and  the  facts  of  its  mismanagenjent  may  have  become 
known.  It  may  be  proved  that  those  in  charge  of  the  company's 
affairs  have  secured  personal  profits  and  that  the  transactions 
have  been  injurious  to  the  company.  Yet  the  plea  may  always 
be  made  by  such  persons  that  mistakes  of  business  judgment  are 
common  to  all  enterprises  and  that  this  is  a  case  of  the  kind. 

Frequently  such  pleas  are  sound  and  the  criticisms  made  by 
stockholders  of  losing  corporations  are  unjustified.  There  is  no 
definite  standard  or  simple  rule  which  can  be  applied  here.     The 

967 


968  CORPORATE  FINANCE  [Bk.  II- 

facts  as  to  every  case  where  exploitation  is  suspected  require 
careful  study,  and  even  then  the  judgment  of  observers  fre- 
quently has  to  be  based  more  upon  probabilities  than  upon 
definite  facts.  In  general,  exploitation  may  be  said  to  differ 
from  fraud  in  that,  while  the  intended  results  are  practically  the 
same,  there  is  always  room,  in  case  of  exploitation,  for  varying 
interpretations  of  the  facts. 

Exploitation  is  dangerous  because  it  may  be  so  easily  dis- 
guised. Plausible  arguments  in  favor  of  almost  any  business  ~ 
proposition  can  be  advanced  so  easily  that  it  is  seldom  possible 
to  arouse  unanimous  opinion  and  action  against  practices  that 
savor  of  exploitation.  Again  and  again  it  has  been  proved  that 
in  large  enterprises  comparatively  few  stockholders  will  vigor- 
ously support  action  intended  to  recover  funds  that  have  been 
lost  by  exploitation.  Consequently,  we  often  see  the  surprising 
spectacle  of  corporations  being  obviously  mismanaged  and 
deliberately  exploited  while  the  management  is  receiving  the 
loyal  support  of  the  very  stockholders  whose  property  it  is 
looting.  Usually  it  is  only  when  the  exploiters  become  over- 
bold, and  take  some  action  verging  on  actual  fraud,  that  the 
injured  stockholders  appoint  committees  from  their  number  and 
take  effective  legal  steps  to  put  a  stop  to  the  management's 
depredations. 

t  nsrj  bannvj^oo^i  lo  nvro/t.M 
§  386.    Exploitation  Favored  by  the  Corporate  Forin 

There  always  has  been,  and  doubtless  will  continue  to  be, 
exploitation  by  the  powerful  and  influential  of  those  who  are 
weak  and  helpless.  But  exploitation  in  its  modem  and  now  most 
prevalent  form,  as  a  factor  in  business  life,  is  comparatively  a 
new  thing,  largely  due  to  the  general  adoption  of  the  corporate 
form  of  organizing  business  enterprises.  The  corporate  form  is 
singularly  well  adapted  for  exploiting  activities.  Through  the 
creation  of  a  small  corporation,  an  individual  may  wholly  or 
partially  hide  his  own  identity  and  rid  himself  of  personal  re- 
sponsibility.    Again  the  large  corporation  with  its  thousands  or 


Ch.  37l  EXPLOITATION  BY  OFFICERS  969 

tens  of  thousands  of  shareholders,  few  of  whom  know  much  about 
or  take  a  personal  interest  in  the  fortunes  of  their  corporation, 
offers  an  inviting  opportunity  for  exploitation. 

The  legal  fiction  of  "corporate  entity"  which  has  been  more 
rigorously  upheld  and  applied  in  American  courts  than  in  English 
courts,  has  undoubtedly  been  a  highly  important  factor  in  favor- 
ing exploitation.  Again  and  again,  the  wrecking  of  great  cor- 
porate enterprises  by  those  in  charge  furnishes  ample  evidence 
that  human  nature  is  still  weak.  The  law  is  slow.  The  wreck- 
ing of  the  Erie  Railroad  in  the  last  century  was  accomplished 
by  methods  not  illegal  then,  but  that  now  might  put  those  that 
used  them  in  the  penitentiary.  But  the  exploiter  of  today 
employs  no  such  crude  methods.     He  has  kept  ahead  of  the  law. 

§  387.    Abuse  of  Official  Position 

It  is  seldom  that  the  chief  officers  of  an  important  modern 
corporation  are  suspected  of  betraying  their  trust.  Recently, 
however,  the  Bar  Association  of  New  York  City  brought  dis- 
barment proceedings  against  a  former  attorney  of  the  Missouri 
Pacific  Railway,  charging  him,  while  counsel  for  that  company, 
with  aiding  and  abetting  its  president  in  the  diversion  of  funds 
from  the  company's  treasury.  As  reported  in  the  New  York 
Times:  1 

According  to  the  Bar  Association  charges,  the  Missouri  Pacific 
transaction  in  which  Mr.  Chadbourne  is  alleged  to  have  been  in- 
■  volved  as  counsel  for  President  Gould  and  the  road  dealt  with  the 
sale  of  about  $19,000,000  worth  of  bonds,  and  the  diversion  of 
almost  $5,000,000  from  the  road  to  Mr.  Gould  and  others.  The 
transaction  took  place  not  long  before  Mr.  Gould  was  ousted  from 
control  of  the  road  by  Kuhn,  Loeb  &  Co.,  the  road's  bankers.   . 

The  Bar  Association  version  of  the  transaction  was  explained 
by  a  member  of  the  Grievance  Committee  yesterday  as  follows: 

"Tailer  &  Co.,  investment  bankers,  of  which  T.  Suflfern  Tailer 
is  a  member,  were  asked  to  lend  money  to  the  Missouri  Pacific. 
They  were  to  take  certain  ngtes  of  the  Missouri  Pacific  and  as  col- 


»  March  7,  1922, 


<^  CORPORATE  FINANCE  [Bk.  II- 

lateral  were  offered  an  option  on  $19,000,000  bonds  of  a  subsidiary 
road  at  81.  Gould  did  not  take  the  notes  he  had  agreed  to  take, 
and  Tailer  &  Co.  sold  them  for  him  to  other  parties,  and  most  of 
his  rights  to  take  up  those  bonds  at  81  disappeared. 

"When  he  found  out  that  Kuhn,  Loeb  &  Co.  offered  to  re- 
organize the  road  but  insisted  that  the  road  must  have  clear  title       " 
to  these  bonds,  he  realized  that  the  bonds  were  getting  valuable, 
and  went,  through  Chadbourne,  to  Tailer  &  Co.  and  insisted  on       i 

.J  J    being  reinstated  in  the  rights  he  had  lost.    Tailer  agreed  against       , 
his  will  to  reinstate  him.  I 

"After  that,  Gould  purchased  the  $19,000,000  worth  of  bonds 
at  81  from  the  front  door  of  the  treasury  of  the  Missouri  Pacific, 

'j;r  and  sold  them  to  Kuhn,  Loeb  &  Co.  at  102,  and  then  they  were 
taken  around  to  the  back  door  of  the  Missouri  Pacific  treasury  and 
sold  at  107.  ) 

"The  point  of  the  accusation  is  that  Mr.  Chadbourne  was  acting 
as  personal  lawyer  to  George  Gould  and  also  as  lawyer  for  the  road, 
and  that  he  stood  by  and  watched  the  robbery  of  the  road  of 
which  he  was  the  lawyer." 

It  may  be  stated  that  the  accused  attorney  denies  he  was 
counsel  for  the  road  at  the  time  the  alleged  looting  occurred. 

§  388.    Abuses  by  Subordinate  Officers 

:X^f  In  a  corporation  which  is  conducted  by  able  business  men 
who  are  single-mindedly  devoted  to  the  up-building  of  the  cor- 
poration, it  is  probable  that  nearly  all  subordinate  officers  will 
be  of  the  same  type.  In  the  business  world,  as  everywhere  else, 
like  attracts  like.  Men  who  are  themselves  honorable  prefer 
to  work  under  chiefs  with  the  same  sense  of  honor.  If  they  sus- 
pect that  their  company  is  being  exploited  by  its  officers,  they 
will  leave  and  their  places  will  be  taken  by  men  who  are  perhaps 
less  able  or  less  scrupulous.  There  are,  of  course,  innumerable 
exceptions  on  both  sides,  but  the  general  rule  holds  good.  Con- 
sequently, when  we  find  a  company  in  which  the  chief  officers 
have  been  primarily  engaged  in  exploitation,  it  is  only  too  likely 
that  graft  will  also  be  found  among  the  subordinates. 

Under  the  old  regime,  the  New  Haven  Railroad  Company, 


Ch.  37]  EXPLOITATION  BY  OFFICERS  971 

according  to  the  report  of  the  Interstate  Commerce  Commission, 
purchased  its  rolling  stock  almost  exclusively  and  without  com- 
petition from  one  individual.  These  purchases  amounted  to 
approximately  $37,000,000.  The  favored  individual  made  no 
secret  of  the  valuable  presents  made  to  the  officials  with  whom 
he  did  business,  claiming  that  they  were  old  friends  of  his.  The 
Commission  makes  the  following  pertinent  comment:  -"Cor- 
porate economy  is  not  practicable  where  gifts  and  obligations 
arising  from  friendship  tend  to  obscure  official  duty." 

§  389.    Exorbitant  Salaries  and  Pa3mients 

In  a  small  corporation  which  has  come  into  the  control  of  one 
faction  and  is  being  exploited  to  the  detriment  of  the  general 
body  of  stockholders,  the  simplest  and  most  common  method  is 
through  payment  of  exorbitant  salaries.  So  long  as  the  salaries 
are  kept  within  the  bounds  of  reason  and  so  long  as  the  real 
purpose — which  is  to  distribute  profits  in  this  form — is  not  made 
too  plainly  evident,  the  practice  is  legally  unassailable.  It  may, 
however,  become  dangerous  to  the  exploiters  in  case  their  salaries 
are  suddenly  increased,  or  in  case  there  is  a  rearrangement  of 
salaries  which  so  clearly  corresponds  to  shareholdings  as  to  leave 
no  doubt  that  the  increases  are  really  mere  devices  for  distribut- 
ing profits  to  the  dominant  faction  at  the  expense  of  the  other 
shareholders.  irrrn^iilisb  "/J-  i  ii^iuwi 

In  the  early  days  of  the  United  States  Shipbuilding  Company, 
there  was  considerable  mystery  as  to  the  failure  of  the  company 
to  live  up  to  the  advance  estimates  of  its  profits.  Later  when  the 
company  went  into  the  hands  of  a  receiver,  it  developed  that 
one  of  the  most  important  subsidiaries  taken  over,  the  Union 
Iron  Works,  had  been  assumed  to  have  a  surplus  of  $1,000,000, 
whereas  it  really  had  an  accumulated  deficit  of  about  $1,400,000. 
Furthermore,  Receiver  Smith  discovered  that  the  Shipbuilding 
Company  had  entered  into  contracts  to  retain  certain  ofiicials 
at  salaries  aggregating  $240,000  per  year.  Most  of  these  salaries 
were  heavy  advances  over  those  which  had  previously  been  paid. 


972  CORPORATE  FINANCE  [Bk.  II- 

In  its  investigation  of  the  affairs  of  the  Rock  Island  Company, 
the  Interstate  Commerce  Commission  found  that  large  extra 
and  secret  payments  were  arbitrarily  allowed  to  some  of  the  chief 
officers  of  the  company,  of  which  the  following  are  examples : 

The  first  vice-president,  in  charge  of  freight  and  passenger 
traffic,  was  secretly  paid  $18,750  per  annum,  making  his  total 
compensation  $43,750,  whereas  the  pay-roll  showed  but  $25,000. 

The  chief  engineer  received  a  salary  of  $15,000  per  annum 
plus  a  secret  bonus  of  $3,000  on  the  first  of  each  year. 

Upon  the  retirement  of  the  general  solicitor,  he  was  given  a 
bonus  of  $100,000  in  cash. 

It  is  perfectly  true  that  some  of  the  above  payments  may  be 
defended,  but  they  at  least  illustrate  with  striking  clarity  the 
almost  unlimited  possibilities  for  abuse  if  a  board  of  directors 
is  inclined  to  be  careless  in  its  use  of  the  property  with  which  it 
is  entrusted. 

§  390.    Contracts  That  Benefit  Officers 

The  history  of  the  Standard  Rope  and  Twine  Company, 
which  was  formed  in  1895  to  take  over  the  assets  of  the  insolvent 
United  States  Cordage  Company,  illustrates  some  of  the  possible 
methods  of  exploiting  a  corporation  to  the  personal  advantage 
of  the  officers.  The  first  president  was  accused — whether  justly 
or  unjustly  cannot  be  definitely  determined — of  discriminating 
against  the  Standard  Company  in  favor  of  a  competing  concern 
in  which  he  was  a  partner,  turning  the  less  profitable  contracts 
toward  the  former  and  the  more  profitable  ones  toward  the  latter. 
In  1896  the  president  proposed  that  the  Standard  Company 
should  take  over  certain  processes  controlled  by  him  for  forcing 
oil  into  rope.  The  company  made  a  contract  which  gave  the 
president  authority  to  spend  $25,000  of  the  company's  money  in 
perfecting  his  invention.  As  a  matter  of  fact,  much  more  than 
this  amount  was  eventually  spent.  In  the  end  the  process 
proved  worthless  and  the  company  had  to  bear  a  heavy  loss, 
amounting  to  over  $126,000. 


Ch.  37]  EXPLOITATION  BY  OFFICERS  973 

In  September,  1898,  some  of  the  officers  of  the  Standard 
Rope  and  Twine  Company  formed  a  selling  agency  known  as 
the  Union  Selling  Company.  This  last-named  company  then 
entered  into  a  contract  with  the  Standard  Rope  and  Twine 
Company  under  which  it  received  7^%  commission  on  all  sales. 
A  stockholders'  committee  in  1900  estimated  that  the  effect 
of  this  contract  was  to  increase  by  more  than  50%  the  selling 
expenses  of  the  Standard  Company. 

The  misuse  of  "construction"  companies  as  a  means  by  which 
officers  may  make  contracts  for  their  own  advantage  has  been  a 
practice  unfortunately  not  at  all  uncommon.  Another  almost 
customary  method  of  "milking"  railroad  corporations  a  genera- 
tion or  two  ago,  was  through  the  organization  of  "fast  freight"  or 
"despatch"  lines  which  made  particularly  favorable  contracts 
with  two  or  more  railroad  companies  for  moving  their  cars  on  an 
express  schedule  and  then  picked  up  highly  profitable  quick 
despatch  business  from  shippers.  In  a  number  of  cases  the 
stockholders  in  these  lines  were  the  officers  and  directors  of  the 
railroad  companies  over  whose  tracks  the  lines  operated.  It 
was  many  years  later  before  the  railroad  companies  stepped  in 
and  purchased  the  ownership  of  these  lines. 

Another  common  method  of  making  contracts  for  the  advan- 
tage of  officers  has  been  through  the  purchase  at  high  prices  of 
subsidiary  or  branch  companies  in  which  officers  were  personally 
interested.  In  1890  the  directors  of  the  Northern  Pacific  who 
were,  as  individuals,  also  in  control  of  the  Wisconsin  Central, 
effected  a  lease  of  the  last-named  road  to  the  Northern  Pacific 
for  999  years  on  terms  which  the  stockholders'  committee  con- 
sidered unfair  to  the  Northern  Pacific.  The  receivers  of  the 
Northern  Pacific  four  years  later,  however,  were  unable  to  obtain 
sufficient  evidence  to  justify  legal  action  against  the  directors. 

§  391.    Ethics  of  Contracts  Benefiting  Officers 

Contracts  made  by  officers  of  corporations  with  corporations 
in  which  these  officers  are  interested  or  with  the  officers  person- 


974-  CORPORATE  FINANCE  [Bk.  U- 

ally,  may  become  one  of  the  most  insidious  forms  of  exploitation. 
The  contracts  with  the  Standard  Rope  and  Twine  Company 
cited  in  the  preceding  section  illustrate  the  dangerous  possi- 
bilities. The  difficult  point  here  is  found  in  the  fact  that  fre- 
quently a  contract  with  a  company  in  which  the  officer  letting 
the  contract  is  interested,  is  justifiable.  The  temptation  is, 
though,  always  present  when  an  officer  is  contracting  with  a  com- 
pany in  which  he  is  interested,  to  give  better  prices  or  better 
terms,  or  other  advantages  that  would  not  be  granted  if  the  con- 
tract were  given  to  an  outsider. 

The  question  may  come  up  when  an  officer  of  a  corporation 
is  interested  in  another  corporation  from  which  the  first  corpora- 
tion buys,  or  when  his  corporation  sells  to  another  corporation 
in  which  the  officer  is  interested.  Possibly  the  corporation  may 
be  able  to  buy  better  from  the  officer's  corporation  than  else- 
where. Or  possibly  the  corporation  may  be  able  to  sell  to  better 
advantage  to  the  officer's  corporation  than  to  others.  In  that 
case  the  transaction  is  justified.  So  true  is  this  that  just  such 
contracts  are  specifically  provided  for  by  some  of  the  larger 
corporations.  Thus  in  the  by-laws  of  the  United  States  Steel 
Corporation  occurs  the  following  provision,  expressly  authoriz- 
ing such  contracts. 

Sec.  8.  Contracts.  Inasmuch  as  the  Directors  of  this  Company 
are  men  of  large  and  diversified  business  interests,  and  are  likely 
(jii  to  be  connected  with  other  corporations  with  which  from  time  to  r 
time  this  Company  must  have  business  dealings,  no  contract  or 
other  transaction  between  this  Company  and  any  other  corpora- 
tion shall  be  affected  by  the  fact  that  directors  of  this  Company 
are  interested  in,  or  are  directors  or  officers  of,  such  other  corpora- 
tion, if,  at  the  meeting  of  the  board  or  of  the  committee  of  this 
Company,  making,  authorizing,  or  confirming  such  contract  or 
transaction,  there  shall  be  present  a  quorum  of  directors  not  so  in- 
terested; and  any  director  individually  may  be  a  party  to,  or  may 
be  interested  in,  any  contract  or  transaction  of  this  Company, 
provided  that  such  contract  or  transaction  shall  be  approved 
or  be  ratified  by  the  affirmative  vote  of  at  least  ten  directors 
not  so  interested.     '  ''"^  "^  h'iiZ'JTiini  vm  ^i^oifio  i»g3tii  ri 


-n 


Ch.  37]  EXPLOITATION  BY  OFFICERS  ^75 

§  392.    Avoidance  of  Contracts  Benefiting  Officials 

But,  as  has  been  stated,  the  temptation  to  exploitation  when 
officers  are  personally  interested  in  the  award  of  contracts  is  so 
strong  and  so  ever-present,  that  such  transactions  should,  as 
far  as  possible,  be  avoided.  Looking  toward  this  end,  the  fol- 
lowing conclusions  would  probably  be  sanctioned  by  most  busi- 
ness men: 

i...,Mj^  The  number  of  concerns  which  are  controlled  by  the 
Officers  and  directors  of  a  corporation,  and  with  which  it  has 
contracts  or  is  otherwise  intimately  connected,  should  be  re- 
duced to  the  minimum.  .,         .  ,    ^.     ,.        '    .w. 

2.  Wherever  the  arrangement  is  unavoidable,  it  should  not 
be  concealed  but  should  be  clearly  stated  and  made  known  to  all 
those  who  are  interested. 

'"''3*  Whenever  such  a  relationship  exists,  the  contracts  between 
the  corporation  and  the  related  concern  should  be  subject  to 
criticism  and  correction  by  competent  and  disinterested  parties. 

4.  When  a  new  company  in  a  related  line  is  to  be  organized 
by  the  officers  of  a  corporation,  and  when  they  are  to  take  an 
active  part  in  its  development,  they  should  leave  the  service  of 
the  old  corporation. 


ii;ffn"lf;j 


§  393*     "Unloading"  and  Securing  Control 

A  somewhat  different  case  arises  when  the  officers  of  a  cor- 
poration are  financially  interested  in  another  company  which 
has  proved  to  be  a  money  loser,  and  wish  to  "step  from  under." 
Then  if  the  business  in  which  they  are  interested  is  in  any  way 
related  to  the  business  of  the  corporation  of  which  they  are 
officers,  it  is  frequently  an  easy  and  tempting  procedure  to 
"unload"  a  portion  of  their  holdings  on  the  latter  corporation  or 
secure  from  it  financial  assistance  for  the  failing  company.  The 
process  is  especially  easy  when  they  are  active  officers  and  able 
to  work  together  without  interference  in  putting  through  their 
plans,  and  when  the  other  directors  have  little  direct  personal 
knowledge  of  the  details  of  the  business.     Under  these  circum- 


976  CORPORATE  FINANCE  [Bk.  II- 

stances,  all  that  is  required  is  to  make  representations  and  recom- 
mendations which  can  hardly  be  challenged  unless  the  other  di- 
rectors wish  to  go  to  the  extent  of  expressing  lack  of  confidence 
in  their  own  officers. 

Sometimes  schemes  of  the  same  general  type  may  be  put 
through  with  a  view  to  enabling  the  officers  to  secure  personal 
control,  for  their  own  benefit,  of  another  company  in  which  they 
are  financially  interested.  By  inducing  the  company  in  which 
they  are  officers  to  take  stock  additional  to  their  own,  they  may 
be  able  to  acquire  the  desired  control. 

§  394.    Misuse  of  Inside  Information 

Another  common  method  of  exploitation  is  through  the  mis- 
use by  officers  or  directors  of  information  which  comes  to  them  on 
the  "inside,"  that  is,  officially,  but  which  is  unknown  to  stock- 
holders or  perhaps  is  unknown  to  some  of  the  other  officers  and 
directors  of  the  corporation.  The  use  of  such  information 
is  most  likely  to  occur  in  connection  with  speculation  in  the 
company's  own  shares. 

Innumerable  instances  might  be  given  of  the  misuse  of  inside 
information  for  the  purpose  of  speculating  in  the  shares  of  the 
officials'  or  directors'  own  company.  The  results  are  not  infre- 
quently unfortunate  for  the  officers  themselves,  due  partly  to 
the  fact  that  the  information  upon  which  they  act  is  in  many 
cases  fragmentary,  and  due  also  to  the  fact,  which  many  people 
fail  to  realize,  that  the  up  and  down  movements  of  stock  market 
prices  are  determined  only  in  part  by  the  intrinsic  merits  of  the 
securities.  Fluctuations  arise  more  largely  from  general  eco- 
nomic and  market  influences,  with  which  'the  officers  of  most  in- 
dustrial corporations  are  not  especially  familiar.  The  matter 
is  discussed  more  fully  in  the  following  chapter, 

§  395.    Misuse  of  Funds 

The  doubtful  use  of  company  funds  by  the  company  offixials 
is  a  common  form  of  exploitation.     It  usually  occurs  in  close 


Ch.  37]  EXPLOITATION  BY  OFFICERS  .  977 

connection  with  the  activities  of  the  company's  own  business. 
For  instance,  the  early  history  of  the  National  Cordage  Company, 
which  has  been  referred  to  previously,  was  a  record  of  wise 
management  and  success.  After  about  three  years,  however, 
two  of  the  important  executives  became  interested  in  an  attempt 
to  bolster  up  the  price  of  sisal  and  hemp  and  devoted  the  re- 
sources of  the  company  quite  largely  to  this  speculation.  "The 
enterprise  was  changed  from  a  business  to  a  speculation.  Ex- 
tension of  control  became  a  mania  with  the  officers  and  their 
ambition  stifled  their  sound  business  judgment."  Inasmuch  as 
the  National  Cordage  Company  was  by  far  the  largest  purchaser 
of  the  two  products  mentioned,  it  seemed  as  if  the  calculations 
of  the  officers,  based  upon  their  absolute  knowledge  of  the  com- 
pany's own  policy,  could  hardly  miscarry.  But  they  did  not 
reckon  on  the  fact  that  the  resources,  even  of  so  great  a  company, 
are  limited,  and  eventually  so  large  an  amount  of  capital  was 
tied  up  in  carrying  great  stocks  of  sisal  and  hemp  that  the  com- 
pany itself  was  forced  into  bankruptcy. 

§396.    Is  Ejqploitation  a  Common  Evil? 

As  has  been  intimated  at  the  beginning  of  this  chapter,- 
exploitation  as  a  factor  in  business  transactions  is  perhaps  a  more 
common  evil  than  it  was  in  the  days  when  business  organizations 
were  simpler  and  more  directly  under  the  control  of  their  owners. 
The  officer  or  director  of  the  modern  corporation  occupies  a 
position,  not  merely  of  dignity  and  responsibility,  but  also  of 
trust.  This  trusteeship  is  more  clearly  recognized,  perhaps, 
than  was  the  case  a  generation  or  more  ago.  But  the  ascendency 
of  the  higher  standards,  which  are  implied  in  the  sense  of  trustee- 
ship, comes  slowly  and  is  the  result  of  innumerable  hard  struggles. 
In  the  meantime,  exploitation  in  its  myriad  forms  goes  on 
apparently  unchecked. 

The  difficulty  of  the  situation  is  due  to  the  great  complexity 
of  present-day  business  relations  and  the  impossibility  in  so  many 
cases  of  arriving  at  clear  and  unquestionable  decisions.     Because 


978  .  CORPORATE  FINANCE  [Bk.  II- 

of  this  it  is  not  easy  to  say  whether  exploitation  is  becoming 
more  or  less  prevalent. 

All  that  can  safely  be  said  is  that  the  gradual  clarifying  of  the 
ethical  standards  which  apply  under  modern  complex  conditions 
will  undoubtedly  tend  to  diminish  exploitation. 

'♦flT"     .aoiJtiiU/5 


lo'j  agiBbioO  funobi;. 


^  Irva  nornmoD  s  rtohlBJf ofqjcS  al    .dog  ,^ 


jto  rrjjarrt  arfi   nl 


CHAPTER  XXXVIII 

EXPLOITATION  BY  DIRECTORS 
AND  STOCKHOLDERS 

1, 397'     Juggling  the  Accounts 

p.;  -Jin  January,  1895,  j^st  about  a  year  before  the  failure  and 
reorganization  in  1896,  the  president  of  the  Baltimore  and  Ohio 
Railroad  Company  issued  a  statement  which  is  typical  of  those 
frequently  put  out  by  officials  of  concerns  that  are  becoming 
embarrassed.  He  said:  "I  can  safely  say  the  road  has  not  been 
in  so  strong  a  position  as  now  for  at  least  fifteen  years."  Shortly 
afterwards,  dividends  on  the  common  stock  were  passed.  The 
company's  own  reports  showed  ratios  of  expenses  to  earnings  of 
75%  in  1894,  80.2%  in  1895,  ^^^  90.2%  in  1896. 

Receivers  were  appointed  in  February,  1896,  and  they  at 
once  put  the  company's  records  into  the  hands  of  competent 
accountants.  Their  report  was  made  in  March  but  it  was  not 
given  out  until  the  following  December.  The  report  showed  an 
overstatement  of  income  during  the  period  of  seven  year§  a;id 
two  months  which  their  report  covered,  as  follows:  ^■■<'t-:>r. 

'•'       Overstatement  of  net  income $  2,721,068 

Mischarge  of  worn-out  equipment  to  profit  and  loss 2,843,596 

Improper  capitalization  of  charges  under  heads  of  con- 
struction and  so  on 2,064,741 

Improper  capitalization  of  so-called  improvements  and 

^            betterments 3.575.453 

t'  

Total $11,204,858 

Earnings  had  been  increased  by  crude  and  arbitrary  means. 
In  1892  the  value  of  Western  Union  stock  in  the  Baltimore  and 
Ohio  treasury  had  been  written  up  by  $468,038,  and  the  stock 
of  the  Consolidated  Coal  Company  by  $114,300.    Advances  to 

97S 


qSo  corporate  finance  [Bk.  II- 

branch  lines  had  been  entered  as  assets  and  interest  on  these 
advances  had  been  credited  to  income,  although  there  was  no 
reasonable  probabiUty  that  either  one  would  ever  be  paid.  The 
report  revealed  indorsements  by  the  company  of  notes  of  sub- 
sidiary companies  to  the  extent  of  $5,481,835.1 

§  398.    Misleading  Statements 

The  juggling  of  corporate  accounts  so  as  to  present  false  or 
misleading  statements  to  the  general  body  of  shareholders  and 
to  the  public  is  extremely  varied  in  form,  but  in  spite  of  its 
technical  intricacies  the  general  idea  underlying  it  is  simple 
enough.  In  most  cases,  certain  assets  are  overvalued  or  certain 
liabilities  are  understated  for  the  purpose  of  swelling  the  earn- 
ings. For  example,  the  value  of  the  capital  or  investment  assets, 
such  as  buildings,  machinery,  and  other  equipment  may  be  in- 
jQated  by  not  writing  off  sufficient  depreciation,  with  the  conse- 
quence that  earnings  are  exaggerated  and  surplus  is  fictitiously 
enlarged. 

On  the  other  hand,  if  the  design  is  to  conceal  a  high  rate  of 
earnings,  certain  assets  are  undervalued,  or  certain  liabilities  are 
overstated.  For  instance,  if  excessive  amounts  are  written  off 
periodically  for  the  depreciation  of  the  capital  assets,  the  reported 
earnings  will  be  less  than  the  real  earnings  and  a  portion  of  the 
actual  surplus  will  be  concealed. 

In  a  corporation  which  is  the  parent  of  a  number  of  subsidiary 
companies,  the  methods  of  juggling  accounts  are  more  compli- 
cated and  less  easily  traced.  This  is  largely  because  the  state- 
ments of  the  subsidiary  concerns  are  not  separately  shown.  The 
earnings  of  these  companies  may  be  falsified  by  the  methods 
described  above,  and  yet  the  published  statement  of  the  parent 
company  may  be  perfectly  regular  so  far  as  it  alone  is  concerned. 
To  guard  against  disclosures,  devious  methods  are  resorted  to. 
These  when  analyzed  consist  of  a  shuffling  of  assets  and  lia- 


>  Daggett's  Railroad  Reorganization,  pp.  20-23. 


Ch.  38]  EXPLOITATION  BY  DIRECTORS  981 

bilities  between  the  subsidiary  companies,  so  that  the  record  of 
these  transfers  is  a  maze  of  cross-entries  on  their  books  of 
account  and  the  real  conditions  can  be  discovered  only  by  expert 
accounting  investigation. 

The  ultimate  objects  sought  in  the  deliberate  juggling  of 
accounts  are  also  varied.  One  of  the  most  common  purposes  is  to 
make  as  good  a  showing  as  possible  for  the  administration  that 
is  in  power.  Either  it  is  hoped  that  later  prosperity  will  permit 
the  subsequent  correction  of  any  inflation  of  values  that  may  be 
written  on  the  books,  or  misrepresentation  is  resorted  to  as  a 
desperate  measure  simply  to  stave  off  a  revolt  among  the  share- 
holders. ' 

Another  common  purpose  is  that  of  giving  the  officers  and 
directors  a  chance  to  buy  or  sell  shares  of  their  own  company  on 
the  basis  of  the  misleading  statements  which  they  put  out.  The 
simple  process  of  purchasing  shares  below  their  true  value  on  the 
strength  of  a  poor,  published  statement  and  later  reselling  them 
in  a  boom  market  on  the  strength  of  some  grossly  inflated  state- 
ment of  earnings,  has  been  so  often  repeated  that  it  has  become 
a  twice-told  tale,  and  in  the  larger  corporations  is  not  often 
attempted.  The  growing  demand  for  adequate  publicity  has 
been  a  strong  factor  in  suppressing  the  practice.  The  growth, 
also,  of  a  well-educated  financial  public  and  the  development  of 
financial  periodicals  which  are  constantly  reviewing  and  analyz- 
ing published  reports  and  statements,  have  been  other  important 
factors.  But  while  the  old-time  process  has  been  refined,  there 
has  not  been  a  total  disappearance  of  the  underlying  purpose, 
which  is  to  mislead  outsiders  into  selling  at  a  deflated,  or  into 
buying  at  an  inflated  price.  In  order  to  accomplish  this,  active 
steps  are  not  always  necessary;  good  news  may  be  withheld 
or  extravagant  rumors  of  anticipated  profits  may  be  circulated. 
Some  obscure  change  in  methods  of  calculating  reserves  may  be 
enough  in  the  course  of  time  to  bring  about  decided  variations 
from  normal  in  the  published  statement  of  earnings  and  of 
surplus. 


982  CORPORATE  FINANCE  [Bk.  II- 

§  399-     Use  of  Inside  Information — A  Banker's  Opinion 

Is  a  director  morally  justified  in  taking  advantage  of  his 
official  position  to  make  profits  for  himself?  Certainly  a  director 
who  realizes  that  his  company  is  doing  well  and  has  good  pros- 
pects is  not  to  be  blamed  for  going  into  the  open  market  and 
purchasing  more  of  its  shares.  In  so  doing  he  merely  shows  a 
proper  confidence  in  the  future  of  his  company.  On  the  other 
hand,  when  his  business  judgment  tells  him  that  dark  days  are 
ahead,  is  there  any  reason  why  he  should  not  sell  his  shares  to 
others  whose  opinions  differ  from  his  own?  The  distinction 
between  what  is  proper  and  what  is  improper  is  perhaps  to  be 
found  in  the  principle  that  the  director  may  buy  or  sell  as  he 
chooses,  so  long  as  he  is  not  basing  his  action  on  information 
that  ought  properly  to  be  made  public.  The  application  of  that 
principle  is  naturally  left  with  each  man's  conscience. 

The  question  as  to  whether  directors  ever  have  the  right  to 
use  inside  information  for  personal  profit  was  the  subject  of  a 
highly  interesting  investigation  carried  on  some  years  since 
by  a  member  of  the  editorial  staff  of  the  New  York  Annalist. 
The  investigator  went  direct  to  a  number  of  prominent  directors, 
whose  opinions  he  quotes.  The  question  was  first  put,  according 
to  the  investigator,  to  one  of  the  best-known  bankers  in  the 
United  States,  who  is  a  director  in  many  corporations,  including 
financial  institutions,  industrial  companies,  and  railroads.  His 
answer  was  in  part  as  follows : 

If  we  were  all  Christian  gentlemen  with  a  very  fine  sense  of 
honor,  I  suppose  no  director  would  buy  or  sell  stocks  in  his  own 
company  on  information  which  comes  to  him  as  a  director.  As  a 
practical  matter  nearly  all  directors  do.  If  a  director  was  a 
trustee  it  would  be  a  different  matter,  but  so  far  as  I  see  he  is  not 
that.  He  is  an  administrator  on  behalf  of  himself  and  of  other 
stockholders,  but  he  does  not  surrender  his  individual  freedom 
when  he  becomes  a  director.  If  it  were  held  that  a  man's  holdings 
of  a  stock  should  be  frozen  up  the  moment  he  becomes  a  director, 
he  being  put  under  obligation  neither  to  add  to  them  nor  to  reduce 
them,  I  fancy  verv  few  could  be  induced  to  become  directors. 


Ch.  38]  EXPLOITATION  BY  DIRECTORS  983 

There  is  this  question  to  be  considered.  A  director  gives  his  time 
and  ability  to  the  management  of  a  corporation  and  gets  $20  a 
week  if  weekly  meetings  are  held.  That  is  surely  not  compensa- 
tion enough.  What  the  director  can  make  in  the  market  on  the 
basis  of  what  he  learns  as  a  director  is  part  of  the  pay  which  he 
gets  for  his  work.  It  might  be  better  if  directors  were  paid  a  sum 
commensurate  with  their  services  and  were  then  barred  from  deal- 
ing in  their  own  stock,  but  as  a  practical  matter  it  is  not  so. 

§  400.    Use  of  Inside  Information— Wall  Street  Opinions 

A  more  advanced  position  is  taken  by  a  wealthy  and  in- 
fluential man  described  as  "one  of  the  self-made  men  of  Wall 
Street,"  who  said: 

I  am  a  director  in  both  railroads  and  industrial  companies  and 
I  know  of  my  own  knowledge  that  the  chance  to  trade  on  inside 
information  about  railroad  properties  has  become  very  small. 
Earnings  are  reported  too  frequently  for  that.  It  is  different 
with  industrials.  They  do  not  report  monthly,  nor  in  all  cases 
even  quarterly,  and  between  one  annual  report  and  another  there 
is  room  for  the  use  of  inside  information.  There  is  a  good  deal  of 
exaggeration  about  the  big  profits  insiders  make  in  the  stock 
market.  If  they  buy  or  sell  they  take  a  market  risk  and  they  are 
often  wrong  despite  their  inside  information.  Personally  I  am 
in  favor  of  more  frequent  reports  by  industrial  companies. 

The  next  man  interviewed  took  almost  the  contrary  attitude, 
although  even  his  remarks  indicate  a  great  advance  over  some 
of  the  practices  that  have  been  above  described : 

As  for  the  director's  right  to  use  advance  information  to  his 
own  advantage,  you  must  grant  that  self-preservation  is  the  first 
law  of  society.  A  director  has  put  his  money  into  a  company, 
given  it  a  lot  of  his  time,  and  is  entitled  to  increase  or  diminish  his 
investment  in  it  on  the  basis  of  information  which  has  not  yet 
become  public.  If  he  knows  of  a  profitable  contract  about  to  be 
closed,  he  has  more  right  than  anyone  else  to  benefit  by  a  rise  in 
the  stock  on  the  announcement,  because  he  has  helped  to  get  the 
contract.  Should  he  see  bad  times  coming  he  is  not  morally 
bound  to  sit  tight  and  see  his  shares  decline.  He  has  a  right  to  sell 
his  holdings,  and  he  usually  does. 


984  CORPORATE  FINANCE  [Bk.  II- 

An  executive  committee,  of  which  I  am  a  member,  frequently 
meets  at  3 :30,  adjourns  for  dinner  and  resumes  discussions  after- 
wards, lasting  until  late  in  the  evening.  We  each  get  $20  for 
attending.  Recently  we  were  able,  by  dovetailing  our  knowledge 
and  experience,  to  put  a  transaction  through  that  netted  the  com- 
pany $500,000.  The  total  cost  of  our  time  to  the  company  was 
under  $200. 

§  401.    Use  of  Inside  Information — The  Ethical  View 

The  argument  thus  given  is  controverted  by  another  director 
— a  partner  in  a  private  bank  who  says: 

It  is  no  argument  to  say  that  a  director  is  not  paid  because  he 
only  gets  his  weekly  or  monthly  fees  for  attending  meetings.  He  is 
paid  in  the  better  insight  into  affairs  which  he  is  given.  Being  a 
director  in  two  or  three  companies  makes  his  time  worth  more  to 
his  own  business.  Payifig  a  director  several  thousand  dollars  a 
year  would  make  no  difference  in  his  speculations.  If  he  speculates 
when  he  gets  only  fees,  he  will  speculate  just  the  same  on  a  salary. 

The  opinions  above  expressed  are  in  many  respects  disap- 
pointing to  those  who  believe  that  a  directorship  is  primarily  a 
position  of  trust,  the  holder  of  which  should  feel  under  the  most 
exacting  obligations  of  honor  to  work  for  the  best  interest 
of  the  general  body  of  stockholders.  The  first  directqr  above 
quoted  specifically  denies  that  a  director  is  a  trustee  and  calls 
him  an  "administrator  on  behalf  of  himself  and  other  stockhold- 
ers." The  distinction  seems  to  be  largely  verbal,  for  the  under- 
standing that  the  director  represents  others  and  not  merely 
himself  remains  undenied  and  undeniable.  He  surely  cannot  be 
said  to  be  fulfilHng  his  duties  as  a  representative — dropping  the 
word  "trustee"  for  the  moment — if  he  makes  it  his  business  to 
buy  or  sell  stock  on  the  basis  of  information  that  is  concealed 
from  those  who  are  not  members  of  the  board. 

§  402.     The  New  Haven  Raikoad  Exploitation 

The  facts  brought  to  light  by  an  investigation  of  the  Inter- 
state Commerce  Commission  into  the  affairs  of  the  New  York, 


Ch.  38]  EXPLOITATION  BY  DIRECTORS  985 

New  Haven  and  Hartford  Railroad  afford  a  striking  example  of 
the  manner  in  which  corporate  affairs  should  not  be  handled. 

The  Commission's  report  was  published  July  15,  1914.  It 
appears  from  the  report  that  the  affairs  of  the  New  Haven  had 
been  managed  for  several  years  with  remarkable  laxity  and 
extravagance.  Although  the  directors  were  for  the  most  part 
men  of  large  wealth  and  of  business  standing,  they  left  the  actual 
control  of  affairs — even  of  broad  policies — in  the  hands  of  Presi- 
dent Mellen  and  of  certain  prominentdirectors.  President Mellen 
himself  was  frequently  uninformed  as  to  the  policies  and  in 
many  cases  as  to  the  actual  transactions  on  behalf  of  the  rail- 
road, which  were  put  through  by  the  small  group  of  inside 
directors.  Most  of  the  members  of  the  board  seem  to  have 
become  obsessed,  under  President  Mellen's  influence,  with  the 
idea  that  the  New  Haven  Railroad  should  achieve  complete 
control,  at  any  price,  of  all  the  transportation  agencies  in  New 
England.  With  that  idea  in  mind,  they  approved  expenditures 
for  railroads,  trolley  lines,  and  steamship  companies,  which  their 
ordinary  business  judgment  would  not  have  indorsed  and  which 
turned  out  disastrously.  The  result  was  the  practical  wrecking 
of  a  prosperous  railway  with  serious,  and  in  many  cases  disas- 
trous losses  to  thousands  of  its  stockholders. 

§  403.     "Squeezing"  the  Minority  Stockholders 

Exploitation  is  not  confined  to  officers  and  directors  as  such. 
The  circle  of  schemers  may  be  enlarged  to  include  a  majority  of 
the  shareholders  who  exploit  the  minority  shareholders,  or  it 
may  be  further  enlarged  to  include  all  the  shareholders  who  are 
banded  together  for  the  purpose  of  exploiting  the  company 
creditors. 

An  excellent  example  of  what  may  happen  to  minority  stock- 
holders may  be  taken  from  the  history  of  the  National  Salt  Com- 
pany. This  company  was  organized  in  1899  and  the  majority 
of  its  stock  was  secured  by  another  concern,  the  International 
Salt  Company,  in  1901.     The  minority  of   the   National   Salt 


986  CORPORATE  FINANCE  [Bk.  II- 

holders,  however,  refused  to  exchange  their  stock  and  held  out 
for  better  terms  than  those  offered  by  the  International 
Company. 

After  the  International  management  came  into  control  of 
the  National  Salt  Company,  its  previous  liberal  earnings  showed 
a  sudden  decline  and  the  company  became  heavily  involved  in 
debt.  Plausible  reasons  were  offered  for  the  decline  and  the 
new  president  remarked  in  his  report  that,  "the  existing  debts 
were  created  before  the  present  officers  came  into  power." 

In  August,  1902,  the  need  of  the  National  Salt  Company  fgr 
money  was  so  great  that  it  offered  at  auction  sale  a  large  part  of 
the  securities  of  subsidiary  salt  companies  which  it  had  held  in 
its  treasury.  These  securities  were  bid  in  for  $450,000  by  agents 
acting  for  the  international  Salt  Company.  Shortly  afterward 
a  judgment  for  $228,000  was  entered  by  default  against  the 
National  Salt  Company  on  notes  payable  on  demand  to  the 
International  Salt  Company.  During  the  first  six  months  of 
the  same  year  the  business  had  produced  a  net  deficit  of  $174,000 
and  the  current  obligations  exceeded  the  quick  assets  by  nearly 
$300,000.  In  September,  1902,  receivers  for  the  National  Salt 
Company  were  appointed.  The  natural  result  of  the  receiver- 
ship was  to  bring  about  the  dissolution  of  the  company  and  the 
sale  of  its  assets,  enabling  the  International  Salt  Company  to 
acquire  possession  of  the  company's  property  without  settling 
with  the  minority  stockholders. 

It  would  hardly  be  worth  while  to  enter  into  greater  detail 
as  to  methods  of  exploiting  minority  shareholders.  Perhaps  the 
most  common  plan  is  to  pay  all  the  profits  that  are  earned  into 
the  treasury  of  some  other  company  owned  by  the  majority 
shareholders.  The  payment  may  be  made  on  any  one  of  a 
number  of  pretexts.  If  the  corporation  is  small,  the  minority 
shareholders  may  find  that  every  member  of  the  majority  party 
becomes  an  officer  of  the  concern,  and  that  all  the  profits  are  paid 
out  relentlessly  in  the  form  of  exorbitant  salaries  to  these  stock- 
holding officers. 


Ch.  38]  EXPLOITATION  BY  DIRECTORS  987 

§  404.    Exploiting  Creditors — The  Chicago  and  Alton  Episode 

Among  small  trading  corporations  the  scheme  is  not  unknown 
of  purchasing  a  line  of  goods  on  credit,  disposing  of  the  goods, 
paying  out  the  cash  on  some  pretext,  and  permitting  the  com- 
pany to  go  into  bankruptcy.  Operations  of  this  kind  are,  in 
most  instances,  clear-cut  acts  of  fraud  and  do  not  therefore  fail 
within  the  scope  of  this  chapter.  ;0^ 

There  are,  however,  some  examples  on  a  larger  scale  of  similar 
actions.  The  creditor  of  a  modern  corporation  counts  as  a  por- 
tion of  his  margin  of  security  the  accumulated  surplus  of  that 
corporation.  As  has  already  been  set  forth,  this  surplus  be- 
comes in  effect  a  portion  of  the  permanent  capital  investment 
and  is  usually  regarded  as  not  available  for  payment  of  divi- 
dends. Hence,  when  a  bond  issue  of  a  corporation  which  main- 
tains a  surplus  is  floated,  the  issue  is  sold  partly  on  the  strength 
of  the  showing  of  surplus  on  the  company's  balance  sheet. 

In  1899  a  syndicate  bought  control  of  the  Chicago  and  Alton 
Railroad  Company,  and  in  1900  brought  about  a  reorganization 
of  the  company.  It  was  found  by  the  syndicate's  accountants 
that  during  the  previous  thirty-five  years  large  sums  had  been 
charged  to  operating  expenses  which  had  really  been  invested 
in  betterments  and  additions,  and  this  sum  was  found  to  amount 
to  over  $12,000,000.  In  recapitalizing,  the  syndicate  sold  $22,- 
000,000  of  3M%  bonds,  and  out  of  the  cash  receipts  declared  a 
special  dividend  of  over  $6,000,000,  which  was  indirectly  charged 
against  uncapitalized  construction  expenditure  of  $12,444,170. 
In  other  words,  the  syndicate  first  sold  bonds  to  raise  cash  and 
then  distributed  a  substantial  portion  of  this  cash  to  themselves 
under  the  guise  of  dividends  charged  against  surplus. 

The  process  of  paying  dividends  out  of  the  cash  secured 
through  the  sale  of  bonds  is  scarcely  defensible  under  any  cir- 
cumstances. In  this  particular  case  the  transaction  can  hardly 
be  regarded  in  any  other  light  than  as  exploitation  of  creditors 
who  bought  the  bonds  in  good  faith  on  the  assumption  that  their 
joaoney  would  be  used  for  future  betterments,  inyr.jj^  In  boh^j  i 


988  CORPORATE  FINANCE  [Bk.  II- 

§  405.    Interborough  Rapid  Transit  Exploitation 

Another  instance  of  exploitation  of  creditors  is  furnished  by 
the  Interborough  Rapid  Transit  Company,  of  New  York  City. 
In  the  investigation  into  the  company's  affairs  conducted  by  the 
State  Transit  Commission  during  November  and  December, 
192 1,  it  was  disclosed  that  out  of  the  total  net  income  of  $67,- 
867,878  earned  during  the  eighteen  years  of  the  company's  life, 
$65,625,000  was  disbursed  in  dividends,  with  the  result  that  on 
June  30,  192 1,  the  profit  and  loss  surplus  as  shown  on  the  com- 
pany's books  amounted  to  only  $2,242,878.  But  even  this, 
according  to  the  testimony  of  the  Commission's  accountants, 
was  greatly  exaggerated,  as  proper  allowance  had  not  been  made 
for  certain  bad  debts  and  the  amortization  of  the  value  of  a 
subway  lease  of  limited  duration.  It  was  virtually  admitted 
by  the  company's  auditor  that  if  these  and  other  proper  deduc- 
tions had  been  made,  the  gross  earnings,  instead  of  a  profit  and 
loss  surplus,  would  have  showed  a  deficit  of  $12,000,000. 

The  Commissioner's  investigations  seemed  to  show  that 
dividends  had  been  paid  for  some  time  after  current  earnings 
fell  far  short  of  meeting  them,  at  least  one  disbursement  having 
been  made  out  of  the  proceeds  of  loans  from  banks  and  the 
parent  company.  In  its  more  prosperous  days  the  company  was 
also  lavish  with  its  funds  in  other  directions,  large  bonuses  having 
been  voted  and  paid  to  the  president  of  the  company,  its  general 
counsel,  and  the  chief  auditor. 

§  406.    Precautions  Against  Exploitation — Selection  of  Directors 

The  obvious  remedy  against  exploitation,  it  may  therefore 
be  suggested,  would  be  for  those  shareholders  who  desire  honest 
management  to  elect  only  directors  of  unimpeachable  honor  or 
to  refuse  to  buy  the  securities  of  corporations  which  do  not  have 
such  directors.  As  a  matter  of  fact,  this  is  the  fundamental 
remedy  and  it  is  gradually  being  applied.  But  human  nature 
is  too  slowly  changed  to  make  this  remedy  effective  except  over 
a  period  of  generations. 


Ch.  38]  EXPLOITATION  BY  DIRECTORS  989 

As  matters  stand  today,  it  is  quite  impossible  for  the  average 
shareholder  of  a  large  corporation  to  secure  much  information  as 
to  the  personal  characteristics  and  standards  of  the  directors  of 
his  corporation.  Even  in  small  concerns,  where  the  share- 
holders may  be  personally  acquainted  with  each  other  and  with 
the  directors,  it  is  often  extremely  difficult  to  gauge  with  any 
accuracy  the  true  characters  of  the  men  who  are  in  control.  Of 
course,  there  is  always  room  for  the  exercise  of  judgment.  No 
one  of  good  sense  would  deliberately  place  his  capital  under  the 
control  of  men  who  are  known  to  be  of  bad  character.  The 
corporate  shareholder,  however,  is  always  confronted  with  the 
possibility  of  having  overestimated  the  characters  of  the  men  in 
charge,  or  again  of  seeing  the  control  of  the  enterprise  trans- 
ferred into  the  hands  of  unscrupulous  tricksters.  For  these 
reasons,  the  suggestion  that  each  individual  can  protect  himself 
from  exploitation  simply  by  carefully  choosing  the  directors 
to  whom  he  entrusts  his  capital,  is  true  only  within  quite  definite 
limits, 

§  407.    Precautions  Against  Exploitation —  Special  Provisions  in 
Charter 

A  second  suggestion  has  recently  been  made  by  T.  Mulvey, 
formerly  Assistant  Secretary  of  State,  Ottawa,  Canada.  Writing 
in  the  American  Economic  Review,  Mr.  Mulvey  first  discusses  the 
four  methods  named  below  of  tiring  out  the  minority  stock- 
holders and  leading  them  to  sell  their  stock  at  an  abnormally 
low  price : 

1 .  Piling  up  huge  undistributed  surplus. 

2.  Making  a  contract  with  a  subsidiary  company  which 

permits  the  subsidiary  company  to  take  most  of  the 
profits. 

3.  Paying  out  profits  in  the  form  of  exorbitant  salaries. 

4.  Selling  out  the  profitable  features  of  the  enterprise  to  a 
'  new  company,   which  is  promoted  by  a  majority  of 

the   stockholders. 


990  CORPORATE  FINANCE  [Bk.  II- 

Mr.  Mulvey  then  points  out  that  all  these  abuses  may  be 
controlled  by  suitable  provisions  in  the  charter  or  by-laws  of 
the  company,  and  says: 

>.\d 
Salaries  may  be  limited,  the  dealings  with  subsidiary  com- 
panies for  the  purpose  of  withholding  profits  may  be  regulated, 
methods  of  accounting  may  be  devised  whereby  dividends  may 
not  be  withheld.  A  sale  of  the  undertaking  may  be  prohibited, 
except  with  unanimous  consent.  The  shareholder  has  a  contract 
with  the  company  which  is  made  up  of  the  statutes,  charter,  and 
.,rf'j  articles  or  by-laws.  These  may  be  framed  so  that  exactions  or 
overbearing  methods  of  the  majority  may  be  eliminated. 

It  is  quite  true,  as  Mr.  Mulvey  suggests,  that  the  charter  and 
by-laws  should  be  more  carefully  framed  than  is  usually  the  case. 
They  should  provide,  for  instance,  for  cumulative  voting,  which 
assures  even  a  small  minority  of  some  representation  on  the 
board  of  directors.  In  a  few  companies,  the  business  of  which 
is  specially  well  stabilized  and  standardized,  salaries,  contracts, 
accumulation  of  surplus,  and  sale  of  assets  may  all  be  regulated. 
These  companies,  however,  are  relatively  few  in  number.  The 
great  majority  of  enterprises  must  be  highly  flexible  in  order  to 
be  successful.  The  difficulty  of  placing  limitations  of  the  kind 
Mr.  Mulvey  suggests,  without  at  the  same  time  hampering  the 
free  action  so  essential  to  business  success,  seems  in  most  cases 
insuperable. 

'  "  It  may  be  noted  that  Mr.  Mulvey  does  not  discuss  the  follow- 
ing two  methods  of  exploitation  which  are  of  great  importance 
whenever  officers  or  directors  desire  to  take  an  unfair  advantage 
of  their  official  positions:  first,  misrepresentation,  i.e.,  the  sus- 
tained policy  of  creating  false  impressions;  and  second,  misuse 
of  inside  information.  It  would  be  hardly  possible  to  prevent 
either  of  these  abuses  by  regulation.  And  so  long  as  they  are 
available,  officers  and  directors  have  it  in  their  power  to  mislead 
their  associates  and  often  to  procure  their  approval  of  actions 
wliich  more  complete  information  would  show  were  detrimental 
to  their  interests. 


Ch.  38]  EXPLOITATION  BY  DIRECTORS  991 

§  408 .    Precautions  Against  Exploitation — Publicity 

The  most  powerful  weapon  available  for  the  victims,  or 
possible  victims,  of  exploitation  is  publicity.  A  shareholder  in 
a  corporation,  large  or  small,  who  feels  that  he  and  his  associates 
are  being  defrauded,  who  has  a  clear  case  and  who  is  willing, 
with  his  eyes  open,  to  enter  into  a  long  and  gruelling  fight,  is 
likely  to  find  simple  publicity  a  highly  effective  and,  if  properly 
used,  a  highly  legitimate  method  of  attack.  In  a  large  corpora- 
tion the  campaign  of  publicity  may  be  directed  not  only  toward 
stockholders,  but  toward  the  public  at  large.  In  a  smaller  cor- 
poration it  will  naturally  be  confined  to  people  who  are  directly 
affected.  It  goes  without  saying  that  whatever  statements  are 
publicly  made  must  be  clearly  based  on  unmistakable  evidence 
presented  without  personal  bias.  A  single  statement  that  is 
incorrect  may  be  fatal  to  the  whole  case  and  may  involve  the 
one  responsible  in  serious  personal  difhculties. 

Through  the  use  of  effective  publicity  of  the  best  type  in  1906, 
Charles  E.  Hughes,  now  Secretary  of  State,  carried  through  an 
investigation  of  the  prominent  life  insurance  companies,  which 
at  first  was  apparently  of  small  importance,  but  which  ultimately 
brought  about,  through  the  pressure  of  overwhelming,  public 
sentiment,  a  complete  revolution  in  the  financial  management 
of  the  life  insurance  companies  and  a  permanent  uplift  in  stand- 
ards of  business  morality. 

Later,  N.  L.  Amster,  of  Boston,  carried  on  a  campaign  in 
behalf  of  the  Rock  Island  stockholders  which  resulted  in  an 
agreement  to  select  by  general  consent  a  new  board  of  directors 
in  whom  all  the  shareholders  could  place  confidence.  In  19 14,; 
the  Interstate  Commerce  Commission  used  no  weapon  except 
publicity  in  carrying  through  the  investigation  of  the  New  Haven 
Railroad,  which  revealed  the  facts  that  have  been  previously 
stated  in  this  chapter  and  which  led — through  pressure  of  public 
opinion — to  the  retirement  of  the  old  management  and  the 
election  of  an  entirely  new  group  of  directors  and  officers. 


CHAPTER  XXXIX 

INSOLVENCY  AND  RECEIVERSHIP' 

§  409.    Two  Types  of  Insolvency 

The  number  of  business  concerns  which  become  insolvent 
each  year  averages  below  1%  of  the  total  number.  Following 
is  the  record  for  the  last  ten  years:  2 


No.  of 
Failures 

No.    of   Business 
Concerns 

Percentage 
of  Failures 

I9I2 

15,452 

1,564,279 

.98% 

I9I3 

[6,037 

1,616,517 

.99 

I9I4 

18,280 

1,655,496 

i.ro 

I9I5 

22,156 

1,674,788 

1.32 

I9I6 

16,993 

1,707,639 

.99 

I9I7 

13,85s 

1,733,225 

.80 

I9I8 

9,982 

1,708,061 

.58 

I9I9 

6,451 

1,710,909 

.38 

1920 

8,881 

1,821,409 

•49 

I92I 

19,652 

1,927,304 

1.02 

However,  this  record  does  not  present  a  complete  picture, 
for  it  does  not  include  numberless  instances  of  financial  em- 
barrassmertt  which  are  settled  privately  and  of  which  no  avail- 
able record  is  made.  Nor  does  it  include  the  still  larger  number 
of  cases  where  a  business  concern  gradually  sinks  its  capital 
until  finally  the  enterprise  is  sold  or  is  transferred  on  some 
other  contractual  arrangement,  thus  bringing  the  enterprise 
into  the  hands  of  new  men  who  supply  fresh  capital  which  is 
either  sunk  and  lost  or  makes  the  business  a  success. 

Sometimes  the  process  of  passing  a  business  concern  from 
hand  to  hand,  each  new  owner  losing  money  until  he  reaches  the 
point  where  he  is  glad  to  hand  it  over  to  someone  else,  is  carried 


>  See  also  Book  III,  Part  VI,  "Reorganization,  Receivership  and  Dissolution." 
'  Dun's  Review,  January,  1922. 

992 


Ch.  39]  INSOLVENCY  AND  RECEIVERSHIP  993 

on  over  a  remarkably  long  period.  One  instance  is  that  of  a 
small  magazine  which  existed  for  over  twenty-four  years.  Dur- 
ing this  period  its  management  and  control  were  changed  no 
less  than  fifteen  times,  and  for  the  entire  twenty-four  years  it 
had  an  unbroken  record  of  losing  money,  including  considerable 
sums  which  were  sunk  from  time  to  time  in  supplementary  pub- 
lishing schemes,  in  furniture  and  equipment  of  various  kinds,  etc. 
During  its  whole  history  this  magazine  was  never  insolvent  and 
never  was  known  to  be  in  financial  difficulties,  but  never  was  it 
successful.  Finally  it  reached  the  appointed  goal  of  most  small 
magazines  and  was  absorbed  by  one  of  its  stronger  competitors. 
Doubtless  thousands  of  small  retail  stores  and  of  many 
other  business  lines  in  which  full  and  accurate  accounts  are 
not  kept,  lose  money  continuously  over  a  period  of  years.  No 
one  outside  the  enterprise  knows — with  any  definiteness  at 
least — that  as  a  money  maker,  it  is  a  hopeless  failure.  Often 
the  proprietor  himself  is  not  aware  of  this  fact.  There  are 
many  similar  failures  on  a  larger  scale.  It  is  stated,  for  in- 
stance, that  in  eighteen  years,  from  1894  to  191 2,  the  com- 
bination of  cordage  manufacturers  under  its  various  titles  was 
continuously  a  business  failure. 

§  410.    Economic  Insolvency 

The  condition  of  a  business  in  which  income  will  not  suffice 
to  cover  outgo  until  its  liabilities  exceed  its  assets,  may  be 
termed  "economic  insolvency."  If  the  individual,  partnership, 
or  corporation  that  owns  a  business  in  this  condition  becomes 
unable  or  unwilling  to  put  any  further  capital  into  it,  and  is  also 
unable  to  make  an  adjustment  with  creditors  and  reduce  the 
fixed  charges,  or  to  find  a  purchaser  for  the  business,  then  the 
enterprise  may  come  into  the  courts  and  be  adjudged  bankrupt. 

Economic  insolvency  is  sometimes  defined  as  the  condition 
of  a  business  enterprise  that  exists  when  the  total  value  of 
assets  is  less  than  the  total  amount  of  liabilities.  The  net  worth, 
capital  stock,  and  surplus  have  been  dissipated,  and  an  actual 


994  CORPORATE  FINANCE  [Bk.  II- 

deficit  exists  in  their  place.  In  any  money-losing  corporation 
economic  insolvency  will  sooner  or  later  come,  although  it  is 
often  concealed  for  a  time  by  improper  accounting.  In  the  end, 
unless  the  company  succeeds  in  extricating  itself  from  its  in- 
solvent position  before  this  became  known  to  outsiders,  it  comes 
to  grief  and  its  affairs  are  wound  up. 

In  the  period  of  severe  price  decline  during  1920-192 1,  not 
a  few  businesses  found  themselves  suddenly  threatened  with 
economic  insolvency,  and,  as  indicated  by  the  somewhat  violent 
increase  of  insolvency  in  192 1  shown  by  the  table  on  a  preceding 
page,  many  were  forced  into  bankruptcy.  In  the  business 
boom  preceding  the  price  drop  they  had  accumulated  large 
stocks  of  merchandise  and  the  crisis  came  with  these  heavy 
inventories  on  their  hands.  The  cost  of  the  goods  far  surpassed 
their  current  value,  and  the  resulting  losses  obliterated  the 
excess  in  the  total  asset  values  over  and  above  the  liabilities 
where  companies  were  operating  on  a  too  narrow  margin  of 
safety.  Dividend  payments  had  to  be  discontinued  and  a 
policy  of  rigid  retrenchment  of  expenses  had  to  be  adopted  in 
order  to  repair  the  loss.* 

§411.    Technical  or  Financiallnsolvency 

A  second  type  of  insolvency  is  that  which  exists  when 
an  enterprise  that  possesses  a  greater  total  of  assets  than  of 
liabilities  is  unable  to  meet  its  obligations.  This  type  is  some- 
times called  "technical"  insolvency  or  "financial"  insolvency. 
It  may  easily  happen  that  an  enterprise  which  is  a  great  busi- 
ness success  may  in  this  sense  become  insolvent.  There  have 
been  previous  references  to  the  two  insolvencies  and  reorgani- 
zations of  the  Westinghouse  Electric  and  Manufacturing  Com- 
pany, which  has  always  been  a  money-making  enterprise. 

This  second  type  of  insolvency  is  probably  more  common 
than  the  first.  It  is  due,  not  to  intrinsic  weakness  in  the  busi- 
ness, but  to  errors  in  its  financial  management. 

» See  inventory  statistics  in  {  381. 


Ch.  39l  INSOLVENCY  AND  RECEIVERSHIP  995 

Factors  making  for  this  type  of  insolvency  result  in  no 
actual  loss  of  asset  values,  but  merely  in  poorly  balanced  dis- 
tribution of  values  as  between  fixed  and  liquid  assets.  Factors 
making  for  economic  insolvency,  however,  cause  actual  loss  of 
asset  values,  and  therefore  reduce  the  company's  net  worthy  ;.; 

imii 
§412.    Causes  of  Insolvency  ,.•  .... 

The  causes  of  failures,  as  summarized  by  the  commercial 
agencies,  may  be  grouped  in  two  main  classes:  (i)  causes  for 
which  the  management  of  the  failing  concern  may  be  held 
responsible,  and  (2)  outside  factors  over  which  the  business 
can  exercise  little  or  no  control. 

In  the  first  group  we  find  such  causes  as  lack  of  capital, 
incompetence  on  the  part  of  the  management,  the  granting  of 
unwise  credits,  etc.  About  80%  of  all  failures  in  this  country 
are  due  to  this  group  of  causes. 

The  second  class  includes  such  factors  as  losses  by  storms, , 
floods,  and  similar  disasters,  unexpected  failures  of  other  con- 
cerns, severe  competition,  etc.     This  group  of  causes  accounts 
for  approximately  20%  of  the  failures  in  the  United  States. 

§  413.    Lack  of  Working  Capital 

According  to  the  mercantile  agencies,  the  cause  of  a  little 
more  than  one-third  of  the  legal  insolvencies  in  the  United 
States  is  "lack  of  capital."     This  is  rather  a  vague  phrase, 
which  in  the  great  majority  of  instances  should  probably  be  , 
interpreted  to  mean  "lack  of  working  capital."     By  far  the , 
greater  number  of  business  enterprises  can  be  made  successful, 
on  a  small  scale  even  though  their  working  capital  may  be  very 
limited.     It  is  when  these  enterprises  begin  to  expand  and  go 
beyond  the  prudent  limits  imposed  by  their  small  amount  of 
available  working  capital,  that  they  tend  more  and  more  to  , 
convert  working  assets  into  fixed  assets    and   finally  reach  a 
point,  if  care  is  not  exercised,  where  they  cannot  raise  the  ready 
cash  with  which  to  meet  maturing  obligations.     If  we  were  to 


99^  CORPORATE  FINANCE  [Bk.  II- 

call  the  basic  trouble  in  such  cases  "mismanagement  of  capital," 
we  should  not  be  far  frorn  wrong. 

There  are  exceptional  cases,  of  course,  in  which  a  minimum 
amount  of  capital  is  required  in  order  to  equip  a  plant  or  carry 
a  sufficient  stock  of  merchandise.  It  is  stated,  for  example, 
that  a  modern  sugar  refinery  which  expects  to  enter  into  active 
competition  with  those  already  in  operation,  cannot  be  built 
and  equipped  for  less  than  from  $3,000,000  to  $5,000,000. 
Consequently,  a  sugar  refining  enterprise  started  with  a  capital 
of  $1,000,000  would  have  to  build  a  small  and  inelSicient  plant, 
or  else  issue  interest-bearing  obligations  to  such  an  extent  as 
to  endangei  its  financial  safety. 

The  minimum  limits  of  capital  in  each  industry  are  so  well 
known  to  those  acquainted  with  the  industry  that  there  are 
probably  comparatively  few  instances  in  which  a  business  is 
started  by  those  familiar  with  its  requirements  without  sufficient 
capital — if  properly  handled — to  carry  it  through  to  at  least  a 
moderate  success. 

§  414.    Over-Extension 

Financial  embarrassment  due  to  inadequate  working  capital 
is  frequently  ascribable  to  the  failure  of  the  company  to  maintain 
a  proper  balance  between  fixed  and  liquid  assets  as  determined 
by  the  cash  requirements  for  meeting  obligations  currently 
falling  due.  •  In  the  first  place,  the  company  may  become  over- 
extended with  reference  to  its  capital  assets.  Too  much  of  its 
cash,  at  least  for  the  time  being,  has  been  expended,  perhaps, 
in  a  new  building  and  equipment  program.  The  improvements 
and  extensions  may  eventually  prove  to  be  very  profitable 
investments,  but  long  before  this  comes  to  pass  they  have 
taken  the  available  funds  from  the  company's  treasury  and  the 
cash  on  hand  is  insufficient  to  pay  the  obligations  falling  due  in 
the  regular  course  of  business.  The  only  remedy  in  that  event 
is  for  the  company  to  get  outside  money,  that  is,  to  raise  cash 
by  either  selling  new  stock  or  issuing  new  bonds.     But  if  the 


Ch.  39]  INSOLVENCY  AND  RECEIVERSHIP  997 

sale  of  its  securities  is  impossible  because  of  its  low  credit  or 
because  of  the  unsatisfactory  conditions  in  the  general  invest- 
ment market,  nothing  remains  but,  through  receivership  or 
otherwise,  to  come  to  such  adjustment  as  may  be  possible  with 
its  creditors. 

A  similar  situation,  though  not  quite  as  serious  in  its  effects, 
may  result  from  the  tying  up  of  too  much  of  the  company's 
available  funds  in  merchandise  inventories.  The  company 
may  accumulate  in  anticipation  of  increased  sales  a  much  larger 
stock  than  it  usually  carries.  But  if  it  has  misjudged  the 
market  for  its  goods  and  the  sales  prove  disappointing,  and  cash 
does  not  flow  into  the  treasury  in  sufficient  volume  to  meet 
the  current  needs  for  disbursement,  now  increased  by  payments 
for  the  additional  inventory,  the  company  will  find  itself  unable 
to  pay  its  obligations.  But  even  though  the  sales  should  meet 
expectations,  if  the  company  has  been  too  liberal  in  its  selling 
policy,  and  has  not  scrutinized  sufficiently  the  financial  standing 
of  its  customers,  its  collections  may  prove  too  slow  to  offset  its 
outgo.  Then  unless  the  company  can  borrow  of  banks,  or  on 
its  accounts  receivable,  it  may  be  compelled  to  ask  its  creditors 
for  an  extension  of  time.  Of  course,  actual  losses  through 
uncollectible  accounts,  if  of  sufficient  volume,  will  lead  to 
economic  insolvency. 

§  415.    Anxiety  to  Pay  Dividends 

A  frequent  cause  of  technical  insolvency  among  industrial 
combinations  has  been  excessive  anxiety  on  the  part  of  directors 
to  pay  dividends.  Many  industrial  combinations  are  started 
on  the  basis  of  excessive  anticipation  of  profit,  which  has  been 
aroused  by  glowing  prospectuses,  and  the  organizers  feel  called 
upon  to  "make  good."  Dewing  states  that  in  most  of  the 
cases  of  failure  cited  by  him,  financial  difficulties  were  not 
caused  by  overcapitalization,  as  is  usually  alleged,  but  were 
directly  due  to  the  deflection  of  working  capital  to  the  paying 
of  interest  and  dividends.     Beneath  these,  as  the  fundamental 


998  11  n^'/i CORPORATE  FINANCE  [Bk.  II- 

cause,  was  the  lack  of  judgment  of  promoters  in  raising  money  by 
bond  issues  on  untried  enterprises  and  in  some  cases  undue 
haste  to  pay  dividends  before  accumulating  proper  surplus  and 
reserves.  >^fo 

§  416.    Unfavorable  Market  Conditions 

Another  immediate  cause  of  technical  insolvency,  which 
is  quite  frequent  among  railroad  corporations,  is  inability  to 
meet  maturing  obligations  by  reason  of  market  conditions 
which  prevent  the  sale  of  refunding  securities.  A  company 
may  be  reasonably  sound  and  well  able  to  carry  its  load  of 
indebtedness  and  yet  may  find  itself  in  no  position  when  market 
conditions  are  unfavorable,  to  refund  maturing  bonds.  This 
situation  will  very  seldom  arise  with  a  corporation  that  enjoys 
really  high  credit,  but  it  may  easily  arise  with  one  that  enjoys 
only  fair  to  medium  credit.  The  fact  that  an  obligation  falls 
due  at  an  inconvenient  time  may  be  regarded  as  in  one  sense  an 
accidental  misfortune,  though  in  another  sense  the  corporation, 
if  well  handled,  would  hardly  find  itself  in  difficulties  by  reason 
of  an  unreceptive  market. 

§  417.    Methods  of  Procedure  in  Case  of  Insolvency 

When  a  business  enterprise  is  unable  to  meet  its  debts  and 
is  known  to  be  insolvent,  four  courses  of  action  are  open:    j .  > 

1.  Creditors  may  agree  voluntarily  to  a  "readjustment"  or 
settlement  of  their  claims.  This  can  be  done  only  when  all  the 
creditors  are  reasonable  and  have  considerable  faith  in  the 
management  of  the  enterprise.  In  that  case  they  may  prefer, 
for  their  own  sakes,  that  the  situation  should  be  kept  out  of  the 
courts  and  out  of  public  records  and  that  the  buiness  should  go 
on  with  as  little  disturbance  as  possible. 

2.  The  corporation  may  voluntarily  dissolve,  divide  its 
assets  among  its  creditors,  and  go  out  of  business,  all  without 
the  intervention  of  the  courts. 


Ch.  39]  INSOLVENCY  AND  RECEIVERSHIP  999 

3.  The  Individual,  the  partnership,  or  the  corporation 
owning  the  enterprise  may  be  adjudged  a  bankrupt,  and  a  re- 
ceiver in  bankruptcy  be  appointed  to  dispose  of  the  assets  and 
distribute  the  proceeds.  uijoii 

4.  The  corporation  may  secure  the  appointment  of  a  receiver 
in  equity  whose  function  is  to  carry  on  the  business  and  at  the 
same  time  assist,  so  far  as  he  can,  in  working  out  a  generally 
satisfactory  plan  of  reorganization.  rtodv/ 

§  418.    Readjustment  of  Claims 

The  first  of  these  remedies  is  unusual,  except  among  the 
creditors  of  small  corporations.  It  requires  a  degree  of  har- 
monious action  that  is  almost  impossible  to  bring  about  among 
a  great  number  of  people.  The  attempt,  however,  was  made 
in  July,  191 5,  in  the  case  of  the  Missouri  Pacific-Iron  Mountain 
system  under  the  auspices  of  one  of  the  great  banking  houses 
of  America,  Kuhn,  Loeb  and  Company,  who  acted  as  readjust- 
ment managers.  The  details  of  the  plan  of  readjustment 
need  not,  for  this  purpose,  be  considered.  The  point  that 
interests  us  here  is  the  fact  that  in  spite  of  the  obvious  merits 
of  the  plan,  its  remarkably  strong  backing  and  the  general 
indorsement  of  the  financial  press  and  of  financial  authorities, 

__  i^the  final  results  were  disappointing.     It  proved  to  be  impossible 
^to  secure  the  voluntary  assent  of  all,  or  practically  all  the 
security  holders,  and  it  was  found  necessary  to  go  through  the 
cumbersome  and  expensive  process  of  reorganization. 

A  similar  attempt  was  made  in  19 13  in  the  case  of  the  Hudson 
and   Manhattan    Company   which   operates    the   underground 

:  ^railway  system  through   the  Hudson  River  tunnel.     In   this 
ifinstance  the  number  of  holders  of  obligations  was  much  smaller 

;  gand  the  plan  of  readjustment  was  successfully  carried  through. 

;,  -This  plan  is  a  very  common  procedure  with  smaller  companies 
and,  wherever  practicable,  is  by  far  the  most  economical  and 
most  satisfactory  method  of  meeting  a  condition  of  insolvency. 
Its  success,  however,  is  always  dependent  upon  the  presence  of 


lOOO  CORPORATE  FINANCE  [Bk.  II- 

a  fair  degree  of  mutual  confidence  and  good  faith  among  the 
various  parties  concerned.. 

A  typical  embarrassment  which  did  not  involve  any  legal 
action  is  illustrated  by  the  recent  case  of  a  $2,cxx),ooo  printing 
and  lithographing  firm  in  New  York  City.  This  company  had 
outstanding  notes  for  $400,000.  At  first  it  was  thought  to 
be  in  bad  shape  and  the  banks  holding  the  notes  were  undecided 
whether  any  further  accommodation  should  be  extended. 
Representatives  of  the  banks  talked  over  the  situation  and  a 
meeting  of  the  creditors  of  the  company  was  held  at  which 
a  committee  of  five  was  appointed  to  decide  on  the  proper 
steps  to  save  the  firm  and  protect  its  creditors.  This  committee 
agreed  to  put  the  head  of  a  stationery  and  printing  house 
in  whom  all  the  creditors  had  confidence  in  temporary  charge. 
He  reported  that  the  company  had  a  cash  balance  of  $51,780, 
unfilled  contracts  on  hand  worth  about  $1,000,000,  and  bills 
receivable  of  $150,000.  On  the  strength  of  this  report  the 
creditors  agreed  to  wait  two  years  for  a  settlement  of  all  claims. 
Later  developments  proved  the  wisdom  of  their  action,  as  the 
company  regained  a  firm  footing  and  did  a  profitable  business. 

The  following  quotation  from  the  Wall  Street  Journal* 
describes  a  similar  effort  now  under  way :  _  „, 

oi 

A  plan  dealing  with  the  indebtedness  of  the  Columbia  Grapho-  W  [^ 
phone  Manufacturing  Co.,  which  provides  for  freezing  the  entire  —  ^  S  5 
debt  of  the  company  for  the  period  from  April  i,  1922,  to  August  I  o  5  q 
I,  1925,  after  deducting  an  amount  not  in  excess  of  aggregate  bank  2  r  §  "^ 
deposits  on  September  15,  192 1,  has  been  approved  by  the  com-  rn  [n  ™  m 
mittee  formed  to  protect  the  interests  of  holders  of  the  five-year   K  "n  ^  ^ 


8%  notes,  the  bankers'  committee  and  committee  representing  "t*  >  s  _| 

merchandise  and  supply  creditors.    Total  debt  involved  will  be  m  ^  (^  C 

around  $20,000,000.    This  means  that  both  interest  and  principal  "^  O  ^  ^ 

(if  due  in  that  time)  will  be  deferred  for  three  years,  at  the  end  of  2  ^ 

'  which  time,  interest  adjustments  will  no  doubt  be  considered  if  ^  "» 
company  works  out  of  present  difficulties. 

*  April  8.  ^93  2. 


Ch.  39]  INSOLVENCY  AND  RECEIVERSHIP  looi 

The  plan  provides  for  adjustments  of  interest  on  all  debts  to 
April  I,  1922.  Provision  is  also  made  for  appointment  of  a  new 
committee  to  represent  the  total  debt,  which  will  rank  equally. 
This  committee,  known  as  the  readjustment  committee,  is  com- 
posed of  M.  M.  Buckner,  Benjamin  Joy,  J.  C.  Neff,  William  C. 
Dickerman,  and  G.  Herman  Kinnicutt. 

Funding  the  debt  in  this  way  will  in  opinion  of  the  committee 
provide  opportunity  for  the  company  to  work  out  of  present  finan- 
cial difficulties.  It  is  not  considered  that  any  public  financing  will 
be  necessary.  With  approval  of  the  committee,  company  will  be 
given  power  to  borrow  should  funds  be  necessary  for  working 
capital. 

§  419.    Dissolution  of  Insolvent  Corporations 

The  dissolution  of  an  insolvent  corporation  and  the  dis- 
tribution of  the  assets  is  an  uncommon  proceeding.  It  requires 
the  consent  both  of  creditors  who  must  trust  to  the  good  faith 
of  the  officers  of  the  corporal^^  in  carrying  through  the  disso- 
lution and  distribution  (^^e^<ft^eds,  and  also  of  the  share- 
holders who  must  be  convpfi^d^H^tW  other  procedure  is  pos- 
sible. It  is  the  feeling  amg^cjcltjpto^and  shareholders  alike, 
that  those  who  have  manageaCV^&ig,rs^jpiy.which  has  become 
insolvent,  should  not  be  left  fre^<^bc^ak'i^tnfc^  own  arrange- 
ments for  winding  up  the  company,  'fiajr^^tfe^id  B?  checked  and 
supervised  by  some  responsible  officer  wfid'^imls^see  that  all  the 
facts  are  disclosed.  It  is  because  of  this  feeling'that  the  remedies 
of  voluntary  readjustment  and  of  dissolution  are  so  seldom 
used,  and  that  the  remedies  of  bankruptcy  and  receivership 
are  almost  always  necessary. 

§  420.    Voluntary  Dissolution 

Dissolutions  are  not  always  due  to  insolvency,  but  may 
come  as  the  result  of  pressure  of  other  kinds  or  as  the  result 
of  a  conviction  on  the  part  of  a  majority  of  the  shareholders 
that  the  corporation,  while  not  actually  insolvent  or  losing 
money,  is  nevertheless  making  an  unprofitable  use  of  the  capital 
invested  and  is  actually  going  backward.     Under  these  condi- 


I002  '"M^"  CORPORATE  FINANCE  [Bk.  II- 

tions,  it  may  often  be  the  part  of  wisdom  to  bring  about  a 
dissolution  while  the  company  still  possesses  a  valuable  surplus. 
A  number  of  special  cases  of  partial  dissolution— which  might 
also  be  described  as  a  partial  distribution  of  assets— have  arisen 
in  the  United  States  recently,  due  to  decrees  of  the  courts 
requiring  "combinations  in  restraint  of  trade"  to  resolve  them- 
selves into  their  constituent  elements.  The  practical  application 
of  these  decrees  has  in  many  cases  involved  peculiar  difficulties. 

A  typical  instance  of  this  kind  is  the  ordered  dissolution  of  the 
combination  represented  by  the  Reading  Company.  This 
company  is  a  purely  proprietary  or  holding  company,  whose 
assets  consist  exclusively  of  securities  in  other  companies. 
These  assets  include  the  entire  capital  stock  of  the  Philadelphia 
and  Reading  Railway  Company,  the  Philadelphia  and  Reaching 
Coal  and  Iron  Company,  the  Philadelphia  and  Reading  Terminal 
Company,  the  Reading  Iron  Company,  and  $14,504,000  of  the 
outstanding  $27,436,800  capital  stock  of  the  Central  Railroad 
Company  of  New  Jersey.  The  government  brought  suit  against 
this  combination  on  the  ground  that  it  was  in  restraint  of  trade 
and  therefore  in  violation  of  the  Anti-Trust  Law.  In  1920  the 
United  States  Supreme  Court  handed  down  a  decision  compelling 
the  Reading  Company  to  dispose  of  as  much  of  its  security 
holdings  in  the  other  companies  as  would  be  necessary  to  restore 
their  mutual  independence.  Steps  were  immediately  taken  to 
obey  the  court's  mandate,  but  in  the  process  of  segregation  very 
perplexing  difficulties  have  been  encountered,  and  so  serious 
are  these,  that  although  two  years  have  passed  since,  the  Supreme 
Court  decree  was  entered,  no  definite  plan  of  dissolution  has 
yet  been  put  in  operation. 

Another  instance  of  voluntary  dissolution  was  the  winding 
up  of  the  business  of  the  United  States  Express  Company,  a 
concern  that  was  solvent  though  gradually  losing  ground. 
The  company  decided  that  in  the  face  of  the  competition  for 
express  business,  and  particularly  on  account  of  the  competition 
of  the  newly  established  parcel  post,  it  would  be  best  to  liquidate 


Ch.  39]  INSOLVENCY  AND  RECEIVERSHIP  IO03 

its  assets  and  withdraw  from  the  field.  Fortunately,  there  was 
little  duplication  of  contracts  or  facilities  among  the  express 
companies  and  most  of  the  company's  property  could  be  dis- 
posed of  to  the  remaining  express  companies  at  reasonable 
appraised  valuations.  In  this  way  the  liquidation  was  carried 
through  without  serious  loss  or  difficulty.  t 

Ordinarily  there  is  no  special  financial  skill  required  in 
handling  a  voluntary  dissolution,  which  consists  simply  in 
gradually  closing  down  the  business,  disposing  of  the  assets,- 
and  distributing  the  proceeds  to  creditors  and  shareholders. 
Yet  even  this  comparatively  simple  procedure  frequently  involves 
a  vast  amount  of  detail  work. 

§  421.    Origin  and  Nature  of  Bankruptcy 

In  the  early  English  law  an  individual  was  declared  bankrupt 
for  the  purpose  of  enabling  his  creditors  to  seize  upon  and 
distribute  his  assets.  In  case  the  assets  did  not  prove  sufficient 
to  meet  his  debts,  he  was  held  personally  subject  to  the  remaining 
claims  of  his  creditors,  and  in  default  of  payment  was  thrown 
into  jail.  Within  the  last  150  years,  however,  the  popular  and 
legal  conceptions  of  bankruptcy  have  been  greatly  modified. 

In  the  United  States  bankruptcy  proceedings  are  governed 
by  the  National  Bankruptcy  Act  of  1898  as  amended  in  sub- 
sequent years,  and  the  courts  having  jurisdiction  are  those  of  the 
federal  government.  The  purpose  of  bankruptcy  proceedings 
is  no  longer  merely  to  protect  creditors,  but  also  to  free  the 
bankrupt  from  a  load  of  debt  that  had  become  insupportable  and 
to  set  him  on  his  feet  again  as  a  useful  member  of  the  business 
community. 

There  are  abuses,  to  be  sure,  of  this  modern  practice  of 
bankruptcy.  There  are  cases  in  which  dishonest  advantage  is 
taken  of  the  bankpruptcy  law,  and  creditors  are  defrauded, 
wholly  or  partly,  of  their  rightful  claims.  Some  creditors  who 
have  suffered  from  these  abuses  have  gone  to  the  length  of 
advocating  a  repeal  of  the  law.    But  most  business  men  realize 


I004  CORPORATE  FINANCE  [Bk.  11- 

that  as  against  the  chaotic  conditions  which  prevailed  before  the 
passage  of  the  National  Bankruptcy  Act,  the  law  has  proved  a 
blessing  to  the  creditors  as  well  as  to  the  bankrupt.  In  many 
cases  individuals  who  have  been  able  to  rebuild  their  fortunes 
after  having  gone  through  bankruptcy,  have  made  it  a  point  of 
honor  to  repay  in  full  all  the  debts  from  which  they  had  legally 
been  freed. 

§  422.    Two  Kinds  of  Bankruptcy 

Bankruptcy  is  of  two  general  kinds,  voluntary  and  in- 
voluntary. The  benefits  of  bankruptcy  are  open,  not  only  to 
natural  persons,  with  a  few  exceptions,  but  also  to  business 
corporations  except  those  engaged  in  railroad  operation,  insur- 
ance, or  banking.  These  three  Hnes  of  business  are  of  such 
general  importance  that  it  was  thought  to  be  against  public 
interest  to  permit  their  operations  to  be  brought  suddenly  to  a 
close  and  their  assets  scattered.  The  process  of  winding  up 
banking  and  insurance  companies  is  provided  for  under  the 
National  and  State  Banking  and  Insurance  Acts. 

The  definition  of  ''insolvency"  as  given  in  the  National 
Bankruptcy  Act  is,  from  a  legal  standpoint,  peculiar,  although 
it  conforms  to  the  definition  of  "economic  insolvency"  that  has 
been  given  above.  A  person  is  insolvent,  within  the  meaning  of 
the  bankruptcy  law,  "when  the  aggregate  of  his  property, 
exclusive  of  any  property  that  he  has  conveyed,  transferred, 
concealed  or  removed,  or  permitted  to  be  removed  with  intent  to 
hinder,  delay  or  defraud  his  creditors,  is  not,  at  a  fair  valuation, 
sufficient  in  amount  to  pay  his  debts."  An  individual  or  a 
corporation  being  in  a  condition  of  insolvency,  must  then  commit 
an  "act  of  bankruptcy"  if  the  person  or  the  corporation  is  to 
be  thrown  into  involuntary  bankruptcy. 

The  most  common  act  of  bankruptcy  is  the  making  of  a 
general  assignment  for  the  benefit  of  creditors.  As  a  general 
rule,  a  voluntary  assignment  for  the  benefit  of  creditors  is  less 
expensive    than   bankruptcy   proceedings.     It   requires   honor, 


Ch.  39]  INSOLVENCY   AND  RECEIVERSHIP  1005 

mutual  confidence,  and  good  faith,  while  on  the  other  hand 
bankruptcy  procedure  is  especially  valuable  in  case  there  is 
any  suspicion  of  misrepresentation  or  dishonesty.  Bankruptcy 
is  a  harsh  and,  for  most  corporations,  a  fatal  remedy  for  in- 
solvency. It  is,  in  fact,  hardly  worth  while  to  attempt  to 
rehabilitate  a  corporation  that  has  gone  through  bankruptcy. 
It  is  usually  far  easier  and  better  to  form  a  new  corporation 
which  will  purchase  the  assets  and  proceed  to  carry  on  the 
business. 

§  423.     Origin  and  Nature  of  Receivership 

Bankruptcy  proceedings  in  the  case  of  an  insolvent  corpora- 
tion are  usually  wasteful  and  unwise.  A  better  method  of 
meeting  this  situation  is  to  address  a  petition  to  a  court  of 
equity  for  the  appointment  of  a  receiver  to  carry  on  the  business 
under  the  supervision  of  the  court,  until  some  plan  of  reorganiza- 
tion is  worked  out.  The  petition  is  referred  to  in  some  juris- 
dictions as  a  "bill  in  chancery."  It  may  be  presented  by  any 
one  of  four  parties:  (i)  by  the  corporation  itself;  (2)  by  the 
stockholders  of  the  corporation;  (3)  by  the  secured  creditors; 
(4)  by  the  unsecured  creditors. 

Applications  from  the  corporation  itself  or  from  its  own 
stockholders  are  rare,  and  are  still  more  rarely  granted.  Thus 
in  the  early  part  of  1922,  stockholders  of  the  embarrassed 
Columbia  Graphophone  Company  petitioned  for  the  appoint- 
ment of  a  receiver,  but  later  withdrew  their  petition.  Appli- 
cations from  creditors  who  are  friendly  toward  the  corporation 
are  frequently  presented,  however,  and  in  such  cases  the  court  is 
often  requested  to  appoint  one  of  the  officers,  or  someone  else 
close  to  the  management,  as  receiver,  "Friendly  receiverships," 
as  these  arrangements  are  known,  are  not  always  warmly 
favored  by  the  bondholders  and  other  creditors  who  are  usually 
somewhat  suspicious  of  the  management  that  is  responsible  for 
involving  the  company  in  financial  difficulties. 

In  these  friendly  proceedings  the  court  sometimes  appoints 


loo6  CORPORATE  FINANCE  [Bk.  II- 

two  receivers,  who  are  to  act  together — one  an  official  of  the 
company  familiar  with  the  technical  operation  of  the  company, 
and  another  with  no  previous  connections  with  the  company, 
a  distinguished  lawyer,  former  statesman,  etc.,  who  is  the  court's 
chief  reliance.  Thus  in  the  receivership  of  the  Chicago,  Rock 
Island  and  Pacific  Railway  Company  in  191 5,  the  federal  court 
appointed  H.  U.  Mudge,  former  president  of  the  railroad,  as 
one  receiver,  and  J.  M.  Dickinson,  who  had  been  in  President 
Taft's  cabinet,  as  the  other  receiver.  In  all  disagreements 
between  the  two  receivers,  Mr.  Dickinson  was  given  the  deciding 
vote. 

§  424.    Conflicting  Receiverships 

An  appHcation  for  a  receivership  may  be  addressed  to  any 
court,  either  federal  or  state,  which  has  jurisdiction  over  any 
part  of  the  business  of  the  corporation.  As  a  result  it  has  often 
happened  that  two  or  more  courts  have  each  appointed  a  receiver 
and  conflict  of  authority  has  resulted.  The  tendency,  however, 
has  been  strong  toward  putting  all  receivership  proceedings  that 
affect  interstate  corporations  into  the  hands  of  the  federal  courts ; 
and  these  courts  almost  invariably,  as  a  matter  of  courtesy  to 
each  other,  act  in  harmony.  The  judge  who  first  appoints  a 
receiver,  is  usually  accorded  precedence,  and  other  judges 
appoint  the  same  receiver  for  the  property  over  which  they  have 
jurisdiction.  Sometimes  the  incipient  conflict  is  solved  by  the 
appointment  of  an  ancillary  receiver,  who  is  expected  to  co- 
operate strictly  in  harmony  with  the  receiver  first  appointed. 

§  425.    Receivers'  Duties 

The  purpose  for  which  a  receiver  in  equity  is  appointed, 
is  usually  quite  different  from  the  purpose  of  a  receiver  or 
trustee  in  bankruptcy.  The  latter  aims  first  to  take  possession 
of  all  the  property  of  the  insolvent  individual  or  concern;  next  to 
dispose  of  the  property  as  quickly  as  is  practicable;  and  third, 
to  distribute  the  cash  that  has  been  realized.     A  receiver  in 


Ch.  39)  INSOLVENCY  AND  RECEIVERSfflP  1007 

equity,  on  the  other  hand,  has  for  his  function  to  keep  the 
business  running  as  smoothly  and.  with  as  little  loss  as  possible. 
He  may  make  some  changes  in  methods  of  administration  and 
may  properly  retrench  whenever  he  can  do  so  without  impairing 
the  efficiency  of  the  property,  but  in  general  he  carries  on  the 
business  in  about  the  same  manner  in  which  any  business  is 
carried  on.  He  aims  not  to  turn  the  assets  into  cash,  but  to 
keep  them  working  as  profitably  as  possible.  Not  infrequently 
.the  property  of  a  corporation  could  not  be  sold  for  an  amount 
sufficient  even  to  reimburse  the  secured  creditors;  yet  as  a  going 
concern  it  may  be  able  to  earn  normal  profits.  This  is  the 
case,  in  fact,  with  almost  all  companies  that  have  become 
technically  insolvent.  They  are  not,  in  the  first  place,  properly 
subject  to  the  Bankruptcy  Act,  since  their  assets  certainly 
exceed  their  liabilities,  and  to  attempt  to  wind  them  up  would 
be  poor  policy  for  everyone  concerned.  The  best  and  most 
common  procedure  with  all  such  insolvent  corporations,  as 
well  as  with  banks,  insurance  companies,  and  railroads,  is  to 
arrange — usually  through  friendly  proceedings — for  the  ap- 
pointment of  a  receiver  to  conduct  the  business  while  negotia- 
tions for  its  reorganization  are  in  process. 

§  426.    Receivers'  Powers 

The  receiver  carries  on  his  work  under  the  direct  authority 
and  supervision  of  the  judge  who  has  appointed  him.  The 
closeness  of  this  supervision  depends  largely  on  the  personalities 
of  the  judge  and  of  the  receiver,  the  general  practice  of  the 
court,  and  numerous  other  factors.  In  general,  the  receiver 
makes  it  a  point  to  secure  special  authority  for  acts  that  cannot 
be  regarded  as  a  part  of  the  routine  of  conducting  the  business. 

Under  authority  of  the  court,  a  receiver  may  issue  obligations 
known  as  "receiver's  certificates"  which  constitute  a  claim 
on  the  company's  income  and  assets  ranking  ahead  of  all  other 
claims.  He  may  secure  new  equipment,  bring  new  blood  into 
the  management,  find  new  methods  of  niarketing  the  company's 


lOoS  CORPORATE  FINANCE  [Bk.  II- 

products,  and  inaugurate  new  systems  of  operation.  He  is, 
in  fact,  the  general  manager  of  the  company  for  the  time  being, 
with  very  little  restriction  up>on  his  actions.  Sometimes  a 
receiver  will  remain  in  control  for  two  or  three  years  or  more 
before  a  satisfactory  plan  of  reorganization  is  worked  out.  It 
has  been  remarked  above  that  the  receiver  is  frequently  one  of 
the  previous  operating  ofi&cials;  on  the  other  hand,  it  sometimes 
happens  that  the  receiver  makes  so  satisfactory  a  record  that  he 
is  requested,  after  the  reorganization  has  been  completed,  to 
become  an  operating  official  and  continue  to  work  out  the 
policies  which,  as  receiver,  he  has  inaugurated.  F.  W.  Whitridge, 
for  example,  after  successfully  operating  the  Third  Avenue 
Railroad  Company  in  New  York  City  as  receiver,  became  and 
until  his  death  continued  to  be  president  of  the  reorganized 
company, 

§  427.    Customary  Results  of  Receivership 

It  is  frequently  the  case  that  a  corporation  which  becomes 
insolvent  has  for  several  years  been  running  downhill,  either 
because  of  incompetence  or  exploitation  on  the  part  of  the 
management,  or  because  the  impaired  credit  of  the  company 
has  not  permitted  it  to  raise  new  capital  with  which  to  bring 
its  plant  and  equipment  up  to  modern  requirements.  The 
appointment  of  a  receiver,  instead  of  being  another  step  down- 
ward, may  prove  to  be  the  company's  salvation.  That  depends 
in  part,  of  course,  on  the  character  and  ability  of  the  receiver.  If 
he  is  a  man  of  ideas  and  of  executive  talent,  he  may  quickly 
rejuvenate  the  organization. 

As  has  just  been  noted,  the  receiver  has  the  power  to  issue 
certificates  and  thus  secure  funds  which  had  previously  been 
lacking.  Sometimes  a  comparatively  small  amount  of  new 
capital  will  be  enough  to  put  a  decaying  corporation  back  into  a 
moderately  sound  condition.  The  receiver  has  a  free  hand. 
If  it  is  possible  to  do  anything  for  the  corporation  and  if  he  is  the 
man  to  do  it,  the  results  of  his  activities  may  be  a  gratifying  gain 


Ch.  39]  INSOLVENCY  AND  RECEIVERSHIP  IOO9 

in  efficiency  and  earning  power.  In  any  event,  the  receiver 
should  be  able  to  hold  the  organization  and  the  property  intact 
and  to  turn  back,  after  his  service  is  completed,  a  business 
which  at  least  is  none  the  worse  for  the  receivership. 

Ordinarily  the  receiver  takes  some  part  also  in  an  informal 
way  in  the  negotiations  for  financial  reorganization  of  the 
business,  and  advises  with  the  court  as  to  the  plan  of  reorgani- 
zation that  ought  to  be  approved.  It  is  an  object  of  his  efforts 
to  bring  about  the  reorganization  and  thus  terminate  the  re- 
ceivership at  the  earliest  possible  moment. 

Very  infrequently  it  happens  that  these  customary  results — 
maintenance  of  a  going  business  and  financial  reorganization 
—are  not  attainable.  And  in  that  case  the  receivership  may 
finally  end  in  a  forced  winding  up  of  the  business.  Thus  in 
the  early  part  of  1922,  the  receiver  for  Robert  H.  IngersoU  and 
Brother  was  unable  to  continue  the  business,  and  as  no  feasible 
plan  for  its  rehabilitation  or  reorganization  could  be  worked 
out,  the  business  was  sold. 

Although  unusual,  it  is  possible  even  for  a  railroad,  like  other 
business  enterprises,  actually  and  completely  to  go  out  of  busi- 
ness. In  October,  1914,  the  judge  having  jurisdiction  signed 
an  order  directing  the  receivers  of  the  Buffalo  and  Susquehanna 
Railroad  to  discontinue  permanently  the  operation  of  trains,  to 
take  up  the  company's  rails,  and  to  dispose  of  its  assets.  It  is 
stated  that  the  total  population  served  by  this  railway,  which 
was  86  miles  in  length,  was  only  about  17,000;  consequently 
the  railroad  was  wholly  unable  to  pay  its  own  operating  ex- 
penses. At  the  time  when  the  receiver  wound  up  the  business, 
all  that  was  left  to  the  owners  of  $6,000,000  par  value  out- 
standing bonds  (to  say  nothing  of  outstanding  preferred  and 
common  shares)  was  the  scrap  value  of  the  rails  and  rolling  stock, 
the  right  of  way,  and  23  acres  of  land  fronting  on  Lake  Erie. 


CHAPTER  XL 
REORGANIZATION' 

§  428.    Financial  Reorganization  Defined 

In  England  the  term  ''reconstruction"  is  used  to  describe 
the  process  that  we  ordinarily  call  "reorganization."  The 
English  word  is  better  chosen  as  it  embodies  the  idea  which 
underlies  the  whole  process^that  of  tearing  down  the  old 
financial  structure  and  using  the  materials  in  a  new  and  stronger 
structure. 

Financial  reorganization,  in  its  proper  sense,  is  not  merely 
a  series  of  "compromises  and  forced  sacrifices  imposed  upon 
security  holders.  It  is  a  rearrangement  of  the  company's 
liabilities  so  as  to  make  them  conform  more  closely  to  the  assets 
and  earnings.  If  it  is  worked  out  on  ideal  lines  the  reorganiza- 
tion may  be  described  as  a  new  financial  plan  which  replaces 
the  old  plan  that  has  proved  faulty.  The  readjustment  of  the 
company's  finances  should  enable  it  to  proceed  thereafter  under 
more  favorable  conditions  and  to  achieve  better  results. 

The  final  plan  of  reorganization  must  be  approved  by  a 
sufficient  number  of  security  holders  and  must  also  have  the 
approval  of  the  court.  The  relative  influence  of  the  security 
holders,  on  one  side,  and  of  the  judge  and  receiver,  on  the  other 
side,  varies  greatly  in  determining  the  plan  of  reorganization; 
and  it  is  probable  that  in  complicated  reorganizations,  especially 
those  of  railroads,  it  is  more  often  necessary  for  the  courts  to 
intervene  and  take  an  active  part  in  formulating  a  plan  than  it  is 
in  the  simpler  cases  of  reorganization,  particularly  of  industrial 
corporations. 


•  For  accounting  treatment  of  reorganization,  see  Book  III,  Chs.  XXIX-XXXI. 

lOIO 


Ch.  40I  REORGANIZATION  lOII 

§  429.    Conflicts  of  Interests  in  Reorganization 

The  various  interests  which  are  concerned  in  a  financial 
reorganization  may  ordinarily  be  classified  in  three  groups,  as 
follows : 

1.  The  creditors,  including  bondholders. 

2.  The  shareholders,  both  preferred  and  common. 

3.  The  banking  houses  which  propose  to  underwrite  the 

reorganization  plan. 

In  a  complicated  reorganization,  each  one  of  these  three 
groups  is  subdivided.  There  may  be  a  number  of  bond  issues 
which  have  claims  that  in  part  conflict  with  each  other.  The 
interests  of  the  preferred  and  of  the  common  shareholders  are 
by  no  means  identical.  There  may  be  two  or  more  banking 
houses  that  are  working  with  an  eye  to  handling  the  underwriting. 
It  may  often  happen,  therefore,  that  there  is  a  complex  struggle 
among  the  various  groups  of  interests.  On  some  questions  there 
may  be  agreements  and  alliances  between  two  or  more  groups, 
and  on  other  questions  the  cleavage  may  be  entirely  different. 

Naturally  the  chief  influence  is  exerted  by  the  bondholders, 
especially  by  the  holders  of  those  issues  which  are  well  protected 
by  prior  liens. 

Next  come  the  holders  of  the  junior  lien  issues.  The  bank- 
ing houses  are  likely  to  be  in  close  touch  with  all  the  different 
groups  of  bondholders  and  advise  with  them.  Inasmuch  as 
the  active  assistance  of  some  good  banking  house  is  essential 
in  order  to  make  any  plan  a  success,  the  representative  of 
such  a  house  is  likely  to  be  consulted  and  to  have  a  voice  in 
determining  all  important  questions.  Moreover,  he  is  in  the 
advantageous  position  of  an  outsider  who  may  be  trusted  to 
view  the  situation  impartially. 

As  for  the  shareholders  in  a  drastic  reorganization,  they 
have  little  to  say.  Indeed,  it  sometimes  happens  that  their 
claims  to  recognition  are  ruthlessly  brushed  aside  and  they  are 
practically  wiped  out  of  existence.     However,  as  we  shall  see. 


IOI2  CORPORATE  FINANCE  [Bk.  11^ 

they  are  frequently  needed  to  supply  the  fresh  cash  required 
for  the  reorganized  company,  and  for  that  reason  are  permitted 
to  have  some  voice  in  working  out  the  reorganization  plan. 
The  officers  of  a  failed  corporation  sometimes  undertake  to 
direct  the  reorganization,  but  their  efforts  are  seldom  welcomed. 
The  receiver,  as  we  have  seen,  sometimes  takes  a  fairly  active 
though  informal  part  in  working  out  the  reorganization  plan. 
In  view  of  all  these  complications  and  of  the  practical 
difficulties  in  working  out  an  effective  reorganization,  it  often 
requires  months  or  even  years  to  complete  the  plan.  In  the 
larger  reorganizations  there  is  likely  to  be  considerable  dis- 
cussion, not  only  among-  the  security  holders  but  also  in  the 
financial  press.  Attempts  to  curb  and  stifle  this  discussion  are 
sometimes  made  and  usually  are  unfortunate.  The  security 
holders  of  a  company  in  process  of  reorganization  are  by  no 
means  entirely  helpless.  The  assent  of  a  large  proportion  of  the 
holders  of  each  bond  issue  is  usually  required  before  any  plan 
can  be  made  effective;  consequently  the  reasonable  requests  of 
security  holders  for  explanations  and  for  information  in  regard 
to  the  condition  of  the  company  cannot  wisely  be  denied. 

.  It  is,  of  course,  always  possible  for  those  in  charge  of  a 
corporation  or  of  a  reorganization,  arbitrarily  to  refuse  to 
proceed  with  a  discussion,  but  the  effect  is  not  likely  to  be 
helpful  to  their  cause. 

§  430.    Formation  of  Committees 

In  present-day  practice  one  of  the  immediate  results  of  the 
announcement  of  insolvency  of  an  important  corporation  is  the 
formation  of  a  number  of  security  holders'  committees,  each 
one  representing  a  certain  security  issue.  Sometimes  one 
committee  may  represent  two  or  more  issues,  the  interests  of 
which  are  not  conflicting.  The  process  of  formation  of  these 
committees  is  nearly  always  something  of  a  mystery.  They 
seem  to  spring  up  sometimes  overnight  without  special  authority. 
As  a  matter  of  fact  they  are  usually  self-appointed  and  each 


Ch.  40]  REORGANIZATION  1013 

committee  is,  in  reality,  simply  a  group  of  individuals  who  have 
determined  among  themselves  that  it  is  wise  and  proper  for  them 
to  solicit  authority  from  their  fellow  security  holders  to  act  in 
their  behalf. 

In  order  to  secure  this  authority,  it  is  essential  that  the 
members  of  the  committee  should  either  be  personally  well 
known  to  the  security  holders  or  should  be  connected  with 
important  firms  or  banking  houses.  In  large  reorganizations, 
membership  on  these  committees  is  regarded  as  something  of 
a  prize.  The  members  are  frequently  allowed  generous  fees 
for  their  services  and  do  not,  as  a  matter  of  fact,  have  many 
onerous  duties.  The  detailed  work  is  usually  handled  by  the 
secretary  of  the  committee  or  by  counsel.  However,  it  would 
be  an  injustice  to  fail  to  point  out  that  many  reorganization 
committees  composed  of  able  men  devote  a  great  amount  of 
time  and  effort  to  their  work  and  sometimes,  especially  in  the 
smaller  reorganizations,  give  their  services  without  compen- 
sation. 

Even  in  the  latter  case,  the  fees  of  attorneys  for  the  various 
reorganization  committees  must  be  provided  for  in  the  reor- 
ganization plan.  Payments  must  be  made  to  the  managers 
of  the  reorganization  and  to  the  banks  or  trust  companies  which 
act  as  depositaries  for  securities.  The  receiver's  fees,  plus  the 
fees  of  the  attorneys  who  advise  with  him,  are  nearly  always 
heavy.  And  finally,  there  are  numerous  incidental  expenses 
and  fees  for  services  of  Accountants,  for  advertising  and  cir- 
cularizing in  connection  with  the  reorganization  plan,  and  so 
forth,  which  aggregate  a  large  amount.  The  expenses  of  reor- 
ganization are  so  heavy  that  it  is  easy  for  the  members  of 
reorganization  committees  to  persuade  themselves  that  it  makes 
little  difference  if  they  include  a  liberal  compensation  for  them- 
selves. 

The  self-appointed  committee  for  a  certain  group  of  security 
holders  does  not  always  meet  with  instant  acceptance.  Security 
holders  are  likely  to  be  somewhat  skeptical.     Unless  most  of  the 


1014  CORPORATE  FINANCE  [Bk.  II- 

large  holders  are  represented  in  the  reorganization  committee, 
they  are  likely  to  start  an  opposition  committee  and  there  may 
be  an  active  struggle  for  proxies.  If  the  opposition  committee 
is  at  all  successful,  there  may  be  later  a  merger  of  two  committees, 
for  it  is  clearly  essential  that  there  should  not  be  dissension 
among  any  one  group  of  security  holders. 

§  431.    Reorganization  Committee 

In  the  normal  course  of  events,  after  several  committees 
have  been  formed  these  committees  begin  to  negotiate  with 
each  other  and  with  the  receiver  with  a  view  to  arranging  the 
best  possible  terms  for  the  interests  they  represent.  It  is  hardly 
possible  for  any  general  agreement  to  be  reached  except  by  a 
protracted  series  of  negotiations  and  compromises,  and  there 
must  be  some  supreme  judge  or  arbiter.  Unless  the  receiver, 
some  oflScial  of  the  company,  or  some  influential  person  or  bank- 
ing house  can  assume  this  function  and  really  take  charge  of  the 
whole  process  of  bringing  about  an  agreement,  it  is  natural  and 
customary  to  select  from  the  various  security  holders'  com- 
mittees a  group  which  includes  at  least  one  representative  of 
each  set  of  interests  that  must  be  taken  into  consideration; 
this  group  is  customarily  known  as  the  "reorganization  com- 
mittee." This  is  the  committee  that,  in  the  final  analysis, 
devises  the  plan  of  reorganization.  The  various  security, 
holders'  committees  may  negotiate,  but  they  are  likely  to  follow 
the  lead  of  their  representative  on  the  general  reorganization 
committee  and  in  reality  do  little  more  than  give  their  public 
approval  to  the  final  reorganization  plan. 

§  432.    The  Committee  Method  of  Reorganization 

In  spite  of  its  drawbacks,  including  the  ever-present  pos- 
sibility that  not  all  the  security  holders'  committees  will  conscien- 
tiously represent  the  interests  entrusted  to  their  care,  the  com- 
mittee method  of  working  out  a  reorganization  plan  is  in  most 
cases  the  only  practical  method.     In  a  large  corporation  meet- 


Ch.  40]  REORGANIZATION  10 1 5 

ings  of  the  security  holders  are  quite  impracticable;  and  if  they 
were  held  they  would  be  utterly  useless  so  far  as  working  out  a 
plan  is  concerned.  The  only  manner  in  which  they  could  be 
advantageous  would  be  in  bringing  about  free  and  open  election 
of  members  of  the  security  holders'  committees.  Even  though 
their  work  may  sometimes  be  careless,  the  various  security  hold- 
ers' committees,  through  the  general  reorganization  committee 
and  frequently  under  the  active  direction  of  the  banking  house 
that  is  to  handle  the  underwriting,  do  eventually  agree  upon  a 
reorganization  plan.  On  the  whole,  this  method  is  probably  the 
best  that  is  available. 

The  same  idea  might  be  applied  more  frequently  in  smaller 
corporations,  the  security  holders  of  which  cannot  effectively 
express  their  will.  In  a  recent  instance  the  majority  shareholders 
of  an  oil-producing  company  were  believed  by  the  minority 
party  to  have  driven  the  company  into  bankruptcy.  The  sale  of 
its  property  and  assets  had  been  ordered  by  the  Federal  Court 
and  a  so-called  "reorganization  committee"  composed  of  former 
officials  was  planning  to  bid  for  the  company  at  this  sale.  At 
the  last  moment  some  of  the  minority  shareholders  appointed 
themselves  a  committee,  secured  the  co-operation  of  a  good 
proportion  of  the  outstanding  shares,  employed  a  capable  lawyer 
and  incurred  other  necessary  expenses  which  did  not  constitute 
a  heavy  burden  on  any  individual  shareholder,  and  presented 
their  objections  to  the  court.  These  objections  were  sustained, 
and  in  the  end  the  committee  forced  the  adoption  of  a  new  and 
much  more  equitable  plan.  In  this  instance  the  prompt  and 
courageous  action  of  a  few  small  shareholders  checked  what 
probably  amounted  to  a  conspiracy  to  obtain  full  control  of  the 
property. 

§  433.    Procedure  in  Reorganization 

The  first  step  in  a  reorganization  after  some  person  or  group 
of  persons — receiver,  banking  house,  reorganization  committee, 
or  someone  else — has  been  permitted  to  take  charge  of  the  process 


ioi6  CORPORATE  FINANCE  [Bk.  Il- 

ls to  bring  about  a  thorough  examination  and  analysis  of  the 
accounts.  It  may  be  extremely  unsafe  to  accept  without  ques- 
tion the  accounting  statements  issued  by  the  old  management, 
for  it  is  quite  likely  that  their  natural  effort  for  several  years 
has  been  to  conceal  the  company's  growing  financial  weakness. 
Until  the  actual  earnings  and  expenses  are  definitely  determined, 
no  practical  and  really  effective  plan  of  reorganization  can  be 
worked  out.  The  examination  may  be  both  expensive  and 
lengthy.  While  it  is  in  progress,  those  actively  engaged  in  the 
reorganization  may  carry  on  negotiations  and  work  out  a  tenta- 
tive plan,  but  no  final  result  can  be  accomplished. 

The  second  step  consists  of  securing  an  agreement  among  the 
various  committees.  Inasmuch  as  most  of  the  members  of  the 
security  holders  and  reorganization  committee  are  likely  to  be 
men  of  affairs  devoting  only  a  relatively  small  amount  of  time 
and  thought  to  the  reorganization  scheme,  these  negotiations 
are  troublesome  and  are  likely  to  cover  a  long  period  of  time 
before  any  definite  conclusions  are  reached. 

In  the  meantime,  as  a  third  step,  the  receiver  will  be  conduct- 
ing the  company  with  all  possible  economy.  Perhaps,  as  sug- 
gested in  the  preceding  chapter,  he  will  be  raising  new  capital, 
reforming  the  internal  organization,  and  otherwise  raising  the 
enterprise  to  a  higher  plane  of  efficiency.  If  the  company. pos- 
sesses non-essential  or  non-profit-making  property,  the  receiver 
may  proceed,  with  the  consent  of  the  court,  to  dispose  of  some 
of  its  property.     This,  again,  may  be  a  long-drawn-out  process. 

The  final  step,  when  the  reorganization  plan  has  been  worked 
out  and  accepted  both  by  the  security  holders  and  by  the  court, 
is  to  select  and  put  into  execution  the  best  legal  method  of 
accomplishing  the  financial  rearrangement  that  has  been  agreed 
upon.  In  case  the  unanimous,  or  almost  unanimous  consent  of 
the  security  holders  has  been  obtained,  the  court  may  declare 
the  plan  operative  and  binding  even  upon  the  small  proportion 
that  have  not  given  their  assent.  It  is  more  frequently  neces- 
sary, however,  to  go  through  the  legal  form  of  organizing  a  new 


Ch.  4or  REORGANIZATION  IO17 

corporation — usually  with  a  name  very  similar  to  that  of  the 
insolvent  corporation — and  to  bring  about  a  judicial  sale  of  all 
the  property  of  the  old  corporation  to  the  new  corporation.  The 
reorganization  committee  in  that  case  will  turn  in  the  obligations 
of  the  old  corporation  in  payment  for  the  property,  and  will 
issue  in  exchange  obligations  and  shares  of  the  new  corporation 
under  the  terms  that  have  been  agreed  upon. 

Sometimes  stubborn  security  holders  of  the  old  corporation 
who  are  opposed  to  the  reorganization  plan  refuse  to  exchange 
their  securities  for  those  of  the  new  corporation.  The  result 
may  not  be  especially  pleasing  to  them,  for  they  are  likely  to  be 
left  holding  securities  of  a  company  which  is  non-active  and  for 
all  practical  purposes  may  be  called  non-existent.  When  the 
reorganization  of  the  Northern  Pacific  Railroad  Company  took 
place  in  1896,  the  holders  of  some  25,000  shares  refused  to  ex- 
change them  for  shares  in  the  new  company,  the  Northern 
Pacific  Railway  Company.  The  reorganization  was  completed 
nevertheless  and  the  25,cxx5  shares  still  outstanding  are  now 
worthless. 


CHAPTER  XLI 
ENDS  ATTAINED  BY  REORGANIZATION 

§  434.    Raising  Additional  Capital — Methods 

The  general  end  to  be  attained  by  reorganization  is  of  course 
the  rehabilitation  of  the  insolvent  concern.  The  specific  pur- 
poses commonly  sought  in  reorganizations  by  which  this  re- 
habilitation is  to  be  effected  are  as  follows: 

To  raise  the  additional  capital  needed  for  the  reorganiza- 
tion, and  the  operation  of  the  reorganized  company 
thereafter. 

To  reduce  fixed  charges. 

To  simplify  the  financial  structure. 

To  give  increased  facilities  for  raising  any  capital  that 
may  be  needed  in  the  future. 

To  eliminate  unprofitable  business. 

To  pay  or  "refund"  pressing  obligations. 

To  take  care  of  an  accumulation  of  unpaid  preferred  divi- 
dends. 

Usually  the  most  urgent  problem  in  a  reorganization  is  to 
bring  in  fresh  capital,  either  for  the  purpose  of  making  additions 
and  betterments  in  the  fixed  assets,  or  more  commonly  for  the 
purpose  of  providing  adequate  working  capital.  In  either  case 
it  is  usually  necessary  to  secure  a  considerable  amount  of  cash. 
If  the  company  had  been  well,  supplied  with  cash  it  would  not 
presumably  have  become  insolvent.  But  the  fact  that  a  com- 
pany is  in  receivers'  hands  is  naturally  no  recommendation  to 
prospective  purchasers  of  its  securities,  and  the  problem  of  rais- 
ing cash  is  therefore  not  only  urgent  but  often  extremely  difficult. 
It  can  be  solved  only  by  enforcing  drastic  sacrifices  on  security 

1018 


Ch.  41]  ENDS  ATTAINED  BY  REORGANIZATION  loig 

holders.  There  are  three  possible  methods  of  raising  new  capital 
or  of  securing  an  equivalent  reduction  in  the  outstanding  liabil- 
ities of  the  reorganized  concern : 

1.  By  bringing  out  new  issues  of  bonds  or  shares  which  are 

well  secured  and  are  offered  on  terms  particularly 
favorable  to  purchasers. 

2.  By  levying  assessments  on  bond  or  share  holders. 

3.  By  inducing  the  current  creditors,  or  some  of  them,  to 

accept   funded    obligations,    or    sometimes   preferred 
stock,  in  payment  of  the  amounts  due  them. 

§  435.    Raising  Additional  Capital — (i)  Sale  of  Securities 

If  the  company  has  any  valuable  securities  of  other  corpora- 
tions, these  may  be  sold.  However,  this  source  of  cash  is 
seldom  available,  because  a  failing  corporation  usually  exhausts 
all  expedients  for  raising  cash  before  it  is  forced  into  a  receiver's 
hands. 

In  case  the  insolvent  company's  credit  has  not  already  been 
used  to  the  limit,  it  may  be  possible  to  bring  about  some  rear- 
rangement of  claims  upon  assets  and  earnings  which  will  leave 
room  for  the  issuance  of  new  securities.  These  securities  may 
then  be  sold  at  a  heavy  discount  and  thus  the  urgently  needed 
cash  may  be  obtained. 

A  company  which  owns  an  ice  and  light  plant  in  a  small 
western  city  was  recently  in  financial  difficulties.  At  the  original 
organization  of  the  company  some  years  before,  only  about  one- 
half  the  cost  of  the  plant,  which  amounted  to  $43,000,  had  been 
secured  through  the  sale  of  shares;  the  remaining  $21,000  had 
been  borrowed  on  one-year  notes  given  by  the  corporation  and 
indorsed  by  some  of  the  larger  shareholders.  In  subsequent 
years  the  company's  obligations  had  been  reduced  to  about 
$17,000,  but  the  creditors  were  pressing  for  payment  and  the 
indorsers  of  the  company's  notes  were  reported  to  be  unwilling 
to  renew  their  indorsements.  As  a  matter  of  fact,  there  was  a 
suspicion  among  some  of  the  minority  shareholders  that  the 


I020  CORPORATE  FINANCE  [Bk.  II- 

larger  shareholders  were  willing  to  have  them  "shaken  out," 
^nd  altogether  it  was  clear  that  some  form  of  financial  readjust- 
ment was  necessary. 

Inasmuch  as  the  company  was  earning  from  $2,000  to  $4,000 
per  annum,  with  good  prospects  for  a  future  increase,  it  was 
found  possible  to  sell  at  par  a  series  of  one-  to  ten-year  notes, 
each  note  for  $1,200,  bearing  6%  interest.  This  provided  $12,- 
000.  The  remaining  $5,000  was  obtained  by  creating  an  issue 
of  8%  preferred  stock,  which  also  was  sold  at  par.  Inasmuch 
as  this  was  purely  a  local  transaction  handled  by  the  shareholders 
themselves,  there  were  practically  no  reorganization  expenses. 
The  common  shares  were  necessarily  called  upon  to  make  a 
sacrifice  inasmuch  as  they  could  not  reasonably  expect  any 
dividends  for  a  period  of  some  years;  but  after  the  payment  of 
the  ten-year  notes,  they  presumably  will  be  left  with  a  valu- 
able property  which  will  yield  a  high  rate  of  return. 

In  larger  and  more  complex  reorganizations,  precisely  the 
same  principle  may  frequently  be  applied.  The  income  of  the 
corporation  which  may  be  counted  upon  with  reasonable  cer- 
tainty is  taken  away  from  the  shareholders  and  pledged  over  a 
period  of  years  to  the  payment  of  interest  and  repayment  of 
principal  of  a  new  security  issue.  However,  this  plan  is  possible 
only  on  one  of  two  conditions:  a  residue  of  unpledged  property 
and  income  which  has  not  been  utilized  in  the  preceding  financ- 
ing, or  the  drastic  scaling  down  of  the  claims  previously  out- 
standing. The  tendency  in  later  reorganizations  has  been  more 
and  more  strongly  toward  severe  treatment  of  the  old  security 
holders  with  a  view  to  providing  for  an  attractive  issue  that  will 
raise  needed  capital. 

§  436.     (2)  Assessment  of  Security  Holders 

The  second  method  of  raising  cash  is  through  assessment. 
In  nearly  every  reorganization  the  common  shareholders  are 
required  to  pay  some  assessment  in  order  to  secure  any  holdings 
in   the  reorganized  company.     The  same  requirement  is  fre- 


Ch.  41]  ENDS   ATTAINED   BY   REORGANIZATION  I02I 

quently  imposed  upon  the  preferred  shareholders  and  is  some- 
times imposed  even  upon  the  junior  bondholders.  It  may  seem 
strange  that  a  bondholder  or  even  a  preferred  shareholder  should 
be  compelled  to  pay  out  fresh  money  in  order  to  hold  an  interest 
in  the  company;  but  the  truth  is  that  any  security  holder  who 
is  not  amply  protected  by  marketable  assets  is  likely  to  face  this 
experience.  If  he  resists  the  proposal  a  new  company  is  organ- 
ized which,  at  the  judicial  sale,  will  turn  in  the  prior  lien  securities 
in  payment  for  all  the  property  of  the  company.  This  auto- 
matically wipes  out  the  junior  bondholders — unless  they  choose 
to  raise  the  capital  with  which  to  pay  off  the  prior  lien  holders, 
in  which  case  they  will  hold  the  whip-hand.  The  junior  bond- 
holders or  shareholders  are  thus  left  with  the  clear  alternative 
of  either  giving  up  their  previous  investment  without  any  further 
effort  to  protect  and  redeem  it,  or  of  paying  the  assessment. 

When  the  Pere  Marquette  Railroad  was  reorganized  in  19 16- 
1917,  not  only  were  the  three  classes  of  stock,  the  first  preferred, 
the  second  preferred,  and  the  common,  assessed,  but  also  the 
two  classes  of  junior  bonds.  In  fact,  no  distinction  was  made 
between  the  five  issues.  They  were  all  assessed  $9.75  for  every 
$100  par  value  of  the  old  securities,  and  in  return  the  owners 
received  $10  par  value  of  new  first  preferred  stock,  and  in  addi- 
tion a  bonus  of  $20  par  value  of  common  stock.  In  reorganiza- 
tions of  recent  years  a  tendency  to  treat  alike  all  old  issues  that 
are  not  protected  by  any  equity  value,  has  shown  itself  .1 

An  assessment  is  an  extremely  unpleasant  thing  for  the 
security  holder  and  naturally  is  accepted  only  as  a  last  resort. 
Moreover,  it  is  usually  for  the  best  interests  of  the  corporation — 
and  therefore  for  the  best  interests  of  the  shareholders  them- 
.selves  in  the  long  run — that  the  assessment  method  be  used 

Usually  the  shareholder  who  pays  the  assessment  is  given 
at  least  a  nominal  equivalent  in  the  form  of  an  increased  amount 
of  new  stock,  and  perhaps  a  certain  amount  in  securities  of  a 
higher  grade.     If  he  has  faith  in  the  company  and  its  manage- 

'  Dewing  on  Ftnan.  Policy  of  Corp.,  pp.  1 12-1 13. 


I022  CORPORATE  FINANCE  [Bk.  II- 

ment,  he  may  hopefully  look  forward  to  the  time  when  his  new 
securities  will  be  worth  full  par  value.  For  example,  the  reor- 
ganization plan  of  the  Missouri,  Kansas  and  Texas  Railway 
Company,  now  in  process  of  execution,  calls  for  the  payment 
by  the  stockholders  of  $20  per  share  on  preferred  stock  and  $25 
a  share  on  common  stock.  For  this  the  preferred  stockholder 
receives  for  each  100  shares  surrendered,  $1,400  Prior  Lien 
Mortgage  bonds.  Series  C,  6%,  carrying  interest  from  January  i, 
1922;  $600  Adjustment  Mortgage  bonds.  Series  A,  5%,  ranking 
for  interest  from  January  i,  1922;  and  100  shares  common  stock. 
Each  common  stockholder  receives  $1,750  Prior  Lien  Mortgage 
bonds.  Series  C,  6%,  carrying  interest  from  January  i,  1922; 
$750  Adjustment  Mortgage  bonds,  Series  A,  5%,  ranking  for 
interest  from  January  i,  1922;  and  100  shares  of  common  stock. 

Another  instance  of  stockholders  receiving  bonds  as  well  as 
stock  for  the  assessment  paid,  is  to  be  found  in  the  reorganiza-. 
tion  of  the  San  Francisco  Railway  Company  in  19 16.  The  same 
assessment  of  $50  per  $100  par  value  of  the  old  securities  was 
imposed  on  the  first  preferred,  the  second  preferred,  and  the 
common  stock,  and  for  their  payment  the  shareholders  obtained 
$50  par  value  of  a  prior  lien  bond  and  a  common  stock  bonus. 
In  the  distribution  of  the  bonus  some  regard  was  paid  to  the 
relative  position  of  the  three  classes  of  shares — the  first  preferred 
receiving  $100  par  value  of  the  new  common  stock,  the  second 
preferred  $90,  and  the  old  common  $82. 

Probably  the  most  drastic  assessment  on  record  is  that  of  the 
Houston  and  Texas  Central  Railroad  Company  in  1897,  which 
amounted  to  73%  on  the  common  shares. 

Regardless  of  the  amount  of  the  assessment,  however,  the 
,  question  as  to  whether  a  shareholder  should  or  should  not  pay, 
is  always  one  to  be  studied  with  much  care.  Naturally  the  reor- 
ganization managers  will  make  terms  that  will  be  at  least  fairly 
attractive  in  order  to  make  certain  that  the  money  which  is 
required  shall  be  forthcoming.  For  this  reason  it  is  usually 
profitable  for  shareholders  to  pay  up  their  assessment. 


Ct.  41]  ENDS  ATTAINED  BY  REORGANIZATION  161$ 

It  is  stated  that  in  almost  all  cases  of  railroad  reorganization 
the  price  of  the  securities  obtained  by  payment  of  the  assess- 
ment was,  within  six  months  thereafter,  nearly  equal  to  the 
previous  market  quotation  plus  the  assessment.  In  practically 
every  case  later  quotations  have  gone  much  higher.  The  in- 
crease in  value  "has  abundantly  justified  the  payments  which 
stockholders  were  asked  to  make." 

§  437'     (3)  Funding  Floating  Debt 

The  third  method  of  increasing  cash  resources — that  of  in- 
ducing the  current  creditors  to  accept  long-term  securities  in 
settlement  of  their  claims — is  practicable  only  when  the  insolvent 
company  is  fundamentally  prosperous  and  has  been  brought 
into  difficulties  merely  through  a  temporary  shortage  in  working 
capital.  In  both  the  Westinghousc  reorganizations  the  holders 
of  floating  debt  were  persuaded  to  take  long-term  notes  and 
bonds  in  payment,  for  they  were  convinced  of  the  company's 
inherent  soundness.  In  the  first  reorganization  of  1891,  the 
company's  $3,000,000  in  floating  debts  were  replaced  largely 
by  stock  issues. 

In  the  reorganization  of  the  Goodyear  Tire  and  Rubber 
Company,  in  1921,  the  merchandise  creditors  received  125%  of 
the  amounts  due  them  on  January  i  of  that  year  for  merchandise 
actually  delivered  in  prior  preference  8%  cumulative  stock; 
while  in  the  case  of  commitments  for  merchandise  not  delivered 
prior  to  January  i,  192 1,  but  for  which  specifications  and  prices 
had  been  fixed  on  that  date,  they  received  75%  in  cash  and  28% 
in  preference  shares. 

§  438.    Reorganization  Underwriting  Syndicate 

In  every  reorganization  where  it  is  proposed  to  raise  cash, 
whether  by  assessment  or  by  the  sale  of  new  securities,  the  serv- 
ice of  an  underwriting  syndicate  of  bankers  is  indispensable  for 
the  successful  execution  of  the  general  reorganization  plan. 
Security  holders  are  not  obliged  to  pay  the  assessment  if  any  is 


I024  CORPORATE  FINANCE  [Bk.  II- 

levied.  If  the  market  value  of  their  holdings  is  nominal  and 
far  below  the  amount  of  the  proposed  assessment,  many  of  them 
may  decline  to  throw  good  money  after  bad,  as  the  proceeding 
may  appear  to  them.  The  company  has  therefore  no  means  of 
knowing  what  response  it  will  get  from  those  subject  to  the  as- 
sessment; and  as  it  must  be  in  possession  of  the  required  amount 
of  cash  if  the  entire  reorganization  scheme  is  not  to  miscarry,  a 
banking  syndicate  is  formed  to  underwrite  the  assessment. 

In  substance,  a  syndicate  of  this  nature,  for  a  commission, 
obligates  itself  to  pay  the  assessment  of  all  defaulting  security 
holders  and  to  take  over  the  securities  assigned  to  them  in  the 
new  corporation.  If  the  expedient  resorted  to  for  obtaining 
cash  is  the  sale  of  new  securities,  the  syndicate  purchases  the 
issue  on  some  agreed  basis,  precisely  as  it  would  if  the  company 
were  solvent  and  were  doing  a  piece  of  normal  financing. 

The  payment  received  by  the  underwriting  syndicate  nat- 
urally varies  with  the  conditions.  In  the  Missouri,  Kansas  and 
Texas  reorganization  referred  to  above,  the  underwriting  syndi- 
cate "is  to  receive  a  commission  of  5%  on  the  aggregate  syndi- 
cate obligation,  and  $1.50  per  share  for  so  much  of  the  common 
stock  of  the  new  company  so  offered  to  stockholders  under  the 
plan  as  such  syndicate  shall  take  and  pay  for.". 

§  439.     Reducing  Fixed  Charges 

In  the  majority  of  cases  of  insolvency  the  trouble  has  arisen 
primarily  because  the  company  had  a  larger  load  of  fixed  charges 
than  its  income  would  permit  it  to  carry.  That  being  the  case, 
the  only  safe  and  correct  course  in  reorganization  is  to  cut  down 
these  charges.  It. is  useless  to  continue  them  unless  the  com- 
pany's difficulties  are  partly  temporary;  for  to  do  so  would  be 
simply  to  invite  a  new  insolvency. 

One  of  the  simplest  and  most  severe  cases  of  cutting  down 
fixed  charges  was  that  of  the  reorganization  of  the  Northern 
Pacific  Railroad  Company  in  1875.  The  company's  line  was  at 
that  time  still  under  construction  and  its  earnings  were  less  than 


Ch.  4i]  ENDS  ATTAINED  BY  REORGANIZATION  1025 

K  of  1%  on  its  funded  debt.  There  seemed  to  be  no  immediate 
prospect  of  increasing  the  earnings  and  it  was  therefore  deter- 
mined that  all  fixed  charges  should  be  eliminated.  All  outstand- 
ing bonds  were  replaced  by  preferred  shares;  floating  debt  was 
also  exchanged  for  preferred  shares;  and  old  common  shares 
were  replaced  by  new  common  shares. 

It  is  pointed  out  that  out  of  seven  railroad  reorganizations 
in  the  period  from  1893  to  1898,  every  one  showed  a  decrease  in 
fixed  charges  averaging  31%.  In  practice,  experience  shows  the 
advisability  of  keeping  in  view,  in  the  rearrangement  of  fixed 
charges,  the  five  following  principles: 

I.  The  maximum  fixed  charges  after  reorganization  should 

^  not  exceed  the  absolute  minimum  of  net  earnings.      '" 

""       2.  As  large  a  proportion  as  possible  of  the  charges  should 

consist  of  interest  on  bonds.     Sinking  funds  with  their 

requirements,  guaranteed  dividends,  rentals,  and  the 

like,  should  be  avoided  as  much  as  possible. 

3.  The  losses  should  fall  most  heavily  on  the  junior  security 

holders  generally,  leaving  the  first  lien  securities — 
unless  the  reorganization  is  exceedingly  drastic — 
practically  untouched. 

4.  The  nominal  value  of  the  new  securities  received  by 

security  holders  in  the  old  company  should  be  reduced 
as  little  as  possible. 

5.  Bondholders  whose  claims  are  scaled  down  should  be 
^''  given  an  opportunity   to  participate  in   any   future 

increases  of  earnings.2 

If  the  junior  bondholder  who  is  asked  to  accept  a  reduction  in 
the  principal  and  possibly  in  the  rate  of  interest  of  his  holdings, 
is  at  the  same  time  given  preferred  and  common  shares  up  to  the 
full  par  value  of  his  former  bondholdings,  or  perhaps  a  little 
above,  he  is  inclined  to  accept  the  reduction  much  more  readily. 
He  may  feel,  quite  properly,  that  there  is" at  least  a  chance  of  his 
recovering  in  future  all  the  capital  that  he  has  lost. 

»  Daggett's  Railroad  Reorganization,  pp.  357-362. 


I026  CORPORATE  FINANCE  [Bk.  II- 

As  to  industrial  reorganizations,  the  results  of  27  companies 
show  that  fixed  charges  were  reduced  on  the  average  about  2^%.^ 
This  percentage  probably  measures  fairly  well,  the  excessive 
amounts  of  bonded  and  other  obligations  which  were  issued  above 
the  limits  of  prudence  under  the  old  financial  plan. 

§  440.     Trend  of  Reorganization  Procedure 

The  tendency  on  the  whole  has  been  more  and  more  strongly 
toward  avoiding  half-way  measures  in  reorganizations  and  toward 
putting  the  corporation  on  its  feet  financially  so  that  it  will  not 
within  a  short  time  come  back  into  the  hands  of  the  financial 
surgeons.  To  illustrate  this  tendency,  an  interesting  parallel 
may  be  drawn  between  the  first  reorganization  of  the  Erie 
Railroad  in  1859  and  its  reorganization  in  1895,  by  which  time 
the  present-day  methods  and  principles  of  reorganization  had 
become  well  recognized.  In  the  first  reorganization  fixed  charges 
were  not  reduced,  preferred  shares  were  given  in  exchange  for  the 
unsecured  indebtedness,  the  second  mortgage  which  was  about 
to  fall  due  was  extended,  and  an  assessment  of  2}4%  was  levied 
on  both  preferred  and  common  shares.  The  position  of  the  road 
was  not  much  stronger  after  the  reorganization  than  it  had  been 
before,  and  the  money  paid  in  by  the  shareholders  was  dissipated 
without  permanent  benefit  either  to  the  corporation  or  to  them- 
selves. The  reorganization  of  1895,  o^  the  other  hand,  lowered 
fixed  charges,  procured  ample  cash  by  assessments  on  the  share- 
holders, and  gave  shares  rather  than  bonds  in  exchange  for  the 
new  cash  that  was  raised. 

§  441.    Effect  on  Financial  Structure 

One  customary  result  of  reorganization  is  an  increase  in 
capitalization.  At  first  glance  this  may  seem  surprising,  but  it  is 
the  necessary  result  of  the  policy  of  compensating  the  old  security 
holders  for  their  sacrifices  by  giving  them  some  form  of  claim  on 
the  future  earnings  of  the  corporation.     Junior  bondholders  are 

'  Dewing  on  "Corp.  Prom.  &  Reorg.,  p.  6ii. 


Ch.  4i]  ENDS  ATTAINED  BY  REORGANIZATION  t027 

usually  asked  to  accept  a  percentage  of  new  bonds  plus  a  per- 
centage of  preferred  shares,  the  new  securities  having  a  total 
nominal  value  at  least  equivalent  to  the  nominal  value  of  the 
bonds  they  formerly  held.  The  preferred  shareholder  is  perhaps 
asked  to  pay  an  assessment  and  accept  new  securities  consisting 
of  preferred  and  common  shares.  The  common  shares  may  be 
reduced  or  wiped  out,  but  more  often,  upon  payment  of  assess- 
ment, are  replaced  by  shares  of  not  greatly  reduced  nominal 
value.  In  general,  the  tendency  is  strongly  toward  reducing 
bond  capitalization  and  increasing  the  share  capitalization  more 
than  proportionately. 

§  442.     Simplification  of  Financial  Structure 

Another  customary  result  of  reorganization  in  large  corpora- 
tions is  the  simplification  of  the  company's  financial  structure. 
In  the  years  preceding  reorganization  the  company  has  in  all 
probability  put  out  various  issues  of  bonds,  preferred  shares, 
and  common  shares,  some  of  which  may  have  conflicting  or 
uncertain  claims.  Reorganization  gives  an  opportunity  to 
replace  these  various  small  issues  by  a  few  large  issues.  At  the 
same  time,  increased  facilities  for  raising  capital  in  future  are 
often  provided.  The  new  issues  are  made  large  enough  to  pro- 
vide for  the  immediate  needs  of  the  reorganized  company,  with 
the  proviso  that  additional  bonds  may  be  sold  under  the  same 
mortgage  on  fulfillment  of  the  conditions  of  the  deed  of  trust. 
Through  this  simplification  and  provision  for  future  capital 
requirements,-  the  company's  financial  structure  may  be  brought 
into  line  with  the  best  present-day  practice.  This  is  often  one 
great  advantage  of  reorganization. 

§  443.    Elimination  of  Unprofitable  Business 

Another  advantage  frequently  afforded  by  a  reorganization  is 
the  opportunity  to  eliminate  unprofitable  branches  or  depart- 
ments. Sometimes  the  bondholders  who  are  secured  by  a  mort- 
gage or  a  branch  or  an  isolated  plant  are  bluntly  told  that  they 


I028-  CORPORATE  FINANCE  [Bk.  II- 

may  take  the  property  which  is  not  wanted  by  the  parent  corpora- 
tion. More  often,  the  fact  that  the  property  to  which  they  have 
a  claim  is  not  essential,  is  driven  home  and  they  are  forced  to 
agree  to  a  considerable  reduction  in  their  claims,  which  may  be 
sufficient  to  put  the  outlying  branch  or  plant  on  a  profitable 
basis.  Reorganization  is  apt  to  be  carried  on  in  a  cold-blooded 
way  by  financial  men  who  are  impressed  only  with  results  that 
have  actually  been  achieved.  Frequently  the  main  difficulty 
with  a  business  that  has  become  insolvent  has  been  over- 
optimism  and  over-expansion  on  the  part  of  its  management. 
Wherever  that  is  the  case,  a  reorganization  which  eliminates  these 
outside  ventures  or  reduces  the  expense  of  conducting  them  may 
and  in  practice  not  infrequently  does  prove  of  great  and  lasting 
benefit  to  the  corporation. 

§  444.     The  Clafiin  Reorganization 

As  an  interesting  illustration  of  some  of  the  principles  above 
discussed,  we  may  take  up  briefly  the  history  of  the  failure  and 
reorganization  in  19 14  of  the  great  wholesale  dry  goods  house  of 
H.  B.  Clafiin  Company. 

This  company  was  organized  in  1843.  After  a  long  period  of 
prosperity  the  firm  began  to  feel  the  efifects  of  severe  competition 
from  jobbing  houses  in  western  trade-centers,  and  in  order  to 
meet  this  competition  it  began  to  build  up  its  own  retail  outlets. 
Through  certain  controlled  companies,  particularly  the  Associat- 
ed Merchants  Company  and  the  United  Dry  Goods  Company, 
35  well-known  department  stores  in  various  important  cities 
were  brought  under  the  control  of  the  Clafiin  interests.  These 
stores  naturally  purchased  most  of  their  goods  through  the 
H.  B.  Clafiin  Company. 

It  is  questionable  whether  the  close  relationship  thus  estab- 
lished between  a  wholesale  house  and  retail  stores  was  really 
valuable  to  either  party.  Of  course,  it  enabled  the  H.  B.  Claflin 
Company  to  carry  on  extensive  operations  for  a  long  period ;  but 
its  apparent  size  and  prosperity  turned  out  to  be  largely  artificial 


Ch.  41I  ENDS  ATTAINED  BY  REORGANIZATION  1029 

and  unsound.  So  far  as  the  retail  stores  were  concerned,  it  was 
evidently  of  no  advantage  to  them  to  be  compelled  to  purchase 
most  of  their  supplies  from  a  given  wholesale  establishment. 

When  the  failure  wasi  first  reported  it  was  thought  that  the 
total  Claflin  liabilities  amounted  to  about  $34,000,000,  but  it 
soon  became  evident  that  large  amounts  of  notes  had  been  issued 
and  obligations  incurred  of  which  there  was  no  clear  record.  The 
relationships  of  the  many  companies  included  in  the  combina- 
tion had  become  so  involved  that  it  was  months  before  the 
receivers  could  obtain  even  the  approximate  amount  of  the 
liabilities;  and  in  the  end  the  total  liabilities  were  placed  at  about 
$45,000,000. 

It  was  found  that  the  financial  transactions  of  all  the  various 
department  stores  were  being  handled  in  New  York,  and  that  the 
active  managers  of  these  stores  knew  nothing  about  many  of  the 
liabilities  which  the  treasurer  of  their  company,  sitting  in  his 
New  York  office,  had  created.  For  instance,  the  Hennessy 
Corporation,  which  operated  stores  in  Butte  and  Anaconda, 
Montana,  had  on'  its  books  obligations  amounting  to  only 
$83,000.  The  president  of  this  company  had  no  knowledge 
whatever  of  the  existence  of  any  other  obligations;  but  he  was 
suddenly  advised  after  the  receivership  of  the  Claflin  Company 
that  approximately  $1,700,000  in  notes  of  the  Hennessy  Corpora- 
tion had  been  issued  and  after  having  been  indorsed  by  the 
Claflin  Company,  were  discounted  in  New  York.  The  same 
jjractice  was  followed  with  subsidiary  companies  all  over  the 
country.  In  this  way  an  enormous  amount  of  "accommodation" 
j)apcr  was  put  out.  The  parent  company's  contingent  liability 
on  this  paper,  however,  was  not  shown  in  the  financial  statements 
it  had  submitted  to  bankers  and  to  those  who  bought  its  com- 
mercial paper  through  note-brokers. 

The  scheme  of  reorganization  finally  agreed  upon  was  based 
upon  the  idea  that  the  wholesale  business  and  the  retail  business 
of  the  combination  ought  to  be  separated.  The  Dry  Goods 
Economist  pointed  out  that,  while  the  d?Ly  has  gone  when  a 


I030  CORPORATE  FINANCE  [Bk.  II- 

general  jobbing  house  located  in  New  York  could  do  a  great 
national  business,  there  was  still  an  important  field  open  to  the 
H.  B.  Claflin  Company  in  handling  business  within  a  short 
distance  of  New  York. 

The  plan  for  reorganization  provided  that  the  noteholders 
receive  in  exchange  for  their  old  notes  15%  in  cash  and  85%  in 
three-year  collateral-trust  income  notes  issued  by  the  new 
company  which  was  to  be  known  as  the  Mercantile  Stores 
Corporation.  The  Mercantile  Stores  Corporation  was  to  own 
all  the  stock  of  the  insolvent  department  stores  in  the  combina- 
tion, and  turn  these  into  cash  as  rapidly  as  possible.  It  was  also 
provided  that  a  new  company,  known  as  the  H.  B.  Claflin  Cor- 
poration, should  continue  that  portion  of  the  wholesale  business 
which  had  proven  profitable.  All  the  stock  of  the  H.  B.  Claflin 
Corporation  was  to  be  owned  by  the  Mercantile  Stores  Cor- 
poration. 

Under  this  plan  the  new  corporations  were  enabled  to  begin 
their  operations  without  any  current  indebtedness.  The  plan 
of  reorganization  was  somewhat  unusual  in  that  it  did  not  call 
for  any  new  capital  and  at  the  same  time  freed  the  subsidiary 
corporations  from  current  liabilities. 

As  far  as  the  old  stockholders  of  the  H.  B.  Claflin  Company 
were  concerned,  nothing  was  ever  realized.  The  Mercantile 
Stores  Corporation,  however,  distributed  over  $17,000,000  in 
cash  to  the  creditors  of  the  old  company,  and  then  having 
carried  its  liquidation  of  assets  as  far  as  could  be  done  without 
unjustifiable  losses,  was  reorganized  in  1919  as  an  operating 
company  under  the  title  of  Mercantile  Stores  Company,  Inc. 
The  H.  B.  Claflin  Corporation  was  purchased  in  191 7  by,  and 
merged  with,  Claflins,  Inc. 


BOOK  III 
CORPORATE  ACCOUNTING 


Part  I  —  Surplus  and  Reserve  Accounts 


CHAPTER  I 
THE  CORPORATE  RECORDS  AND  ACCOUNTS 

§  I.    Corporate  Accounts 

Strictly  speaking,  there  are  no  books  of  account,  nor  are  there 
entries  on  books  of  account,  which  are  absolutely  peculiar  to 
corporations.  Most  of  the  books  and  accounts  used  will  be  found 
in  any  business  of  similar  nature  conducted  under  any  other 
form  of  business  organization.  When  we  come  to  the  more  dis- 
tinctively corporate  accounts,  we  find  that  the  joint-stock  com- 
pany also  employs  these  same  accounts.  But  the  joint-stock 
company  as  a  form  of  business  organization  is  so  nearly  obsolete 
that  it  may  be  ignored,  and  the  capital  stock  and  dividend 
records  may  be  considered  as  being  distinctly  corporate,  to- 
gether with  the  entries  covering  dividends  and  transactions  in 
capital  stock. 

There  are  also  certain  transactions,  such  as  those  dealing  with 
bonds,  which,  while  not  necessarily  limited  to  corporations,  occur 
rarely  in  other  forms  of  business  and  are  commonly  thought  of 
as  being  distinctive  of  the  corporation. 

Many  transactions  encountered  in  corporate  books  admit 
of  more  than  one  manner  of  treatment.  In  the  following 
chapters  it  will  be  found  that  transactions  identical  in  nature 
have  been  variously  handled  for  purposes  of  exemplifying  these 
different  methods.  In  this  connection  it  should  be  noted  that 
in  some  cases  there  is  a  diversity  of  opinion  as  to  the  entries  and 
names  of  accounts  that  are  best  employed  under  the  varying 

1033 


1034  CORPORATE  ACCOUNTING  [Bk.  III- 

conditions  that  confront  the  corporation  accountant.  In  each 
case,  however,  that  plan  which  will  best  provide  all  of  the  infor- 
mation desired  with  the  fewest  possible  repetitions  and  least 
chance  of  confusion,  has  been  used  in  the  present  volume. 

§  2.    Requirements  of  Corporate  Records 

As  stated,  the  general  books  dealing  with  the  ordinary  com- 
mercial transactions  of  a  corporation  differ  not  at  all  from  those 
of  a  partnership  or  a  single  proprietorship  conducting  a  similar 
line  of  business,  and  for  their  character  and  use  the  reader  is 
referred  to  any  text  on  accounting.  In  a  corporation,  however, 
there  is,  in  addition  to  the  books  of  account  which  record  the 
transactions  of  ordinary  business,  another  class  of  books,  such 
as  the  minute  book,  stock  book,  dividend  book,  bond  record, 
etc.,  for  recording  the  activities  which  are  almost  peculiar  to  the 
corporate  form.  So  necessary  are  these  books  that  in  many 
states  the  laws  specify  that  certain  of  them,  as  the  minute  book, 
stock  book,  transfer  book,  etc.,  shall  be  kept.i  Some  of  these  are 
not  accounting  records,  but  all  of  them  which  are  accounting 
records  and  are  peculiar  to  corporations  are  discussed  in  subse- 
quent chapters. 

§  3.    Choice  of  Corporate  Records 

The  distinctive  books  of  record  to  be  kept  by  a  corporation 
are  frequently  set  forth  in  its  by-laws;  although  the  books  so 
enumerated  would  usually  be  kept  as  a  matter  of  course  by  any 
well-managed  corporation. 

Under  these  conditions  the  accountant,  when  devising  an 
accounting  system  for  a  corporation,  must  first  consult  the 
statutes  of  the  state  to  ascertain  the  legal  requirements.  Fre- 
quently the  statutes  not  only  prescribe  certain  books,  but  also 
specify  where  these  books  must  be  kept  and  what  they  must 
contain.     Next  he  must  consult  the  by-laws  of  the  corporation 


•  For  a  discussion  of  the  minute  book  see  Book  I,  Part  IX,  "Meetings  and  Records"; 
also  Book  IV,  Ch.  XVI,  "Minutes  of  Corporate  Meetings," 


Ch.  i]  CORPORATE  RECORDS  AND  ACCOUNTS  1035 

to  ascertain  their  requirements  as  to  books  and  records.  Then, 
in  addition  to  the  books  required  by  the  laws  and  the  corporation 
by-laws,  he  must  add  such  other  books  as  are  needed  to  make  a 
complete  record  of  the  financial  transactions  of  the  corporation. 
The  usual  corporate  records  include  :2 

Minute  book 

Subscription  records 

Instalment  receipts 

Instalment  book 

Stock  certificate  book 

Stock  transfer  book        .  " 

Register  of  transfers 

Stock  ledger 

Dividend  book. 

Bond  register 

This  number  might  be  extended  considerably,  and  subdi- 
visions made,  especially  in  the  case  of  large  corporations.  On  the 
other  hand,  in  the  case  of  a  small  company  some  of  the  enum- 
erated books  would  be  omitted  entirely.  Indeed,  in  some 
companies,  especially  where  the  stock  is  held  by  a  few  individuals, 
the  bookkeeping  is  as  informal  as  in  a  partnership  and  but  few 
of  the  distinctive  corporate  records  are"  kept.  It  is,  however,  a 
wise  precaution  always  to  provide  for  the  proper  record  of  all 
corporate  transactions,  no  matter  how  small  the  corporation 
or  how  closely  its  stock  may  be  held.  If  this  is  not  done,  trouble 
may  result,  and  "an  ounce  of  prevention  is  worth  a  pound  of 
cure." 

All  the  books  enumerated  above  are  auxiliary  books  sub- 
ordinate to  the  general  books.  Many  of  them  are  subsidiary 
ledgers,  by  which  it  is  meant  that  they  contain  the  detailed 
accounts  with  individuals  or  things,  only  the  grand  total  of 
whose  balances  appears  on  the  general  ledger. 


'  From  the  accounting  standpoint  these  records  are  discussed  in  later  chapters  of  the 
present  book;  from  the  technical  standpoint  in  Book  I,  "Corporate  Law";  their  forms  will  be 
found  in  Book  IV,  "Corporate  Forms'  ;  see  index  and  list  of  forms  for  specific  references. 


1036  CORPORATE  ACCOUNTING  [Bk.  III- 

A  book  known  as  a  "combination  record"  is  frequently  used 
by  the  smaller  corporations  for  the  distinctive  corporate  records. 
This  book  is  divided  into  parts,  each  of  which  takes  the  place  of 
the  more  important  of  the  distinctive  corporate  records  men- 
tioned above.  If  the  forms  included  in  it  are  good,  the  combina- 
tion record  will  be  found  convenient  for  the  ordinary  small 
corporation.     For  the  larger  corporation  it  is  not  suitable 

§  4.    The  Net  Worth  Accounts 

It  is  in  the  accounts  which  represent  the  proprietorship, 
capital,  or  net  worth  of  the  corporation  that  the  greatest  dif- 
ference from  the  accounts  of  other  forms  of  business  organiza- 
tions is  found.  In  an  individual  proprietorship  or  a  partnership 
the  investment  consists  of  the  cash  or  property  contributed  by 
the  proprietor  or  by  the  partners.  In  a  corporation  it  consists 
of  the  proceeds  of  the  stock  sold.  The  investment  of  a  sole 
proprietor,  or  of  partners,  plus  the  amount  of  profits  left  in  the 
business  is  represented  by  the  capital  accounts;  while  only  the 
investment  of  stockholders  is  represented  by  the  capital  stock 
accounts,  the  undivided  profits  being  carried  in  a  separate 
account. 

Even  then  it  is  not  always  true  that  the  original  investment 
is  represented  by  the  capital  stock  accounts,  for  if  in  a  corpora- 
tion with  par  value  shares  the  stockholders  contribute  more  or 
less  than  par,  the  difference  is  considered  as  a  form  of  paid-in 
surplus  or  as  a  discount  on  stock — a  reduction  of  surplus. 
Whether  the  shares  are  with  or  without  par  value,  the  number 
of  shares  owned  by  each  stockholder,  as  shown  by  his  account 
on  the  corporate  stock  ledger  at  any  particular  time,  represents 
his  proportionate  interest  rather  than  his  property  interest.^ 

In  a  partnership  the  profits  are  usually  credited  to  the  pro- 
prietors' accounts  and  remain  there  until  drawn  out  according 
to  agreement,  but  the  profits  of  a  corporation  are  credited  once 


•  But  see  discussion  of  rights  attached  to  preferred  stock,  Book  I,   Ch.  XI,  "Preferred 
Stock." 


Ch.  i]  CORPORATE  RECORDS  AND  ACCOUNTS  1037 

a  year  or  of tener  to  Surplus  and  never  to  the  accounts  of  the 
individual  stockholders  until  a  dividend  is  declared.  In  fact, 
only  close  corporations  with  but  few  stockholders  have  general 
ledger  accounts  with  their  individual  stockholders. 

The  capital  accounts  of  the  proprietor  or  partners  represent 
the  book  value  of  the  net  assets,  but  the  capital  stock  accounts 
of  the  corpoiration  represent,  in  the  case  of  the  corporation  with 
no-par-value  stock,  the  amount  received  by  the  corporation  for 
its  capital  stock;  and  in  the  case  of  the  corporation  with  par- 
value  shares,  only  an  arbitrary  figure  dependent  on  nothing  but 
the  par  value  of  the  outstanding  stock,  the  difference  between 
this  figure  and  the  value  of  the  net  assets  (whether  due  to  profit 
or  loss,  to  donated  capital  and  withdrawals  of  capital,  or  to 
appreciation)  being  carried  in  the  Surplus  account. 

The  place  of  the  proprietorship  accounts  of  the  individual  or 
partnership  is  taken  in  corporation  accounting  by  two  groups  of 
accounts  known  as  the  "net  worth  accounts"  because  their  total 
represents  the  book  value  of  the  net  assets  (gross  assets  less 
liabilities),  or  the  net  worth  of  the  corporation.  These  two 
groups  are  the  capital  stock  accounts^  and  the  surplus  account 
or  accounts,  5 


<  See  Part  II,  "The  Original  Capital  of  the  Corporation." 
s  See  Ch.  II,  "The  Surplus  Account." 


'    »»i  '^m'-  <[^')   l)ffi 


CHAPTER  II 
THE  SURPLUS  ACCOUNT 

§  5.     Nature  of  Surplus 

The  surplus  account  usually  contains  all  those  profits  that 
are  not  reserved  for  some  special  purpose.  Or,  more  broadly,  it 
is  the  account  in  which  is  entered  all  excess  of  assets  over  lia- 
bilities except  any  of  that  excess  which  Jias  been  set  aside  so 
as  to  be  unavailable  for  dividends.  In  the  balance  sheet  it  is 
represented  by  the  excess  of  assets  over  liabilities  and  capital. 

Surplus  is,  then,  a  general  term  used  to  represent  the  differ- 
ence between  the  net  worth  of  a  corporation  and,  in  the  case  of 
a  corporation  with  par-value  shares,  the  par  value  of  its  out- 
standing stock,  or,  in  the  case  of  a  corporation  with  no-par-value 
stock,  the  amount  received  for  its  stock. 

Such  a  surplus  may  arise  in  several  ways.  It  may  result 
from  profits  on  ordinary  operations  or  unusual  transaction.^,  or 
from  donations  to  the  corporation,  or  it  may  be  brought  about 
by  increasing  the  book  values  of  the  assets  above  their  cost. 
In  the  case  of  corporations  with  shares  of  a  specific  par  value, 
the  surplus  may  be  the  result  of  sales  of  stock  at  more  than  par. 

A  surplus  so  built  up  may  be  reduced  in  any  of  the  opposite 
ways:  by  selling  a  corporation's  own  stock  below  par;  by 
losses,  whether  from  operations  or  casualty  or  unusual  trans- 
actions; by  donations  by  the  corporation;  by  writing  down 
the  book  values  of  assets;  or  by  distributions  of  the  profits 
among  the  stockholders  (dividends). 

§  6.    Analysis  of  the  Surplus  Account 

A  large  surplus  is  the  pride  of  every  well-managed  corpora- 
tion, and  especially  of  banking  institutions  in  which  the  surplus 

1038 


Ch.  2] 


THE  SURPLUS  ACCOUNT 


1039 


is  frequently  larger  than  the  capital  stock  itself.  Where  a  sur- 
plus exists,  it  is  usually  maintained  as  a  measure  of  safety  to 
strengthen  the  financial  condition  of  the  company  and  to  safe- 
guard it  against  unforeseen  contingencies. 


Surplus 


Debit: 

At  the  close  of  each  fiscal  period,  with 
the  net  loss,  if  any,  as  shown  by  the 
Profit  and  Loss  account.^ 

With  any  adjustment  during  the  fiscal 
period  which  diminishes  the  profits  of  a 
previous  fiscal  period.^ 


With  the  amount  of  extraneous  or 
unusual  losses.' 

With  amounts  set  aside  so  as  not  to 
be  available  for  dividends.* 

With  the  discount  on  the  sale  of  the 
corporation's  capital  stock.* 

With  amounts  by  which  the  book 
values  of  assets  are  decreased  other 
than  through  wear  and  tear. 

With  the  amounts  of  dividends 
declared.' 


Credit: 

.  At  the  close  of  each  fiscal  period,  with 
the  net  profit,  if  any,  as  shown  by  the 
Profit  and  Loss  account.  ^ 

With  any  adjustments  made  during  a 
fiscal  period  which  should  have  been 
credited  to  some  profit  and  loss  account 
within  a  prior  fiscal  period;  or  which 
increase  the  profits  of  a  prior  fiscal 
period.^ 

With  the  amount  of  extraneous  or 
unusual  profits.' 

With  amounts  previously  set  aside 
as  not  available  for  dividends,  and  no  .v 
returned  to  the  general  surplus.* 

With  the  premiums  received  on  the 
sale  of  the  corporation's  capital  stock. ^ 

With  amounts  by  which  the  book 
value  of  fixed  assets  is  increased.* 

With  amounts  of  donations  to  the 
corporation.  1" 


Surplus  account  may  be  credited  with  the  year's  net  profit 
before  the  dividend  is  declared,  or  with  the  portion  of  profits 
to  be  retained  in  the  business  after  payment  of  dividends. 
Dividends  are  usually  not  declared  until  the  amount  of  net 
profit  is  known,  unless  the  unapportioned  surplus  is  ample  to 
cover  any  shortage  that  might  result;  to  do  otherwise  might 
result  in  wiping  out  the  surplus  already  created. 


'  See  {  22. 

'  See  I  7. 
»  See  f  8. 

*  See  Ch.  III. 

•  See  i  17. 


•  See  Ch.  VIII. 

'  See  }§  23,  24,  25;  also  Ch.  VIII. 
'See  {J  26  and  27. 
» See  Ch.  XIV. 
i°See  H  28,  99;  also  Ch.  X. 


I040  CORPORATE  ACCOUNTING  (Bk.  IH- 

Surplus  is  an  increment  of  capital.  When  added  to  the 
balance  of  the  capital  stock  accounts,  the  sum  total  should 
represent  the  net  worth  of  the  business.  Surplus  account  may 
even  show  a  debit  balance  as  a  result  of  business  depression, 
heavy  losses,  or  payment  of  excessive  dividends.  In  that  case 
such  deficit  represents  a  loss  and  a  capital  impairment. 

The  Surplus  account  is  frequently  entitled  "Surplus  and 
Deficit"  account,  in  order  that  it  may,  without  misnomer,  not 
only  accommodate  surplus  but  any  deficiency  as  well.  This  is 
the  plan  used  by  public  service  commissions  in  their  schedules 
and  reports.  The  account  is  credited  with  surplus  profits  and 
charged  with  such  net  loss  as  may  result  in  any  year.  A  debit 
excess  of  this  account,  of  course,  represents  a  deficiency  or 
impairment  of  capital,  while  a  credit  excess  is  the  opposite. 

§  7.    Adjustments  of  Profits  of  Previous  Years 

In  closing  the  books  of  a  personally  owned  business,  the 
profits  of  the  period  are  credited  to  the  account  of  a  sole  pro- 
prietor or  divided  between  the  accounts  of  partners.  In  closing 
the  books  of  a  corporation,  the  nominal  accounts  are  first  closed 
into  Profit  and  Loss  account  and  the  resulting  balance  in  the 
Profit  and  Loss  account  is  closed  into  Surplus  account.  By 
thus  closing  the  nominal  accounts  they  will  in  any  period  show 
only  items  which  affect  the  gain  of  that  period. 

But  after  the  books  are  closed  corrections  are  often  found 
necessary  or  omissions  are  discovered.  These  may  aflfect  the 
profit  of  the  previous  period.  In  order  that  the  adjustments 
of  these  may  not  wrongfully  affect  the  profit  of  the  new  period, 
they  must  not  be  allowed  to  appear  in  the  newly  reopened 
nominal  accounts.  The  corrections,  then,  instead  of  being  en- 
tered to  the  nominal  accounts,  are  made  directly  to  the  Surplus 
account  as  adjustments  of  the  amount  of  profit  or  loss  previ- 
ously carried  to  that  account,  thus  preventing  them  from  affect- 
ing profits  of  the  current  year  by  keeping  them  out  of  the  nomi- 
nal account  of  the  current  year. 


Ch.  2]  THE  SURPLUS  ACCOUNT  1041 

For  example,  if  an  invoice  of  $547.50  for  merchandise  pur- 
chased in  December,  1921,  was  erroneously  entered 

Merchandise  Purchases $574 •  5° 

To  Accounts  Payable ,<  .^f iio*,!  $S74- S© 

and  the  error  was  discovered  in  January  after  an  annual  closing, 
the  correction,  instead  of  being  made  by  the  usual  entry 

Accounts  Payable $27 .00 

To  Merchandise  Purchases .i.lfj.  ttU: . $27 . 00 

.    would  be -made  by  the  entry 

Accounts  Payable ......,,.,, $27 .  00 

To  Surplus A^'J.  .[im.^A-. $27.00 

This  would  indicate  an  increase  of  $27  in  the  profit  for  the  pre- 
ceding year,  cost  of  sales  being  reduced  by  that  amount. 

In  the  above  exposition  it  is  assumed  that  the  closing  inven- 
tory was  correct.  If  it  was  not,  the  rule  would  still  apply  that 
the  amount  by  which  the  profit  of  the  preceding  year  is  affected 
should  be  entered  directly  to  Surplus.  If  the  adjustments  found 
necessary  are  few  in  number  and  small  in  amount,  there  is  no 
great  objection  to  letting  them  appear  as  factors  in  the  current 
Profit  and  Loss  account.  But  errors  that  are  of  any  importance 
should  be  adjusted  through  Surplus,  so  that  exact  statements 
of  the  transactions  of  previous  years  may  be  prepared  by  re- 
casting the  previous  statements  and  exact  comparisons  be  made 
between  the  operations  of  various  years. 

It  is  evident  that  omissions  and  errors  in  showing  the  trans- 
actions of  previous  years  afifected  the  final  net  credit  to  Surplus 
in  the  years  in  which  they  occurred.  It  therefore  follows  that 
the  present  surplus  is  larger  or  smaller  as  a  result,  and  that 
Surplus  is  the  account  to  be  corrected. 

§  8.    Extraordinary  Gains  and  Losses 

The  practice   is  common   of  entering  directly   to   Surplus 

"  account  any  extraordinary  gains  and  losses  whose  inclusion  in 

the  current  Profit  and  Loss  account  would  render  the  resulting 

total  of  that  account  useless  for  purposes  of  comparison  between 


1042  CORPORATE  ACCOUNTING  [Bk.  III- 

various  periods.  Uncjer  this  practice  the  Profit  and  Loss  account 
is  limited  to  use  as  a  clearing  account  for  the  normal  items  of 
income  and  expense,  all  abnormal  charges  and  credits  to  pro- 
prietorship being  made  directly  to  Surplus. 

There  may  thus  be  entered  direct  to  Surplus  any  gains  or 
losses  which  are  not  the  result  of  the  regular  normal  operation 
of  the  business.  In  this  category  will  be  found  such  items  as 
losses  by  fire  and  gains  or  losses  from  sales  of  fixed  assets. 

The  function  of  the  Profit  and  Loss  account  is  held  to  be  the 
collection  of  the  items  affecting  the  normal  operations  of  the 
business.  If  a  concern  not  in  the  real  estate  business  credits 
Profit  and  Loss  with  the  gain  resulting  from  the  sale  of  a  factory 
site,  it  destroys  the  basis  of  comparison  between  the  profits  of 
different  years. 

The  objection  is  raised  against  this  practice,  that  the  habit 
of  using  the  Surplus  account  for  such  purposes  as  this  may  re- 
sult in  its  becoming  abused  by  being  turned  into  a  dumping 
ground  Hke  the  proverbial  General  Expense  account.  While 
the  wrqngful  use  of  an  account  does  not  furnish  sufficient  ground 
for  not  sanctioning  a  legitimate  use,  yet,  because  also  of  the 
added  reasons  given  in  the  next  section,  the  Surplus  account 
should  be  used  only  with  the  greatest  discretion  for  entries  of 
this  type.  In  any  event  the  extraneous  and  unusual  items  can 
be  shown  in. a  separate  section  of  the  profit  and  loss  statement 
after  operating  profits  have  been  determined. 

§  9.    Federal  Income  Tax  and  the  Surplus  Account 

The  federal  income  tax  laws  and  forms  have  had  a  marked 
influence  on  accountancy.  One  feature  in  which  their  influence 
has  been  noticed  is  in  bringing  into  considerable  disfavor  the 
practice  of  charging  directly  to  Surplus  any  items  of  gain  or  loss 
applicable  to  the  current  period. 

The  changed  policy  in  this  regard  is  due  not  to  anything  in 
the  laws  themselves  but  to  the  form  of  reconciliation  or  proof 
of  Profit  and  Loss  and  Surplus  required  to  be  filled  out  as  a 


Ch.  2]  THE  SURPLUS  ACCOUNT  1043 

part  of  the  corporation  income  tax  return. n    A  condensation  of 
this  form  is  given  below  with  the  subclassifications  eliminated. 

Net  taxable  income $  43,271.10 

Non-taxable  income : 

Interest  on  Liberty  bonds 44.00 

Other  items none 

^         Total $  43,315.10 

Unallowable  deductions: 

Donations $      160.00 

Income  and  profits  taxes  paid 12,362.64 

Other  items none 

Total 12,522.64 

Net  profit  by  books $  30,792.46 

Surplus  at  beginning  of  year 122,360.62 

Credits  to  Surplus  during  year none 

$153,153-08 

Dividends  paid '. $20,000.00 

Other  debits  to  Surplus none 

Total 20,000.00 

Surplus  at  close  of  year ; $133,153.08 

From  this  it  will  be  seen  that  it  is  the  expectation  of  the 
Bureau  of  Internal  Revenue  that  all  items  affecting  profit  of  the 
year  (income  whether  taxable  or  not,  and  losses  whether  de- 
ductible or  not)  will  be  handled  through  the  Profit  and  Loss 
account,  so  that  the  book  profit  may  be  proved  by  adding  back 
to  the  taxable  income  those  items  of  income  which  are  not 
taxable  (such  as  certain  interest  on  Liberty  bonds)  and  sub- 
tracting those  expenses  (such  as  donations)  which  are  not  de- 
ductible. The  form  of  this  schedule  has  had,  as  stated,  a  ten- 
dency to  reduce  the  number  of  charges  made  directly  to  Surplus, 
because  an  awkward  adjustment  is  necessary  if  extraneous  and 


"See  Ch.  XXXVI,  "Federal  Income  Tax  Returns." 


I044  CORPORATE  ACCOUNTING  [Bk.  III- 

unusual  gains  and  losses  are  handled  directly  through  Surplus 
account. 

When  such  items  are  entered  through  the  regular  Profit  and 
Loss  account,  however,  they  should  invariably  be  shown  as 
unusual  items  in  a  separate  section  of  any  profit  and  loss  state- 
ment which  may  be  prepared,  in  order  that  the  profit  made 
through  normal  operations  may  stand  out  by  itself  for  compara- 
tive purposes.  / 

•  L.nJ 

§  10.    Entry  of  Federal  Income  and  Profit  Taxes 

The  best  accounting  practice  calls  for  the  entry  of  federal  in- 
come and  profit  taxes  as  a  charge  against  the  profits  of  the  year 
against  which  they  apply.  In  no  way  can  they  be  considered  as 
an  expense  of  the  year  in  which  they  are  paid. 

The  failure  to  recognize  this  latter  fact  has  been  the  cause  of 
many  of  the  objections  against  the  "injustice"  of  the  income  tax 
laws.  All  public  accountants  have  had  cases  similar  to  that 
shown  by  the  following  example :  A  corporation's  profit  for  the 
calendar  year  I'giS  was  $200,000;  the  amount  of  tax  assessed  on 
this  profit  was  $130,000.  The  next  year,  1919,  showed  a  book 
loss  of  $30,000,  the  $130,000  of  tax  paid  on  the  income  of  1918 
having  been  charged  as  an  expense  in  191 9.  There  was  therefore 
a  taxable  profit  of  $100,000  in  1919,  since  the  amount  of  the  in- 
come tax  paid  may  not  be  taken  as  a  deduction  in  determining 
the  amount  of  taxable  profit.  The  tax  on  this  amount  was 
$40,000. 

The  president  of  the  corporation  expressed  himself  rather 
vigorously  about  having  to  pay  an  income  tax  on  a  loss,  and  also 
said:  "They  tax  you  on  your  income  and  then  tax  you  on  the 
tax  you  pay."  If  in  his  own  mind  he  had  appHed  the  tax  of  $130,- 
000  paid  in  1 91 9  against  the  profits  of  1918,  reducing  them  to 
$70,000,  and  had  applied  the  tax  payable  in  1920  against  the 
profits  of  1 919,  reducing  them  from  $100,000  to  $60,000,  he 
would  have  seen  that  his  point  of  view  was  unfair,  although  of 
course  this  particular  corporation  was  in  a  high  tax  class. 


Ch.  2]  THE  SURPLUS  ACCOUNT  1045 

It  is  wise,  whenever  possible,  to  determine  the  amount  of  in- 
come tax  liabiUty  at  the  time  of  closing  the  books,  and  to  charge 
this  amount  either  to  Surplus  or  to  Profit  and  Loss  for  the  period, 
entering  of  course  the  offsetting  liability.  This  procedure  would 
not  have  been  so  heartily  recommended  before  the  passage  of  the 
192 1  Revenue  Act,  because  of  the  adjustments  necessary  in 
computing  invested  capital.     This  objection  no  longer  applies. 

In  regard  to  making  a  choice  between  the  Profit  and  Loss 
account  and  Surplus  account,  accountants  are  still  somewhat  dis- 
agreed, with  the  weight  of  authority  in  favor  of  making  the  entry 
to  Surplus.  For  this  stand  it  is  argued  that  the  income  tax  is  not 
a  charge  against  the  profit,  for  one  if  not  both  of  the  following 
reasons:  (i)  it  is  an  extraneous  item  determined  after  the 
profit  is  ascertained;  and  (2)  it  is  a  distribution  of  profits  after 
they  are  made,  somewhat  in  the  nature  of  a  dividend. 

Those  who  prefer  to  charge  the  tax  to  Profit  and  Loss  have 
also  two  arguments,  viz. :  (i)  that  it  is  no  more  an  extraneous 
item  than  is  a  bonus  which  is  based  on  the  amount  of  net  profits 
and  which  consequently  cannot  be  determined  until  the  amount 
of  the  profit  has  been  ascertained;  and  (2)  that  Schedule  "L"  of 
the  income  tax  return  is  more  easily  prepared  if  the  disbursement 
is  charged  against  profit  on  the  books,  and  re-added  as  an  unal- 
lowable deduction  on  the  schedule. 

The  credit  should  be  to  Accrued  Taxes,  and  the  entry  to  set 
up  the  amount  of  tax  payable  on  the  income  of  the  year  whose 
accounts  are  being  closed,  will  be : 

Profit  and  Loss,  or  Surplus $1,000 

To  Accrued  Taxes $1,000 

Amount  of  federal  income  tax  payable  on  profit  shown  by 
above  closing. 

§  II.    Surplus  Does  Not  Represent  Specific  Assets 

While  surplus  is  always  represented  by  an  equivalent  of  assets, 
these  assets  as  a  rule  are  not  earmarked  or  designated  in  any 
way.  It  is  simply  the  excess  of  assets  over  liabilities  and  capital 
stock,  and  does  not  represent  any  specific  assets. 


1046  CORPORATE  ACCOUNTING  [Bk.  III- 

It  is  a  common  practice  for  corporations  to  invest  part  of  their 
surplus  cash  in  gilt-edged  securities,  such  as  bonds  and  stocks  of 
other  companies.  This  insures  the  company  against  danger  of 
being  without  liquid  funds  in  case  of  a  crisis;  but,  on  the  other 
hand,  when  the  low  rate  of  return  from  these  securities  is  consid- 
ered, it  is  manifest  that  the  money  "thus  invested  could  be  used 
more  profitably  in  the  business.  Most  corporations,  neverthe- 
less, follow  the  practice  of  investing  in  such  securities,  knowing 
that  they  can  be  used  at  any  time  as  collateral  for  securing  bank 
loans  or  be  readily  sold  on  the  stock  exchange. 

Such  outside  investments  may,  but  generally  do  not,  repre- 
sent all  of  surplus  profits,  but  in  any  case  it  should  be  remembered 
that  it  is  the  surplus  cash  (cash  not  needed  for  immediate  pur- 
^poses)  and  not  the  surplus  shown  by  the  Surplus  account  which 
is  being  invested. 


CHAPTER  III 
RESERVE  ACCOUNTS 

§  12.     Withholding  Surplus  from  Dividends 

Surplus  fundamentally  represents  the  amount  which  is  under 
the  direct  control  of  the  board  of  directors  for  purposes  of  declar- 
ing dividends.  To  this  rule  there  are,  of  course,  certain  exceptions 
created  by  law  or  established  by  contract,  such  as  those  whereby 
reserves  for  the  redemption  of  bond  issues  are  required  to  be  set 
aside  out  of  earnings.  With  these  exceptions,  boards  of  directors 
have  practically  free  control  over  the  surplus.  They  may  set 
aside  certain  portions  of  it  for  specific  purposes,  as  for  new  equip- 
ment, for  contingencies,  or  for  other  purposes,  thus  impounding 
or  appropriating  those  portions  of  the  surplus  and  rendering 
them  not  available  for  dividend  purposes. 

But  the  fact  that  a  board  of  directors  has  set  aside  a  certain 
amount  of  the  profits  for  a  specific  purpose  does  not  guarantee 
that  the  amount  set  aside  will  be  so  used,  for  the  board  may  at  a 
later  date  vote  to  turn  back  this  reserve  into  the  general  surplus. 
The  impounding  of  surplus  is,  therefore,  often  mpre  apparent 
than  real,  because,  unless  other  persons  are  definitely  a  party 
thereto,  the  board  may  reverse  its  action. 

Many  business  men  are  under  the  impression  that  the  very 
term  "surplus"  involves  a  certain  limitation  of  distribution. 
There  are  those  who  separate  surplus  into  two  items  on  the  bal- 
ance sheet,  one  called  "undivided  profits"  or  a  similar  name  and 
the  other  called  "surplus."  This  is  intended  to  convey  the  idea 
that  the  item  designated  as  surplus  is  intended  to  be  retained  in 
tjie  business,  and  that  the  giving  of  the  name  surplus  is  public 
notice  of  such  intention.    But  the  term  surplus  is  used  in  such  a 

1047 


1 048  CORPORATE  ACCOUNTING  [Bk.  III^ 

variety  of  ways  that  it  may  not  give  to  the  observer  any  such 
idea.i 

If  the  balance  sheet  of  a  corporation  shows  a  large  surplus,  on 
the  strength  of  which  the  corporation  borrows  money,  there  is 
nothing  to  keep  it  from  immediately  thereafter  greatly  reducing 
this  surplus  through  dividends.  It  makes  no  difference  whether 
the  surplus  is  shown  as  appropriated  for  specific  purposes  or  not. 
While  it  might  be  held  that  the  directors  declaring  dividends  im- 
mediately thereafter  have  deceived  the  lenders  of  the  money, 
they  are  technically  within  thdr  rights.  On  this  account  it  might 
seem  desirable  to  adopt  a  more  definite  terminology  for  the  funds 
intended  to  be  withheld  from  dividends — a.  designation  so  specific 
that  its  mere  use  would  be  a  pledge  on  the  part  of  the  directors 
that  the  funds  so  earmarked  were  to  be  retained  for  the  use  of 
the  business. 

Such  a  definite  appropriation  of  surplus  might,  on  the  other 
hand,  sometimes  prove  harmful.  Occasion  might  arise  when  the 
corporation's  credit  would  be  impaired,  and  consequently  the 
creditors'  rights  endangered,  unless  dividends  should  continue  to 
be  paid  with  regularity.  But  it  might  be  that  dividends  could 
not  be  paid  without  encroaching  upon  surplus  which,  although 
legally  available  for  distribution,  had  been  appropriated  for  other 
purposes  at  some  preceding  date. 

§  13.    Entries  for  Appropriation  of  Surplus 

When  it  is  thought  to  be  desirable  to  reserve  a  certain  amount 
of  surplus  at  least  temporarily  from  distribution  in  dividends,  an 
entry  should  be  made  debiting  Surplus  and  crediting  the  proper 
reserve  account.  Such  accounts  may  be  called  Reserve  for  Sink- 
ing Fund,  or  Reserve  for  Contingencies,  or  Reserve  for  Improve- 
ments, or  Preferred  Stock  Redemption  Reserve,  depending  on 
their  purpose.  The  entry  would  be  made  in  the  following 
manner: 

>  See  f  31. 


Ch.  3]  RESERVE  ACCOUNTS  1049 

Surplus $50,000 

To  Reserve  for  Improvements '.  $50,000 

To  remove  from  the  general  Surplus  the  above  sum,  setting 
it  aside  as  a  reserve  out  of  which  it  is  planned  to  make 
certain   improvements,    as   directed   by   the    Board   of 
.    Directors,  January  3,  1922. 

Some  accountants,  in  closing  a  set  of  books,  prefer  to  estab- 
lish or  increase  the  reserve  directly  out  of  the  year's  profits  in- 
stead of  first  closing  those  profits  into  Surplus.  The  one  practice 
would  require  two  entries  as  follows: 

Profit  and  Loss $40,000 

To  Sutplus $40,000 

To  close  Profit  and  Loss  account  of  year  to  Surplus. 

Surplus $10,000 

To  Reserve  for  Bond  Redemption $10,000 

To  set  aside  from  surplus  a  reserve  for  redemption  of  bonds, 
as  ordered  by  the  Board  of  Directors. 

The  second  method  needs  only  the  single  entry: 

Profit  and  Loss $40,000 

To  Reserve  for  Bond  Redemption $10,000 

Surplus 30,000 

To  set  a.side  out  of  the  net  profits  of  the  year  the  amount 
ordered  by  the  lioard  of  Directors  to  be  withheld  toward 
redeeming  the  bond  issue,  and  to  close  the  remainder  of 
the  profits  into  Surplus  as  available  for  dividends. 

In  making  the  entry  in  this  form  it  must  not  be  thought  that 
the  charge  to  Profit  and  Loss  for  the  amount  placed  in  the  Re- 
serve for  Bond  Redemption  is  of  the  same  nature  as  ordinary 
charges  which  reduce  the  amount  of  net  profit  for  the  period. 
This  charge  is  not  a  reduction  of  the  profits  of  the  year;  it  is 
made  to  Profit  and  Loss  merely  as  an  appropriation  of  this  par- 
ticular year's  profits,  just  as  the  charge  when  made  to  Surplus  is 
an  allocation  of  the  undivided  profits  in  general. 

§  14.    Reserves  Which  Are  Chargeable  Against  Profits 

On  the  other  hand,  it  must  not  be  thought  that  all  reserves 
are  established  out  of  profits  already  ascertained.    There  is  a 


lOSo  CORPORATE  ACCOUNTING  [Bk.  IH- 

class  of  reserves  which  are  direct  charges  against  the  profits  of 
the  period,  and  while  the  discussion  of  them  is  a  matter  of  gen- 
eral accounting  interest  rather  than  one  of  corporate  procedure 
solely,  yet  the  distinction  must  be  presented  for  the  sake  of 
clarity. 

Any  reserve  which,  like  those  discussed  in  the  previous  sec- 
tions, is  an  appropriation  or  impounding  of  surplus,  is  a  non- 
operating  reserve.  Such  reserves  are  not  necessitated  by  ex- 
penses and  do  not  indicate  a  deduction  from  profits.  They  are 
set  up  solely  to  show  the  amount  of  realized  profits  which  have 
been  set  aside  for  some  purpose  such  as  the  construction  of  a  new 
building  or  improvements,  the  paying  off  of  a  bond  issue,  etc. 
If  definite  assets  are  set  aside  for  these  purposes,  such  assets 
become  part  of  a  fund.  The  fund  itself  is  an  asset;  the  reserve 
is  a  setting  aside  of  surplus,  and  appears  on  the  liability  side 
of  the  balance  sheet.2 

Operating  reserves,  however,  are  made  up  of  amounts  set  up 
to  show  some  expense — not  expenditure — which  must  be  entered 
before  the  net  profits  can  be  determined.  The  prudent  business 
man,  being  careful  not  to  overstate  his  profits,  makes,  through 
operating  reserves,  allowances  to  meet  expected  losses  or  those 
incurred  but  indefinite  in  amount.  Examples  of  this  type  of  re- 
serves are  reserves  for  bad  debts,  for  depreciation,  for  discounts 
to  be  taken  by  customers,  for  taxes,  etc.  For  instance,  it  is  a 
well-known  fact  that  customers'  accounts  are  in  part  frequently 
uncollectible,  and  experience  has  shown  the  advisability  of  mak-. 
ing  due  allowance  for  such  losses. 

§  15.    Operating  Reserves  Represent  Expenses 

The  debits  offsetting  the  credits  to  operating  reserves  are  "to 
expense  accounts,  and  the  entries  cover  expenses  of  two  classes : 

The  first  class  consists  of  expenses  which  have  occurred 
through  the  reduction  of  the  value  of  assets.  In  this  case  the  re- 
serve accoimt  is  used  when  it  is  desired  not  to  reduce  the  book 

'  S«e  also  {  215. 


Ch.  3]  RESERVE  ACCOUNTS  1051 

valuation  of  the  assets  by  writing  off  the  proper  amount,  as  for 
example  the  writing  down  of  the  cost  of  machinery  by  a  credit  to 
Reserve  for  Depreciation  instead  of  to  the  Machinery  account 
itself,  or  the  writing  down  of  the  total  accounts  receivable  by  a 
credit  to  Reserve  for  Doubtful  Accounts  instead  of  to  Accounts 
Receivable,  as  would  be  done  if  specific  accounts  were  definitely 
written  off.  Such  reserves  as  these  are  preferably  called  "allow- 
ances," in  order  to  lessen  the  confusion  which  has  arisen  from 
the  different  uses  to  which  the  so-called  "reserve"  accounts  are " 
put.  Some  authorities  plaCe  much  stress  on  this  distinction, 
speaking  very  strongly  in  favor  of  the  titles  "Allowance  for  De- 
preciation," "Allowance  for  Doubtful  Accounts,"  etc. 

The  second  class  consists  of  expenses  which  have  occurred 
through  the  establishment  of  a  liability,  as  a  reserve  for  taxes  or 
for  royalties.  In  the  case  of  most  operating  reserves  set  up  to 
indicate  a  liability,  the  account  is  better  distinguished  by  the 
term  "accrued,"  as  Accrued  Taxes  or  Accrued  Royalties. 

The  use  of  the  term  "reserve"  in  connection  with  the  oper- 
ating reserves  can  by  these  suggested  substitutes  be  entirely 
avoided.  .  This  one  vital  distinction  should  be  made :  that  in  the 
case  of  operating  reserves  the  debit  is  to  an  expense  account,  as 
Bad  Debts,  Depreciation,  Taxes,  or  Royalties,  and  the  entry  re- 
duces the  profits;  while  in  the  case  of  non-operating  reserves, 
although  the  debit  may  be  to  Profit  and  Loss  instead  of  to  Sur- 
plus, the  entry  does  not  reduce  the  profits,  but  disposes  of  a  part 
of  the  profits  after  their  amount  has  been  determined. 

§  16.    Surplus  Impounding  Not  Necessarily  Permanent 

Emphasis  should  be  placed  on  the  fact  that  the  establishment 
of  a  reserve  does  not  set  aside  any  specific  funds  which  cannot, 
even  temporarily,  be  used  for  any  purpose  which  may  come  up. 
The  creation  of  the  reserve  merely  appropriates  for  purposes  set 
forth  a  certain  amount  of  what  might  otherwise  be  declared  as 
a  dividend,  and  prevents  for  the  time  being  the  distribution  of 
that  much  of  the  surplus.    The  setting  aside  and  possible  invest- 


I052 


CORPORATE  ACCOUNTING 


[Bk.  III- 


ment  of  specific  funds  for  the  same  purpose  is  an  altogether  dif- 
ferent matter,  the  consideration  of  which,  because  such  invest- 
ment occurs  most  frequently  in  connection  with  the  redemption 
of  bond  issues  and  is  necessarily  treated  in  discussing  them,  is 
deferred  to  a  later  chapter.* 

It  should  always  be  remembered  that  the  appropriation  of 
Surplus  does  not  in  any  way  change  its  character.  It  is  still  sur- 
plus— still  a  part  of  the  excess  of  net  assets  over  the  capital  stock 
■ — and  is  an  item  in  the  net  worth. 


§  17.    Analysis  of  Non-Operating  Reserve  Accounts 

The  entries  made  to  a  reserve  account  which  is  an  impound- 
ing of  surplus  will  be  of  the  following  nature : 


Debit: 

With  any  deductions  necessitated  by 
loss  or  return  of  moneys  credited. 

With  transfers  or  appropriations 
from  this  reserve  for  the  benefit  of  some 
other  reserve,  or  back  to  the  general 
surplus. 

With  any  amounts  of  money  or  other 
assets  applied  to  the  purpose  for  which 
the  reserve  was  created,  the  corre- 
sponding credit  being  to  surplus. 


Credit: 

With  the  amount  appropriated  out  of 
profits  at  designated  periods  for  the 
specific  purpose  for  which  the  profits 
are  reserved  from  distribution,  the 
corresponding  debit  being  made  to 
Surplus  or  to  Profit  and  Loss. 

With  all  income  derived  from  the 
deposit  or  investment  of  money  set 
aside  in  specific  funds. 

With  any  profit  on  sales  of  securities 
belonging  to  a  fund  for  which  the 
reserve  was  established. 


Reserve  accounts  show  credit  balances.  As  the  expenditures 
are  made  for  which  the  reserve  was  created,  the  amounts  of  these 
expenditures  should  be  debited  to  the  reserve  account  and 
credited  to  Surplus.* 

§  18.    Secret  or  Hidden  Reserves 

The  terms  "hidden  reserves,"  "hidden  assets,"  and  "secret 
reserves"  are  practically  synonymous.  These  terms  are  famil- 
iar to  accountants  as  representing  the  excess  of  actual  net  worth 

'  See  Ch.  XXII,  "Principles  of  Fund  Accounting" 
«  See  also  Ch.  XXIII.  "Entry  of  Fund  Transactions." 


Ch.  3I  .  RESERVE  ACCOUNTS  1053 

of  a  concern  over  and  above  the  amount  indicated  on  its  balance 
sheet.  Such  reserves  are  not  pecuHar  to  corporations  except  as 
big  business  usually  expresses  itself  through  the  corporate  form. 
They  are  true  reserves,  because  they  represent  net  worth  which, 
not  appearing  in  the  Surplus  account,  is  not  available  for  divi- 
dends, being  impounded  by  methods  not  used  for  open  im- 
pounding. 

Such  secret  reserves  may  be  created  either  intentionally  or 
unintentionally.  For  some  reason,  the  directors  may  not  wish 
to  disclose  in  a  financial  statement  the  true  status  of  the  coiri- 
pany's  condition,  and  they  act  accordingly  in  understating  the 
true  facts.  This  may  be  due  to  a  spirit  of  conservatism  which  is 
permissible  in  case  no  one  is  injured  thereby.  Sometimes,  how- 
ever, the  actual  net  profits  for  a  given  year  are  understated  for 
the  purpose  of  lessening  the  state  and  federal  corporation  tax, 
and  perhaps  to  keep  both  stockholders  and  competitors  in  ignor- 
ance of  the  company's  actual  earnings. 

Following  are  various  acts  or  omissions  which  result  in  the 
creation  of  secret  reserves :  • 

1.  Intentionally   or   inadvertently   omitting   assets   which 

should  be  included. 

2.  Undervaluing  assets,  intentionally  or  otherwise. 

3.  Writing  off  too  much  depreciation. 

4.  Charging  additions   and  improvements   to   Repairs  or 

Maintenance  account  instead  of  to  Plant  account.  • 

5.  Creating  reserves  for  bad  debts  in  excess  of  the  amount 

required. ' 

6.  Charging  production  costs,  intentionally  or  otherwise,  to 

expense  instead  of  to  the  manufactured  article,  thus 
undervaluing  the  cost. 

7.  Including  fictitious  liabilities  in  the  accounts,  or  over- 

stating actual  liabilities. 

8.  Making  additions  or  improvements  and  charging  the  cost 

to  Surplus  account,  thereby  hiding  their  value.  • 


I054  CORPORATE  ACCOUNTING  .  [Bk.  III- 

9.  Neglecting  to  take  into  consideration  in  the  accounts 

natural  increases  in  value  of  real  or  other  property. 
10.  Understating  values  in  good  years  and  increasing  them  in 
lean  years  as  a  means  of  keeping  the  dividends  uniform 
from  year  to  year. 
The  secret  reserve  is  sometimes  considered  a  commendable 
creation  in  case  it  is  not  carried  to  excess  and  provided  it  is  not 
detrimental  to  interested  persons.    The  spirit  of  conservatism,  to 
a  reasonable  extent,  is  to  be  commended  by  the  accountant  rather 
than  criticized.    If,  however,  stockholders  are  kept  in  ignorance 
of  secret  reserves  of  considerable  amount,  an  injustice  is  done  to 
anyone  who  may  thus  be  induced  to  sell  his  stock  for  less  than 
it  is  really  worth. 

§  19.    Depletion  and  Exhaustion  Reserves 

In  the  ordinary  commercial  undertaking  the  profits  are  made 
on  the  turnover,  and  at  the  end  of  a  term  of  years  the  investment 
• — save  in  case  of  disaster — is  intact,  and  presumably  the  business 
is  far  more  valuable  than  when  it  was  started.  In  mining  and 
similar  undertakings,  however,  the  profit  is  made  from  the  re- 
moval of  the  mineral,  and  under  ordinary  conditions  the  value  of 
the  property  becomes  steadily  less  with  each  ton  of  ore  removed, 
until  on  its  final  exhaustion  there  is  left  a  tract  of  rough  and 
worthless  land  and  machinery  of  but  little  further  value.  In 
other  words,  the  original  investment  has  disappeared — has  been 
consumed,  or  realized  upon,  in  the  course  of  operation. 

This  gradual  working  out  or  liquidation  of.  the  original  invest- 
ment is  characteristic  of  mining,  quarrying,  timbering,  and  other 
operations,  and,  if  the  conditions  are  clearly  recognized,  is  not  in 
any  way  objectionable.  Frequently,  however,  the  owners  prefer 
to  establish  a  depletion  reserve  that  will  preserve  the  integrity  of 
the  original  investment,  so  that  profits  only  will  be  paid  the  own- 
ers from  current  operation. 

The  establishment  of  such  a  depletion,  exhaustion,  or  replace- 
ment reserve  is  a  comparatively  simple  matter.    The.amount  of 


Ch.  3]  RESERVE  ACCOUNTS  1055 

mineral  in  the  mine,  or  of  timber  on  the  tract,  is  estimated;  and 
a  certain  amount  calculated  to  replace  the  original  investment 
upon  or  before  the  exhaustion  of  the  property,  is  reserved  and  set 
aside  for  each  ton  of  ore  mined,  or  for  each  thousand  feet  of  lum- 
ber cut.  The  part  of  the  original  investment  which  is  thus  con- 
sumed as  each  ton  of  ore  is  removed  and  sold  or  as  each  thousand 
feet  of  lumber  is  cut  and  disposed  of,  is  then  charged  to  expense 
and  credited  to  the  Reserve  or  Allowance  for  Depletion.  This  is 
distinctly  an  operating  reserve,  being  the  amount  of  an  expense 
incurred  in  making  the  profit,  and  is  not  an  impounding  of  profits. 
Indeed,  unless  the  cost  of  that  part  of  the  original  investment 
consumed  is  charged  against  profits,  these  will  be  overstated. 

§  20.    Summary 

Under  the  most  common  modern  corporate  practice,  assets 
are  seldom  specially  set  aside  to  represent  true  reserves  or  appro- 
priations of  surplus  (non-operating  reserves),  except  in  compul- 
sory cases, 5  the  regular  cash  assets  being  relied  on  to  meet  any 
demands  made  for  the  purposes  for  which  the  reserves  are  estab- 
lished. But  cash  may  be  withdrawn  from  the  business  to  provide 
an  actual  fund  for  any  of  these  purposes,  instead  of  simply  re- 
serving profits  from  distribution.  This  cash,  which  is  placed  in  a 
fund  which  is  usually  invested  in  securities  easily  realized  upon, 
may  be  placed  in  the  hands  of  a  trustee,  or  of  a  committee  of 
directors,  or  of  the  entire  board. ^ 


'See  i  216. 

•  See  Ch.  XXII,  "Principles  of  Fund  Accounting." 


CHAPTER  IV 

CLASSIFICATION  OF  SURPLUS 

§  21.    Need  of  a  Better  Terminology 

The  fact  has  long  been  recognized  that  the  term  "surplus"  has 
too  broad  a  meaning,  in  that  as  used  it  is  simply  a  balancing  figure 
between  the  net  assets  and  the  capital  stock  accounts.  In  fact  it 
has  many  varying  meanings  and  there  is  no  uniformly  accepted 
interpretation  which  can  invariably  be  placed  upon  it.i  It  em- 
braces too  wide  a  scope,  from  earnings  to  items  of  arbitrary  ap- 
preciation, including  the  margin  legally  available  for  dividends 
along  with  entries  which  could  by  no  stretch  of  the  imagination 
be  considered  as  proper  for  that  purpose.  Such  a  surplus  may  be 
diminished  by  writing  down  assets  below  their  real  value.  When 
this  is  done  the  process  is  called  "creating  a  secret  reserve." 
When  the  credit  side  of  the  Surplus  account  is  increased  by  fig- 
ures which  do  not  represent  realized  profits,  the  act  is  called 
"creating  fictitious  assets,"  or  "watering  the  assets.'^ 

When  an  asset  account  is  arbitrarily  increased  by  a  book 
entry,  the  credit  usually  finds  its  way  to  Surplus.  When  a  busi- 
ness wishes  to  falsify  the  amount  of  its  surplus,  it  usually  does  so 
by  inflating  some  fixed  asset  account.  Consequently,  a  report  of 
an  auditor  is  of  no  value  unless  he  analyzes  all  debits  and  credits 
to  the  Surplus  account  from  the  beginning  of  business,  and  is 
willing  to  certify,  without  qualification,  to  the  correctness  of  the 
balance  of  the  Surplus  account  at  the  time  his  audit  is  made. 

In  certain  businesses  and  industries  the  term  surplus  has  de- 
veloped special  meanings.  In  banks  the  surplus  is  almost  as  in- 
violable as  the  capital  stock  itself  and  is  never  used  for  dividends. 
The  surplus  of  most  banks  is  initially  the  premium  on  stock 

'Of.  {{  6,  12. 

1056 


Ch.4l 


CLASSIFICATION  OF  SURPLUS 


1057 


sold,  in  addition  to  which  each  year  they  carry  a  given  amount 
of  the  net  profit  to  Surplus  account  to  serve  as  permanent  work- 
ing capital,  while  the  remainder  after  payment  of  dividends  is 
carried  in  the  Undivided  Profits  account. 

Such  special  uses  of  the  term  surplus  have  become  in  many 
cases  so  well  established  that  no  change  in  the  interest  of  general 
uniformity  may  be  expected.  As  a  result  surplus  means  one 
thing  to  one  man,  while  to  another  it  may  mean  an  entirely  dif- 
ferent thing.  But  the  confusion  exists  and  as  it  cannot  readily 
be  dissipated  it  must  be  faced  and  surmounted.  The  best  way  of 
doing  this  is  by  dividing  the  functions  of  the  Surplus  account^ 
among  several  accounts,  each  of  which  will  have  a  title  sufjfi- 
ciently  distinctive  to  show  the  source  of  its  balance. 

§  22.    Earned  Surplus 

The  most  common  form  of  surplus  is  earned  surplus,  and  the 
word  "surplus"  probably  carries  with  it  the  connotation  of 
"earned  surplus"  more  often  than  any  other.  The  uses  of  an 
Earned  Surplus  account,  when  the  Surplus  account  is  divided  on 
the  books  into  its  component  parts,  are  as  follows: 

Earned  Surplus   • 


Credit: 

With  any  adjustment  during  a  fiscal 
period  which  increases  the  profits  of  a 
previous  fiscal  period. 

At  the  close  of  each  fiscal  period, 
with  the  net  profit,  if  any,  as  shown  by 
the  Profit  and  Loss  account. 


Debit: 

With  any  adjustment  during  a  fiscal 
period  which  diminishes  the  profits  of  a 
previous  fiscal  period. 

At  the  close  of  each  fiscal  period, 
with  the  net  loss,  if  any,  as  shown  by  the 
Profit  and  Loss  account. 

With  any  dividends  declared  or  paid, 
or  any  amount  appropriated,  out  of 
earned  surplus. 

Several  different  methods  of  handling  profits  on  the  books  are 
in  use.  Some  of  these  introduce  an  account  known  as  "Undivided 
Profits,"  a  name  which  itself  has  three  uses.    In  one  usage  Un- 


'  See  Ch.  II,  "The  Surplus  Account.". . 


I058 


CORPORATE  ACCOUNTING 


[Bk.  Ill- 


divided  Profits  account  has  the  same  meaning  as  that  assigned 
above  to  Earned  Surplus.  In  another  usage  it  is  the  account  in 
which  earnings  are  first  entered  and  from  which  certain  amounts 
are  occasionally  -transferred  into  a  permanent  surplus  account. 
This  method  merely  subdivides  the  earned  surplus  into  two  ac- 
counts more  or  less  arbitrarily.  The  third  use  of  the  account  as 
distinguished  from  Earned  Surplus,  is  as  a  place  in  which  to 
carry  the  unappropriated  profits  of  the  last  closing,  the  undivided 
profits  of  other  periods  being  transferred  to  the  Surplus  account. 

§  23.    Capital  Surplus 

The  term  ''capital  surplus"  has  a  rather  wide  range  of  mean- 
ings, including  all  accretions  to  capital  other  than  ordinary  earn- 
ings. Within  this  scope  will  be  the  functions  assigned  below  to 
Paid-in  Surplus,  Surplus  from  Appreciation,  and  Donated  Sur- 
plus. The  term  is  used  sometimes  to  include  also  unusual  and 
extraneous  profits  and  losses,  especially  those  resulting  from 
the  sale  of  capital  assets. 

§  24.    Paid-in  or  Contributed  Surplus 


Debit: 

With  the  discount  on  the  sale  of  the 
corporation's  capital  stock. 

With  any  dividends  declared  or  paid, 
or  any  amounts  impounded  out  of 
Paid-in  or  Contributed  Surplus. 


Credit: 

With  the  premium  received  on  the 
sale  of  the  corporation's  capital  stock. 

With  payments  made  on  stock 
subscriptions,  if  forfeited  on  account  of 
failure  to  complete  contract. 

With  the  amounts  of  assessments  on 
stock. 

With  the  difference  between  the  par 
value  of  reductions  of  capital  stock 
outstanding  and  the  price  paid  to  the 
holders,  if  less  than  par. 

With  the  amount  by  which  the 
value  of  tangible  assets  received  for 
stock  unquestionably  exceeds  the  par 
value  of  the  stock  issued  therefor. 

With  the  profit  on  sales  of  treasury 
stock  which  has  been  repurchased  for 
value. 


Ch.  4]  CLASSIFICATION  OF  SURPLUS  1059 

§  25.    Sources  of  Paid-in  Surplus 

Sometimes  stock  is  subscribed  for  at  a  figure  above  its  par 
value,  and  a  surplus  is  thus  created  by  contribution  at  the  time 
the  company  is  organized.  This  is  done  in  order  that  the  com- 
pany may  have  a  safety  fund  for  emergencies,  or  additional  work- 
ing capital  while  the  business  is  being  launched.  In  that  case 
Paid-in  Surplus  or  Contributed  Surplus  account  is  usually 
credited  with  the  amount  of  the  premium  on  the  capital  stock. 
This  plan  is  commonly  employed  in  the  organization  of  national 
banks  in  which  the  stockholders  are  liable  for  debts  of  the  com- 
pany to  an  amount  equal  to  the  stock  they  hold.  The  practice 
is  to  sell  the  stock  at,  say,  $125,  $150,  or  even  $200  per  share,  in 
which  case  the  double  liability  of  the  stockholders  is  completely 
provided  for  and  the  institution  itself  secures  a  material  addition 
to  its  working  capital. 

While  dividends  may  be  declared  out  of  paid-in  surplus  as 
out  of  earned  surplus,  yet  payments  by  banks  out  of  premiums 
received  on  capital  stock,  if  they  have  the  efifect  of  reducing  that 
premium  below  the  amount  for  which  stockholders  are  liable  to 
creditors,  would  counteract  the  freedom  from  liability  secured 
by  the  original  premium. 

Paid-in  surplus  results  also  from  the  reduction  of  the  par 
value  of  capital  stock  outstanding  without  full  recompense  to 
the  stockholders.  This  circumstance  frequently  occurs  in  reor- 
ganizations, when  fewer  shares  of  the  new  stock  are  given  than 
were  held  of  the  old.  *  The  original  stock  was  paid  for  with  cash 
or  other  assets;  wherefore,  if  less  stock  is  now  issued,  the  excess 
becomes  a  premium  on  the  purchase  of  the  new. 

Assessments  on  stock,  when  lawful  or  when  accepted,  also 
create  a  paid-in  surplus.  Such  assessments  are  usually  made  pro 
rata  on  the  outstanding  shares  in  cases  of  reorganization  or  im- 
pending bankruptcy.  They  are  generally  used  either  for  wiping 
out  a  deficit  from  operating  losses,  or  else,  as  in  the  case  of  fra- 
ternal insurance  organizations,  for  providing  for  expenses  and 
losses  as  they  arise. 


Io6o  CORPORATE  ACCOUNTING  [Bk.  III- 

If  stock  is  sold  in  exchange  for  tangible  assets  which  have  a 
value  unquestionably  greater  than  the  par  value  of  the  stock 
issued  for  them,  there  is  created  a  paid-in  surplus.  The  valua- 
tion of  intangibles  is,  however,  so  much  a  matter  of  opinion  that 
it  would  be  difficult  to  say  that  any  such  assets  purchased  for 
stock  had  a  value  unquestionably  greater  than  the  par  value  of 
the  stock  issued  therefor.  For  this  reason  it  is  improbable  that 
the  accountant  is  ever  justified  in  allowing  a  paid-in  surplus  to  be 
created  on  account  of  intangibles. 

A  paid-in  surplus  also  results  from  the  making  of  initial  pay- 
ments on  subscriptions  for  capital  stock  and  their  subsequent 
forfeiture. 

If  a  corporation  sells  at  a  profit  its  own  stock  which  it  has  re- 
purchased from  holders  for  value,  a  paid-in  surplus  is  thereby 
created. 

§  26.     Surplus  from  Appreciation 

When  it  is  felt  necessary  to  increase  the  book  figures  for  capi- 
tal assets  whose  market  value  has  increased  since  they  were  ac- 
quired, the  credit  should  never  be  merged  with  real  gains  legally 
available  for  dividends,  but  should  be  entered  to  an  account 
called  "Surplus  from  Appreciation"  or  "Appreciated  Surplus." 
This  is  true  even  if  all  other  forms  of  surplus  are  handled  through 
one  general  Surplus  account.  The  practice  of  entering  apprecia- 
tion on  the  books  is  widely  condemned  because  of  improper  in- 
flations which  may  be  hidden  behind  it.  if,  however,  a  surplus 
so  created  is  displayed  on  the  balance  sheet  in  such  a  way  as  to 
be  definitely  separated  from  surplus  arising  from  other  sources, 
no  one  need  be  deceived  by  it. 

A  surplus  created  by  appreciating  the  book  values  of  capital 
assets  should  be  reduced  through  the  remainder  of  the  life  of  the 
asset.    This  very  important  point  should  not  be  overlooked. 

The  depreciation  on  assets  carried  on  the  books  at  an  appre- 
ciated value  should  be  divided  into  two  parts,  as  not  all  of  it  is 
a  charge  against  income.    The  portion  of  the  depreciation  which 


Ch.  4]  CLASSIFICATION  OF  SURPLUS  I061 

applies  against  the  cost  of  the  asset  is  properly  a  debit  to  income, 
but  the  part  which  applies  against  the  appreciation  must  be 
charged  against  Surplus  from  Appreciation,  and  not  as  an  oper- 
ating expense. 

For  example,  a  factory  is  erected  on  a  certain  piece  of  prop- 
erty at  a  cost  of  $100,000.  If  the  life  of  the  building  is  estimated 
at  50  years,  an  annual  amount  of  $2,000  will  have  to  be  charged 
against  income  for  the  depreciation  of  the  building  (using 
straight-line  methods).  If  at  the  end  of  10  years  the  building  is 
appraised  at  $200,000  and  it  is  thought  necessary  to  put  the  ap- 
praisal figure  on  the  books,  the  entry  required  will  be : 

Buildings $1 20,000 

To  Surplus  from  Appreciation $120,000 

To  record  increase  in  value  of  building  from 

its  present  book  value  of $100,000 

Less:  Reserve  for  Depreciation  of 20,000 

Net  book  value $  80,000 

To  the  appraised  value  of 200,000 

An  appreciation  by  appraisal  of $120,000 

The  remaining  life  of  the  building  is  40  years,  over  which  the 
present  book  value  of  $200,000  must  be  charged  ofif,  making  an 
annual  reduction  by  straight-line  methods  of  $5,000.  But  since 
an  annual  charge  of  $2,000  will  be  sufficient  to  extinguish  the 
cost  of  the  asset  at  the  expiration  of  its  period  of  usefulness,  the 
remaining  $3,000  must  be  charged  against  the  amount  of  appre- 
ciation.   The  annual  entry  will  be:  ' 

Depreciation ,. , . ..'. ......  $2,000        ■    "  " 

Surplus  from  Appreciation K*.\0)P.i  A^.'.  3,000        V!''^- 

To  Reserve  for  Depreciation ao*  MtkitUH-  •■  $5,000 

(With  the  proper  explanation.)  .      , 

A  proof  of  the  accuracy  of  this  method  is  shown  by  the  fol- 
lowing figures.  The  $120,000  of  Surplus  from  Appreciation  pre- 
viously set  up  is  charged  off  at  the  rate  of  $3,000  for  40  years, 
clearing  the  original  appreciation  during  the  life  of  the  building. 
The  cost  of  $100,000  is  charged  of!  at  the  rate  of  $2,000  a  year 


io62 


CORPORATE  ACCOUNTING 


[Bk.  in- 


fer 50  years.  The  amount  charged  to  Buildings  account,  namely, 
$100,000  of  cost  and  $120,000  of  appreciation,  is  offset  at  the  end 
of  50  years  by  a  Reserve  for  Depreciation  made  up  of: 

$2,000  per  year  for  10  years $  20,000 

$5,000  per  year  for  40  years 200,000 

Total ...,.,, $220,000 

I'   •■  i:  ill 7;  OOcX^ 

Only  the  $2,000  depreciation  of  the  actual  cost  of  the  build- 
ing is  a  charge  against  income. 

The  uses  of  the  Surplus  from  Appreciation  account  may  then 
be  summarized  as  follows: 

Surplus  from  Appreciation 


Debit: 

With    the    depreciation    taken    pe- 
riodically  on    appreciation    previously 
entered. 

Credit: 

With  the  amounts  by  which  the  book 
value  of  fixed  assets  is  increased. 

§  27.    Objection  to  Appreciation  of  Book  Values 

The  objection  to  entering  appreciation  on  the  books  is  not 
due  to  anything  necessarily  inherently  wrong  in  that  procedure, 
but  results  from  the  confusion  which  follows  the  attempt  to 
overdo  such  recording  of  fluctuations  of  value,  and  from  the  mis- 
fortunes which  have  resulted  from  making  it  appear  as  though  a 
dividend  were  possible  in  excess  of  the  truth.  It  is  possible,  per- 
haps, to  see  an  argument  for  entering  increases  of  value  which 
are  permanent  and  reasonably  definite  in  amount,  as  a  credit  to 
Surplus;  but  the  entry  of  such  increases  for  the  purpose  of  creat- 
ing a  fictitious  surplus  on  which  to  declare  dividends,  should  be 
severely  condemned  by  accountants  and  corporation  officials.  It 
is  not  good  business  prudence  to  use  appreciation  of  values  for 
dividend  purposes.  Dividends  declared  and  paid  on  the  strength 
of  fictitious  profits  must  as  a  rule  be  accounted  for  in  case  of  the 
company's  failure;  it  is  equivalent  to  paying  dividends  out  of 
capital,  an  impairment  for  which  directors  are  personally  liable. 


Ch.  4]  CLASSIFICATION  OF  SURPLUS  1063 

§  28.    Donated  Surplus  ,„^  (r:iri7/ 

Another  source  of  surplus  arises  from  donations  to  the  cor- 
poration of  part  of  its  own  capital  stock  by  the  stockholders. 
The  purpose  of  such  donations  is  to  provide  working  capital, 
usually  in  cases  where  the  entire  or  a  large  percentage  of  the  cor- 
poration's capital  stock  has  been  originally  issued  in  exchange  for 
fixed  or  intangible  assets,  leaving  no  means  of  securing  funds  for 
making  those  assets  yield  an  income. 

It  may,  however,  usually  be  assumed  that  the  donation  of 
capital  stock  immediately  after  its  issue  is  prima  facie  an  indica- 
tion that  the  assets  for  which  the  stock  was  issued  were  turned 
in  at  a  value  so  inflated  that  those  who  turned  them  in  are  more 
than  recompensed  by  the  amount  of  stock  which  they  have  with- 
held. The  assets  being  thus  carried  at  an  inflated  value,  there  is 
no  real  surplus  existing  in  the  donation. 

This  kind  of  a  surplus  involves  a  number  of  accounting  prob- 
lems which  are  fully  discussed  in  a  later  chapter.^ 

There  is  another  form  of  donated  surplus  against  which  there 
is  no  such  prejudice  as  exists  against  a  surplus  created  by  the 
immediate  return  of  stock  to  a  corporation.  This  arises  from 
donations  from  outsiders  of  factory  sites  and  other  bonuses  such 
as  are  sometimes  given  to  induce  business  enterprises  to  locate 
in  certain  places.  The  entry  of  the  values  of  these  donations  on 
the  books  when  the  conditions  of  the  gift  have  been  fully  complied 
with  and  it  can  no  longer  be  forfeited,  is  not  improper.  Such  en- 
tries involve  debits  to  various  asset  accounts  and  a  credit  to 
Donated  Surplus. 

§  29.    Consolidated  Surplus 

There  is  another  kind  of  surplus  which,  while  related  to  Sur- 
plus from  Appreciation,  is  of  unquestioned  propriety  because  in 
it  is  found  almost  the  only  way  of  handling  the  adjustments  found 
necessary  in  the  preparation  of  consolidated  balance  sheets. 


•  Ch.  X,  "Par- Value  Donated  Stock." 


Io64  CORPORATE  ACCOUNTING  [Bk.  III- 

When  one  company  owns  the  stock  of  another  and  it  is  desired  to 
present  a  consolidated  balance  sheet  showing  the  total  assets 
represented  by  the  stock  of  the  first  company  together  with  its 
existing  liabilities,  it  is  necessary  to  substitute  for  the  cost  of  the 
stock  of  the  subsidiary  company  the  entire  list  of  the  assets  of 
that  company  together  with  its  liabilities.  It  is  seldom  that  the 
net  worth  of  the  second  or  subsidiary  company,  as- shown  by  its 
books,  will  be  exactly  equal  to  the  cost  of  its  stock  to  the  holding 
company,  and  in  the  preparation  of  the  consolidated  balance 
sheet  the  difference  must  be  taken  up  through  a  consolidated 
surplus  (or  a  consolidated  deficit,  if  the  book  net  worth  of  the 
subsidiary  were  less  than  the  cost  of  its  stock  to  the  holding  com- 
pany) .  The  causes  of  the  conditions  which  make  this  necessary, 
together  with  the  accounting,  are  fully  discussed  in  later 
chapters.* 


«  See  Chs.  XXXIV  and  XXXV,  "Consolidated  Statements." 

■)i  jr!l  /{'jj.ffv/ 


Part  II — The  Original  Capital  of  the  Corporation 


CHAPTER  V 

PAR-VALUE  STOCK  OF  ORIGINAL  ISSUE 
FULL-PAID  AT  ONCE 

§  30.     General  Conditions 

The  opening  entries  on  the  books  of  a  corporation  are  deter- 
mined by  the  conditions  under  which  the  stock  is  sold,  and  it  is 
important  that  such  entries  should  be  complete  and  clear.  They 
sometimes  fail  in  this  and  are  obscure  because  of  insufficient 
data  in  the  journal  entries.  This  may  be  due  to  carelessness  or 
ignorance,  or  occasionally  to  the  desire  of  thfe  incorporators  to 
withhold  certain  facts  regarding  the  company's  organization 
that  might  be  used  later  to  their  disadvantage.  As  to  this,  it 
can  only  be  said  that  all  entries  should  tell  the  truth  clearly  and 
unmistakably;  and  it  may  be  added  that,  no  matter  how  cun- 
ningly such  entries  are  devised,  a  competent  accountant  can 
always  discover  their  true  meaning. 

Entries  covering  the  various  conditions  of  stock  issues  as 
given  in  the  present  and  the  succeeding  chapters,  include  the 
following : 

1.  Entries  for  original  issues  of  stock  sold  under  different 

conditions. 

2.  Entries  relating  to  stock  donated  to  the  treasury. 

3.  Entries  where  an  original  issue  of  stock  or   treasury 

stock  is  given  in  direct  payment  of  corporate  obliga- 
tions. 

1065 


lo66  CORPORATE  ACCOUNTING  [Bk.  IH- 

4.  Entries  relating  to  the  purchase  and  sale  by  the  corpora- 
tion of  its  own  stock  (not  an  original  issue),  and  of 
other  stocks. 

The  entries  given  are  intended  merely  to  show  the  debits 
and  credits  directly  resulting  from  the  transactions  considered. 
In  practice  all  cash  entries  are  of  course  recorded  in  the  cash  book 
and  are  thence  posted  to  the  proper  ledger  accounts;  but  through- 
out the  present  volume,  for  the  sake  of  clearness,  the  entire 
transaction  is  in  each  case  expressed  in  the  form  of  a  journal 
entry  regardless  of  whether  it  belongs  in  the  cash  book  or 
journal  or  should  be  divided  between  the  two  books. 

§  31.     Capital  Stock  With  and  Without  Par  Value 

The  recording  of  transactions  in  a  corporation's  own  stock 
differ^  when  the  stock  has  a  specified  par  value  from  that  re- 
quired when  the  stock  is  of  no  par  value.  This  and  the  chapters 
immediately  following  deal  entirely  with  stock  which  has  a 
specified  par  value.  The  much  simpler  accounting  of  stock 
without  par  value  is  discussed  in  a  later  chapter.^ 

§  32.     Formal  Statement  upon  Opening  Books 

Some  authorities  advocate  opening  the  books  of  a  corpora- 
tion with  a  short  statement  of  the  facts  of  organization  and 
original  issue,  such  as  the  following: 

The  Davison  Mercantile  Company  has  this  day  been  organized 
with  a  capital  stock  of  S^  -o  --oo,  divided  into  1,500  shares  of  a  par 
value  of  $100  each,  all  of  which  were  subscribed  for  at  par,  as 
follows: 

A.  W.  Davison 800  shares 

George  H.  Brandon 300     " 

R.  S.  Cooke 200     " 

James  Robinson .'.';. C', 200     " 

All  subscriptions  have  been  paid  in  cash,  excepting  that  of 
Davison,  who  turned  over  merchandise  on  his  subscriptipu  to  the 

»  Ch.  XI,  "Capital  Stock  Without  Par  Value." 


Ch.  5]  PAR- VALUE  STOCK  OF  ORIGINAL  ISSUE  1067 

value  of  $so,cxDo  and  paid  the  balance,  $30,000,  in  cash.  The 
total  amount  paid  in  is  therefore  $150,000,  of  which  $100,000  is 
cash. 

Such  an  entry  should  be  a  reasonably  complete  statement  of 
the  conditions  under  which  the  corporation  is  organized,  and  is 
desirable  in  order  to  bring  together  into  one  clear,  concise  state- 
ment all  the  details  of  the  incorporation  required  by  the  accoun- 
tant. This  relieves  the  opening  entries  of  this  data.  The  full 
facts  regarding  the  organization — so  far  as  they  affect  the  ac- 
counting— should  appear  on  the  books;  if  the  formal  statement 
is  not  used,  the  explanation  of  the  initial  journal  entries  must 
be  the  more  extended. 

§  33.     Initial  Issue  of  Stock,  Full-Paid 

The  following  entries  are  required  to  record  the  issuance  of 
stock  to  the  incorporators  of  the  Davison  Mercantile  Company 
for  the  cash  and  merchandise  turned  over: 

Cash  Book: 

Cash. $100,000 

To  Capital  Stock $100,000 

Cash  received  by  the  company  in  fuU  payment  of  sub- 
scriptions to  its  capital  stock,  as  follows: 

A.  W.  Davison 300  shares 

George  H.  Brandon 300      " 

R.  S.  Cooke 200     " 

James  Robinson 200     " 

Journal: 

Merchandise $50,000 

To  Capital  Stock $50,000 

Merchandise  to  amount  of  $50,000  turned  in  by  A.  W. 
Davison  as  part  payment  of  his  subscription,  the 
balance  teing  paid  in  cash. 

Such  entries  as  these  on  the  books  of  a  new  corporation 
should  contain  a  reasonably  complete  statement  of  the  conditions 
under  which  the  corporation  is  organized,  at  least  as  full  as  that 
given  above,  unless  a  formal  opening  statement2  is  used. 

*  See  I  32. 


io68 


CORPORATE  ACCOUNTING 


[Bk.  III- 


The  above  entries  are  the  simplest  possible.  Incoming  cash 
and  merchandise  receive  their  proper  debits,  and  Capital  Stock 
account  is  credited  with  the  amounts  subscribed,  paid  for,  and 
issued.     The  function  of  Capital  Stock  account  is  as  follows: 

Capital  Stock 


Debit: 

With  the  par  value  of  any  reduction 
in  the  amount  of  the  stock  authorized 
to  be  issued. 


Credit: 

With   the   par  value  of   shares  au- 
thorized for  issue. 


This  account  shows  a  credit  balance,  indicating  the  par  value 
of  stock  authorized  for  issue,  and  is  frequently  known  as  Capital 
Stock  Authorized  account. 


§  34.    Unissued  Stock 

In  the  above  example  the  entire  amount  of  stock  authorized 
was  immediately  issued.  But  let  us  suppose  that  the  Davison 
Mercantile  Company  had  been  authorized  to  issue  2,000  shares 
instead  of  1,500,  all  the  other  conditions  as  to  par  value  and 
amount  subscribed  remaining  the  same.  In  this  case  it  would 
be  desirable  to  show  the  entire  amount  of  the  authorization  by 
an  opening  entry  in  the  following  form  before  recording  the 
issuance  of  any  of  the  stock: 

Capital  Stock  Unissued $200,000 

"  To  Capital  Stock  (or  Capital  Stock  Authorized) $200,000 

The  Davison  Mercantile  Company  has  been  organized 
with  an  authorized  capital  stock  of  $200,000,  divided 
into  2,000  shares  of  a  par  value  of  $100  each. 

The  function  of  the  Capital  Stock  Unissued  account  is: 
Capital  Stock  Unissued 


Debit: 

With  the  par  value  of  shares  au- 
thorized, the  offsetting  credit  being 
made  to  Capital  Stock  Authorized. 


Credit: 

With  the  par  value  of  shares  issued, 
the  offsetting  debit  being  made  to  Cash, 
to  the  proper  property  account,  or  to 
Capital  Stock  Subscribed,  as  the  case 
may  be. 


Ch.  si  PAR-VALUE  STOCK  OF  ORIGINAL  ISSUE  1069 

The  debit  balance  of  this  account  shows  at  all  times  the  par 
value  of  the  stock  authorized  by  the  corporate  charter  but  not 
yet  issued.  The  account  is  a  negative  to  Capital  Stock  Au- 
thorized account.  The  par  value  of  the  stock  issued  at  any  date 
is  the  difference  between  the  ledger  balances  of  the  Capital 
Stock  Authorized  and  Capital  Stock  Unissued  accounts. 

When  this  plan  of  first  setting  up  the  authorization  is  fol- 
lowed, all  entries  for  the  issuance  of  stock  will  be  credits  to  the 
Capital  Stock  Unissued  account  instead  of  to  the  Capital  Stock 
or  Capital  Stock  Authorized  account.  In  the  case  of  the 
Davison  Mercantile  Company,  the  cash  book  and  journal 
entries  recording  the  receipt  of  the  cash  and  merchandise  for 
the  stock  would  be  exactly  as  given  above,  with  the  single  ex- 
ception that  in  each  case  the  credit  is  to  Capital  Stock  Unissued. 

§  35.    Preferred  Stock 

The  accounts  above  presented,  Capital  Stock  Authorized  and 
Capital  Stock  Unissued,  are  used  as  shown  when  but  one  class 
of  stock  is  authorized.  If  there  is  more  than  one  kind  of  stock 
it  will  be  necessary  to  use  these  same  accounts  with  distinctive 
titles  for  each  kind  of  stock,  as  Common  Stock  Authorized, 
First  Preferred  Stock  Authorized,  Second  Preferred  Stock  Au- 
thorized, Common  Stock  Unissued,  First  Preferred  Stock  Unis- 
sued, Second  Preferred  Stock  Unissued,  etc.  These  accounts 
are  handled  just  as  are  the  Capital  Stock  Authorized  and 
Capital  Stock  Unissued  accounts,  each  account  of  course  con- 
taining entries  affecting  only  its  particular  class  of  stock. 

The  same  rule  will  apply  to  the  capital  stock  accounts  sub- 
sequently discussed,  such  as  Capital  Stock  Subscribed,  etc. 

§  36.    Another  Use  of  the  Capital  Stock  Account 

Many  corporations,  instead  of  showing  on  the  books  the 
amount  of  capital  stock  authorized  when  not  all  of  it  has  been 
issued,  have  followed  the  practice  of  simply  crediting  Capital 
Stock  account  with  the  par  value  of  the  issued  stock.     When 


I070  CORPORATE  ACCOUNTING  [Bk.  III- 

this  is  done  the  balance  of  the  Capital  Stock  account  represents 
the  par  value  of  the  stock  issued  and  outstanding,  and  the  amount 
of  the  original  authorization  does  not  appear,  whereas  the  use 
of  accounts  for  Capital  Stock  Authorized  and  Capital  Stock 
Unissued  affords  a  means  of  recording  a  neutral  opening  entry 
in  the  corporate  books,  showing  the  amount  of  the  original 
authorization. 

In  the  case  of  the  Davison  Manufacturing  Company,  the 
entries  for  the  stock  issued  would  be  the  same  as  those  suggested 
first  above,3  Capital  Stock  being  credited.  The  opening  entry 
setting  up  the  amount  of  capital  stock  authorized  would,  how- 
ever, be  entirely  omitted. 

The  use  of  this  single  account  is  going  out  of  favor,  the  present 
tendency  and  the  better  practice  being  to  require  the  books  to 
show  the  amount  of  the  authorized  stock.  The  amount  issued 
is  determined  by  subtraction  of  the  balance  unissued  (as  shown 
by  the  Capital  Stock  Unissued  account)  from  the  amount 
authorized  (as  shown  by  the  Capital  Stock  or  Capital  Stock 
Authorized  account).  Of  course,  if  there  is  no  unissued  stock,' 
the  balance  of  the  Capital  Stock  account  will  be  both  the  amount 
authorized  and  the  amount  issued. 

§  37.     Summary  of  the  Capital  Stock  Accounts 

The  capital  stock  accounts  as  above  constituted  show  the 
amount  of  capital  invested  in  the  corporation  by  the  stock- 
holders (who  are  the  real  owners),  very  much  as  the  capital 
account  of  a  partnership  or  sole  proprietorship  business  shows 
the  investment  of  the  partners  or  proprietor.  The  accounts  do 
not  represent  any  strict  liability  to  the  stockholders,  -whose 
claims  in  the  event  of  liquidation  are  considered  only  after  all 
secured  and  unsecured  creditors  are  satisfied. 

If  the  single  Capital  Stock  account  is  used,  its  balance  will 
represent  the  par  value  of  the  stock  issued  and  outstanding. 
If  the  authorized  and  unissued  accounts  are  opened,  the  balance 

»See}33. 


Ch.  si  PAR-VALUE  STOCK  OF  ORIGINAL  ISSUE  107 1 

of  the  Capital  Stock  Authorized  account  shows  the  total  author- 
ized stock,  while  the  balance  of  the  Capital  Stock  Unissued 
account  shows  the  amount  still  unissued,  the  difference  being 
the  par  value  of  the  stock  outstanding. 

§  38.     Subsidiary  Stock  Records  * 

The  amount  of  outstanding  stock  is  shown  in  shares  by  the 
stock  certificate  book.  The  stock  ledger  will  also  show  the 
stock  issued  and  outstanding,  though  ordinarily  in  shares  and 
not  in  value.  These  books  will  constitute  a  subsidiary  record, 
the  Capital  Stock  account  becoming  the  controlUng  account  if 
only  that  account  is  used.  If  the  Capital  Stock  Authorized 
and  Capital  Stock  Unissued  accounts  are  used,  the  control  is 
the  amount  of  the  difference  between  their  balances. 

§  39.     Stock  Ledger 

Some  form  of  stock  book,  stock  ledger,  or  share  ledger — 
which  are  practically  one  and  the  same — must,  in  most  states, 
be  kept  as  a  matter  of  statutory  requirement.  The  stock 
ledger  is  intended  primarily  to  show  the  stock  acquired,  any 
transferred,  and  the  number  of  shares  held  at  the  time  by  each 
stockholder;  but  it  is  sometimes  used  also  as  a  ledger  to  show 
payments  made  on  account  of  subscriptions.  This  record  is 
better  kept  in  a  separate  subscription  ledger.  It  is  obvious  that 
the  great  majority  of  the  stock  ledger  entries  are  transfers  of 
stock  in  which  the . corporation  has  no  financial  interest;  and 
the  financial  side  of  the  comparatively  few  original  entries  in 
which  it  is  interested  should  not  be  brought  into  this  book. 

The  stock  ledger  is  the  proper  legal  evidence  of  the  owner- 
ship of  stock  in  a  corporation.  It  records  the  name  and  address 
of  each  stockholder,  the  number  of  shares  issued  to  him,  any 
shares  subsequently  acquired,  any  shares  transferred,  and  the 
balance  of  shares  remaining  to  his  credit.     It  also  shows  the 


«  See  Book  I,  Ch.  XXXVII,  "The  Stock  Records";  also  Book  IV,  Ch.  VI,  "Stock  Certi- 
ficates," and  Ch.  VII,  "Stock  Books." 


1072  CORPORATE  ACCOUNTING  [Bk.  IH- 

numbers  of  the  certificates  issued  to  the  individual,  the  numbers 
transferred,  and  the  date  of  each  transaction.  Postings  to  the 
stock  ledger  are  made  from  the  stock  certificate  books,  except 
that  transfers  of  stock  may  be  posted  from  the  transfer  book, 
transfer  register,  or  stock  certificate  books. s 

Preferred  stock  should  be  recorded  in  a  separate  stock  book, 
or  in  its  own  section  of  the  stock  ledger;  for  it  is  obvious  that 
the  attempt  to  keep  a  record  of  both  kinds  of  stock  in  one 
account  would  lead  to  confusion. 

A  Capital  Stock  account  is  sometimes  opened  on  the  front 
page  of  the  stock  ledger,  and  debited  with  the  aggregate  amount 
of  shares  credited  to  the  stockholders'  accounts.  This  provides 
a  double  entry  for  the  stock  ledger,  and  enables  the  secretary 
to  tell  at  any  time  the  amount  of  stock  outstanding.  The  stock 
ledger  must,  of  course,  agree  as  to  totals  with  the  Capital  Stock 
account  in  the  general  ledger,  or  with  the  Capital  Stock  Au- 
thorized account  less  the  shares  represented  by  the  Capital  Stock 
Unissued  account,  depending  on  which  method  is  followed. 

§  40.    Form  of  Stock  Ledger 

It  must  always  be  kept  in  mind  that  the  great  object  of  the 
stock  ledger  is  to  show  at  any  time  the  number  of  shares  then 
standing  in  each  stockholder's  name — not  the  amounts  paid  on 
these  shares,  nor  their  par  value,  but  the  number  of  shares.  In 
practice  there  are  two  methods  of  keeping  this  record.  In  some 
forms  the  stockholders'  accounts  are  debited  for  stock  pur- 
chased, and  credited  for  stock  sold;  while  in  others  the  stock- 
holders' accounts  are  credited  when  stock  is  purchased,  and 
debited  when  it  is  sold.  This  variation  is  not  a  matter  of 
importance  so  long  as  the  details  are  correctly  recorded  and  full 
information  is  obtainable,  but  inasmuch  as  the  stock  ledger  is 
subsidiary  to  certain  accounts  in  the  general  ledger,  the  usual 
practice  in  regard  to  subsidiary  ledgers  should  be  followed. 
This  rule  would  indicate  that,  since  the  entry  of  the  issuance  of 

» See  i  43. 


Ch.  5]  PAR-VALUE  STOCK  OF  ORIGINAL  ISSUE  1073 

the  stock  is  a  credit  on  the  general  ledger,  the  stock  should  be  a 
credit  to  the  individuals  on  the  stock  ledger;  that,  since  the 
balance  of  the  controlling  account  is  a  credit,  the  items  which 
make  it  up  should  be  credits.  The  stock  accounts  of  the  indi- 
viduals are  credit  accounts  just  as  are  proprietorship  accounts  or 
partners'  capital  accounts. 

§  41.    Reconciliation  of  Subsidiary  Stock  Records 

Many  corporations  have  treated  the  stock  ledger  and  certifi- 
cate books  as  if  they  were  not  a  part  of  the  general  accounting 
system.  The  sooner  the  fact  is  fully  recognized  that  these 
records  are  subsidiary  to  certain  accounts  on  the  general  ledger, 
the  less  difficulty  there  will  be  in  keeping  both  records  accurate. 
Many  of  the  corporations  which  have  sprung  up  in  such  numbers 
during  the  last  few  years  and  opened  their  subscription  lists  to 
the  public,  using  many  salesmen  to  sell  their  shares  over  a  wide 
territory,  have  had  to  spend  large  amounts  on  audits,  the 
greater  part  of  which  expense  has  been  due  to  the  cost  of  recon- 
ciling records  which  should  have  been  kept  in  as  close  accord 
as  the  customers  ledger  and  its  controlling  Accounts  Receivable, 
or  the  purchase  ledger  and  its  controlling  Accounts  Payable. 

In  corporations  of  this  type  especially,  should  the  stock 
ledger  be  balanced  with  the  certificate  books  monthly,  and  the 
amount  of  outstanding  stock  be  reconciled  with  the  general 
ledger.  If  any  adjustments  are  needed,  they  should  be  made  at 
once. 

When  a  corporation  has  issued  no  new  stock  of  original  issue 
during  the  month,  the  reconciliation  of  the  former  m6nth  may 
of  course  be  used.  When  all  the  authorized  stock  has  been  issued 
the  problem  of  reconciliation  no  longer  exists.  But  just  as  the 
Accounts  Receivable  control  is  represented  by  a  schedule  of 
amounts  due  from  customers,  which  is  a  trial  balance  of  the  cus- 
tomers ledger,  so  should  the  Capital  Stock  control  (or  the  differ- 
ence between  the  balances  of  the  Capital  Stock  Authorized  and 
Capital  Stock  Unissued  accounts)  be  represented  by  a  schedule 


I074  CORPORATE  ACCOUNTING  [Bk.  III- 

of  outstanding  stock  of  the  same  par  value,  which  is  nothing 
more  than  a  trial  balance  of  the  stock  ledger  and  certificate 
books. 

§  42.    Transfers  of  Stock 

The  transfer  of  stock  has  been  very  fully  discussed.^  Because 
of  its  bearing  on  the  ease  of  keeping  the  accounting  records 
accurately,  one  point  must  be  repeated  here.  When  the  holder 
of  a  certificate  for  a  number  of  shares  desires  to  transfer  part  of 
them,  his  certificate  is  canceled,  a  new  one  is  issued  in  favor  of 
the  transferee  for  the  number  of  shares  transferred,  and  a  new 
one  is  also  made  out  in  favor  of  the  transferrer  for  the  number  of 
shares  retained.  The  lack  of  knowledge  or  lack  of  care  through 
which  secretaries  of  corporations  have  issued  certificates  for 
transferred  portions  or  the  whole  amount  of  outstanding  cer- 
tificates without  requiring  the  surrender  of  the  old  ones  for  can- 
cellation, has  led  to  much  trouble. 

Sometimes  a  stockholder  desires  to  surrender  a  certificate 
and  take  in  exchange  two  or  more  certificates,  each  for  a  smaller 
number  of  shares.  This  is  called  a  "split."  Or  sometimes 
several  certificates  of  smaller  amounts  are  surrendered  in  ex- 
change for  a  single  certificate.     This  also  is  known  as  a  "split." 

In  any  of  these  cases,  the  certificates  must  be  assigned  as 
required  by  the  conditions,  and  the  proper  records  must  be  made 
in  the  transfer  book,  in  the  transfer  register,  and  in  the  stock 
certificate  book  (or  such  of  these  books  as  are  used),  the  can- 
celed certificates  being  pasted  back  on  their  own  stubs  at  the 
time  the  new  issue  is  made. 

§  43.    Register  of  Transfers ' 

A  transfer  register  or  transfer  Journal  is  sometimes  used. 
This  book  serves  as  a  convenient  medium  through  which  postings 
are  made  to  the  stock  ledger.     It  is  apparent,  of  course,  that  for 

•  See  Book  I.  Part  VIII,  "Stock  Records  and  Stock  Transfers." 
'  See  Book  IV.  Form  256. 


Ch.  5]  PAR-VALUE  STOCK  OF  ORIGINAL  ISSUE  1075 

every  stock  certificate  transferred,  a  debit  must  be  made  to  the 
transferrer  and  a  credit  to  the  transferee. 

A  transfer  register  is  required  only  in  large  corporations 
where  many  transfers  are  being  made.  In  a  small  company 
where  the  stock  is  inactive,  it  is  not  necessary;  and  postings 
may  then  be  made  from  the  transfer  book  or  even  from  the  stock 
certificate  book. 

Transfers  of  stock  require  no  entry  on  any  books  except  those 
ha\'ing  to  do  solely  with  transfers  and  the  stock  ledger. 


CHAPTER  VI 

PAR-VALUE  STOCK  OF  ORIGINAL  ISSUE 
NOT  FULL-PAID  AT  ONCE 

§  44.    Setting  Up  Subscription  Assets 

Sometimes  subscriptions  to  stock — especially  when  on  the 
instalment  plan — fail  after  they  are  made.  Stock  certificates 
should  not  be  issued  to  subscribers  until  their  respective  sub- 
scriptions have  been  paid  in  full.  In  the  interim  their  subscrip- 
tions are  in  the  nature  of  accounts  receivable,  although  these  are 
assets  which  do  not  rank  so  highly  as  do  amounts  due  from 
customers.  To  set  such  assets  up  on  the  books  and  to  show  the 
amount  of  stock  reserved  to  fill  these  subscriptions,  the  opening 
entries  shown  below  are  necessary.  The  Davison  Mercantile 
Company,  whose  stock  was  in  the  preceding  chapter  considered 
as  full-paid,  is  again  taken  as  an  illustration,  but  now  with  the 
assumption  that  Robinson  did  not  pay  for  his  stock  immediately. 

Capital  Stock  Unissued $200,000 

To  Capital  Stock  Authorized $200,000 

(Explanation  as  in  §  S3-) 

Subscriptions  to  Stock $150,000 

To  Capital  Stock  Subscribed $150,000 

1,500  shares  subscribed  for  at  par  by  the  incorporators: 

A.  W.  Davison 800  shares 

George  H.  Brandon 300     " 

R.  S.  Cooke 200     " 

James  Robinson 200     " 

Cash $80,000 

To  Subscriptions  to  Stock $80,000 

.    Payments  of  incorporators'  subscriptions  to  stock: 

A.  W.  Davison $30,000 

George  H.  Brandon 30,000 

R.  S.  Cooke 20,000 

1076 


Ch.  6]  PAR-VALUE  STOCK  OF  ORIGINAL  ISSUE  107  7 

Merchandise $50,000 

To  Subscriptions  to  Stock $50,000 

Payment  of  balance  of  Davison's  subscription  to  stock, 
paid  in  merchandise  as  per  agreement. 

Capital  Stock  Subscribed f,  J.  .Vl^".':-!''..^ '.'!'/.'. .    $150,000 

To  Capital  Stock  Unissued •         $150,000 

Certificates  Nos.  i,  2,  and  3  issued  to  those  of  the  in- 
corporators who  have  paid  the  amounts  of  their  sub- 
scriptions. 

§  45.    Subscriptions  to  Stock  ^ 


Debit:  Credit: 

With  the  amount  of  subscriptions  With  all  moneys  or  property  received 
for  capital  stock.  (At  this  time  credit  to  cover  subscriptions;  or  with  the 
Capital  Stock  Subscribed.)  amount    of   each    instalment   due    by 

subscribers  when  an  Instalment  account 
is  maintained. 

With  the  unpaid  balances  of  sub- 
scriptions canceled.  , , 

Other  names  for  this  account  are  "Subscription,"  "Stock  Sub- 
scriptions," and  "Subscribers."  It  is  debited  with  the  full 
amount  of  the  subscriptions,  and  credited  with  the  payments 
made.  When  the  account  balances,  it  shows — except  when  an 
Instalment  account  is  used — that  all  stock  subscribed  has  been 
paid  for.  Any  balance  in  the  account  is  an  asset,  and — again 
save  when  an  Instalment  account  is  opened — represents  the 
amount  due  and  unpaid  on  subscriptions  for  capital  stock.  The 
account  is  opened  to  show  the  total  amount  of  subscriptions, 
even  though  payment  of  part  or  all  of  these  is  to  be  made  in  full 
at  once  or  in  a  short  time.  Subscriptions  to  treasury  stock  should 
preferably  be  opened  under  another  heading,  such  as  "Subscrip- 
tions to  Treasury  Stock,"  to  distinguish  them  from  subscriptions 
to  unissued  stock.  A  subscription  ledger  should  be  kept  as  a 
subsidiary  record  to  Subscriptions  to  Stock  account,  as  explained 
later  in  the  chapter. 

>  Separate  account  for  each  class  of  stock  sold. 


1078  CORPORATE  ACCOUNTING  [Bk.  III- 

§46.     Capital  Stock  Subscribed'' 


Debit:  'Credit. 

With   the   par  value  of   stock   sub-  With  the  par  value  of  capital  stock 

scribed  for  and  credited  to  this  account.      subscribed,    debiting   Subscriptions   to 
(Entry  to  be  made  when  certificates  of      Stock  account, 
stock  are  issued  covering  the  number 
of    shares    subscribed    and    paid    for, 
crediting  Capital  Stock  Unissued.) 

With  the  par  value  of  any  canceled 
stock  subscriptions  which  have  been 
credited  to  this  account.^ 

Capital  Stock  Subscribed  account  is  opened  as  a  suspense  acT.v 
count  in  which  the  amount  of  stock  reserved  on  account  of  sub- 
scriptions received  and  entered  may  be  carried  until  the  certifi- 
cates are  issued,  which  it  is  ordinarily  assumed  will  not  be  until 
they  have  been  paid  for  in  full.  It  is  the  actual  issuance  of  the 
certificates  which  controls  the  debits  to  this  account  rather  than 
the  payments.  The  Capital  Stock  Unissued  account  is  not 
affected  until  the  certificates  are  actually  issued.  In  this  con- 
nection it  should'  always  be  remembered  that  the  issuance  of 
certificates  for  unpaid  or  partly  paid  subscriptions  is  to  be 
condemned.*  ,j 

The  Capital  Stock  Subscribed  account  shows,  not  the  amount  j 
due  on  subscriptions,  which  is  shown  by  Subscriptions  to  Stock 
account,  but  the  total  original  par  value  of  all  subscriptions  the 
certificates  for  which  have  not  been  issued.    When  subscriptions 
are  paid  in  full  and  certificates  are  issued,  the  Capital  Stock  Sub- 
scribed account  is  debited  and  Capital  Stock  Unissued  account  ^ 
is  credited.     If  sales  are  made  at  par  and  no  certificates  are^, 
issued  until  full  payment  is  received,  the  difference  between  the 
balance  of  Subscriptions  to  Stock  account  and  the  balance  of  this  ^ 
account  should  show  the  amount  of  cash  received  on  account  of  ■ 
subscriptions  for  which  certificates  have  not  been  issued. 

Assume  that  A,  B,  and  C  have  subscribed  for  stock  in  the  re- 

2  Separate  account  for  each  class  of  stock  subscribed. 

»  See  }  48. 

*  See  Book  I,  {  259. 


Ch.  6]  PAR-VALUE  STOCK  OF  ORIGINAL  ISSUE  1079 

spective  amounts  of  $100,  $500,  and  $1,000,  and  that  A  has  paid 
all  of  his  subscription,  B  has  paid  $200,  and  C  nothing.  C  is  to 
get  his  stock  for  $800.  None  of  the  certificates  have  been  issued. 
The  entry  setting  up  the  subscriptions  would  be: 

Discount  on  Stock _ $    200 

Subscriptions  to  Stock '.JVll'7.^.^.' 1,400 

io        To  Capital  Stock  Subscribed $1,600 

_  ,  (With  full  explanation.) 

The  receipt  of  the  money  would  be  recorded  by  entries  which 
aggregate:  '  i  ,'jnifnTjj 

Cash - $300 

To  Subscriptions  to  Stock $300 

It  was  said  above  that  the  Capital  Stock  Subscribed  account 
represented  the  total  original  par  value  of  all  subscriptions  the 
certificates  for  which  have  not  yet  been  issued.  The  apphcation 
of  this  principle  to  the  simple  case  given  will  be  apparent. 

In  reconciling  more  complicated  cases  it  is  of  value  to  remem- 
ber that  the  balance  of  the  Capital  Stock  Subscribed  account  at 
any  time  represents  the  sum  of  the  par  value  of  any  stock  sub- 
scribed for  and  now  fully  paid  but  not  yet  issued,  plus  the  balance 
in  the  Subscriptions  to  Stock  account,  plus  the  cash  received  on 
account  of  the  outstanding  subscriptions,  plus  any  discount  or 
minus  any  premium  at  which  the  stock  not  yet  fully  paid  for 
was  sold.     Applying  this  rule  to  the  case  just  given  we  have: 

Par  value  of  the  stock  subscribed  for  and  now  fully  paid  but  not  yet  issued 

(A's  subscription  and  payment) $    100 

Balance  in  the  Subscriptions  to  Stock  account  ($1,400  minus  $300) 1,100 

Cash  received  on  account  of  the  outstanding  subscriptions  (from  B) 200 

Discount  at  which  the  stock  not  yet  fully  paid  for  was  sold  (on  C's  sub- 
scription)    200 

Balance  in  the  Capital  Stock  Subscribed  account .i  .(jOiA  .    $1,600 

When  A's  stock  is  issued  the  following  entry  will  be  made : 

Capital  Stock  Subscribed ,  .^. ........... , $ioo 

To  Capital  Stock  Unissued .  .  . .''.'! 'P^. .  ??f^. ,".  .v!^'.' $100 

(With  full  explanation.) 


io8o  CORPORATE  ACCOUNTING  [Bk.  III- 

The  balance  in  the  Capital  Stock  Subscribed  account  will 
then  be  $1,500,  which  will  be  represented  by  all  the  items  in  the 
above  schedule  except  the  first,  there  being  then  no  stock  sub- 
scribed and  fully  paid  for  but  not  issued. 

Instead  of  opening  the  Capital  Stock  Subscribed  account, 
credits  for  stock  subscribed  on  the  instalment  plan  are  frequently 
but  not  wisely  made  directly  to  Capital  Stock.  The  question  of 
when  it  is  worth  while  to  open  accounts  with  Subscriptions  to 
Stock  and  Capital  Stock  Subscribed  is  for  the  accountant  to  de- 
termine, but  any  doubt  as  to  the  advisability  of  using  them  will 
usually  be  most  safely  resolved  by  an  affirmative  answer. 

§  47.    The  Subscription  Ledger 

Subscriptions  to  Stock  account  is  debited  with  the  full  amount 
of  each  subscription.  As  these  are  paid  the  account  is  credited. 
When  there  is  an  unpaid  balance  in  the  account  the  items  making 
up  that  balance  will  be  found  by  taking  a  trial  balance  of  the  sub- 
scription ledger,  which  should  be  kept  as  a  record  subsidiary  to 
the  Subscriptions  to  Stock  account.  An  account  with  each  sub- 
scriber will  be  kept  therein.  The  respective  subscribers'  accounts 
should  be  debited  separately  with  the  amounts  of  their  subscrip- 
tions, and  credited  with  the  amounts  of  the  payments  which  they 
make  on  account  of  the  subscriptions.  The  result  of  a  trial  bal- 
ance taken  from  this  subsidiary  ledger  should,  as  suggested  above, 
agree  with  the  balance  of  the  Subscriptions  to  Stock  account, 
and  such  a  comparison  should  be  made  monthly  as  long  as  the 
Subscriptions  account  is  active. 

Any  form  of  small  ledger  sheet,  card,  or  bound  book  is  suit- 
able for  a  subscription  ledger,  as  the  debits  usually  show  only 
date,  subscription  number,  number  of  shares  subscribed  for, 
journal  folio  from  which  posted,  and  amount;  and  the  credits 
show  only  date,  receipt  number,  cash  book  folio  from  which 
posted,  and  the  amount. 

Subscribers'  accounts  are  sometimes  opened  in  the  general 
ledger;  but  in  practice  it  is  better  to  open  the  individual  accounts 


Ch.  6]  PAR-VALUE  STOCK  OF  ORIGINAL  ISSUE  io8l 

in  a  subsidiary  ledger  as  above  suggested,  letting  Subscriptions 
to  Stock  account  in  the  general  ledger  represent  all  these  as  a 
controlling  account. 

§48.    Cancellations  of  Subscriptions    ^iiA^rfadtcs  io«s,iBa    .pi.^ 

^'"Cancellations  of  subscriptions  are  frequently  permitted  by 

corporations  in  the  interests  of  business  policy.    If  no  payment 

has  been  received  the  cancelling  entry  will  be  simply : 

J 

Capital  Stock  Subscribed $S,ooo 

To  Subscriptions  to  Stock $S,ooo 

Recording  cancellation  of  subscription  No.  108  of  Charles  J. 
Davis,  for  50  shares. 

If  money  has  been  received  which  it  is  decided  to  refund,  the 
transaction  will  be  entered  in  the  journal  as  follows  for  the 
amount  unpaid:  onijldB-. 

Capital  Stock  Subscribed $4,700      .  ri?.B'3 

To  Subscriptions  to  Stock m         $4,700 

Recording  cancellation  of  unpaid  balance  of  subscription  Noo-j:nYiiq 
108  of  Charles  J.  Davis,  for  50  shares. 

The  following  entry  will  be  made  in  the  cash  book  for  the 
amount  paid  and  now  refunded:  u,   ^ 

Capital  Stock  Subscribed $300 

To  Cash $300 

Charles  J.  Davis,  refund  of  payment  on  subscription. 

If  some  or  all  of  the  money  paid  is  to  be  retained  by  the  cor- 
poration, the  same  journal  entry  will  be  made.  If  in  this  case 
the  company  refunds  in  cash  $209.Qt^.the  $300  paid,  the  book 
entry  will  be: 

Capital  Stock  Subscribed " $300 

To  Cash $200 

Premium 100 

Charles  J.  Davis,  refund  of  $200  of  payment  on  canceled  subscrip- 
tion, balance  being  retained. 


I082  CORPORATE  ACCOUNTING  [Bk.  III- 

The  Premium  account  is  credited  with  the  amount  of  cash 
forfeited  when  stock  subscriptions  are  canceled.  Other  uses  of 
the  account  are  presented  in  a  later  chapter,  s 

§  49.    Sales  of  Stdck  After  Organization 

Later  sales  of  stock  by  a  company  will  be  entered  just  as  were 
the  sales  at  the  time  of  incorporation.  Assuming  that  on  Janu- 
ary 3,  1922,  $100,000  of  the  unissued  stock  of  the  Lancaster 
Cement  Company  has  been  sold  at  par  to  Frank  K.  Brennan, 
one-half  for  cash  and  one-half  in  30  days,  the  following  entries 
would  be  required:      — "  : 

January  3,  1922  .eaiEda  o^  idi  .aivfiO 

Subscriptions  to  Stock $100,000 

To  Capital  Stock  Subscribed $100,000 

The  Lancaster  Cement  Company  has  this  day  sold  to 
Frank  K.  Brennan  $100,000  of  its  unissued  stock,  one- 
half  payable  in  cash  and  the  balance  in  30  days. 

Cash $50,000 

To  Subscriptions  to  Stock $50,000 

First  fMiyment  of  50%  on  Brennan's  stock  subscription. 

Febraary  2,  1922 

Cash $50,000 

To  Subscriptions  to  Stock $50,000 

Final  payment  of  50%  on  Brennan's  subscription  to 
$100,000  of  stock. 

Capital  Stock  Subscribed $100,000 

To  Capital  Stock  Unissued $100,000 

Certificates  Nos.    725-744  for   1,000  shares,   issued  to 
;,.; Frank  K.  Brennan  upon  full  payment  of  his  sub- 
scription. 

§  50.    Transfers  ot  Subscriptions 

Transfers  of  subscriptions,  whether  entirely  unpaid,  or  partly 
or  fully  paid,  are  sometimes  permitted.  If  these  are  proving  in 
any  particular  case  to  be  numerous,  it  is  sometimes  wise  to  pro- 
vide a  subscription  transfer  journal  along  the  lines  of  the  stock 

i  See  i  66. 


Ch.6j 


PAR-VALUE  STOCK  OF  ORIGINAL  ISSUE 


1083 


transfer  journal  or  register;**  or  the  "Unpaid"  column  of  that 
form  may  be  used  for  recording  transfers  of  subscriptions.  If 
the  latter  practice  is  followed,  the  full  number  of  shares  unissued 
on  the  transferred  subscription  should  be  shown  in  this  column. 
The  subscription  transfer  journal  is  provided  with  columns 
headed  "Shares"  and  "Unpaid  Balance,"  instead  of  those  en- 
titled "Paid  In"  and  "Unpaid"  on  the  stock  transfer  register. 
\\^'-  In  any  case  the  amount  of  the  unpaid  balance  is  credited  to 
the  transferrer  on  the*  subscription  ledger,  and  debited  to  the 
transferee.  It  is  well  to  show  the  entire  transaction  on  the  new 
account  opened  for  the  transferee.  The  entries  might  be  made 
as  follows:  '  ^'*"  "•'■"  ^"i>'>  ■\.iuJ\ 

H.  W.  jARVis  ''T'"'^  '>^T 


Transferrers  Account: 


1922 
,  June  16     100  shares.  ...  116     $10,000 


1922 

June  16     Cash C7     $r,ooo 

July  14    Cash C19       1,000 

Aug.   2     Transfer  to 

CM.  Ready... Tj2        8,000 


Transferee's  Account: 


CM.  Ready 


1922 


Aug.  2   ,100  shares TJ2     $10,000 


^922  !-f:>^dug  oeofi? 

Aug.  2    Transfer  from         ,     ,     .  ,    , 

H.  W.  Jarvis..Tj2     $2,000 


§  51.    Summary  of  Accounts  Used 

The  general  ledger  accounts  affecting  capital  stock  transac- 
tions are  four  in  number,  viz.,  Capital  Stock  Authorized  (credit 
balance),  Capital  Stock  Unissued  (debit  balance),  Capital  Stock 
Subscribed  (credit  balance),  and  Subscriptions  to  Stock  (debit 
balance). 

The  Capital  Stock  Authorized  account  on  the  general  ledger 
is  credited  with  the  par  value  of  the  stock  which  the  corporation 
is  originally  authorized  to  issue,  and  with  any  subsequent  in- 
creases in  the  amount  of  that  authorization.    It  is  debited  with 


•  See  i  43;  also  Book  IV,  Form  356. 


lo84  .    CORPORATE  ACCOUNTING  [Bk.  III- 

any  reductions  in  the  amount  of  the  authorized  stock.  The  net 
credit  balance  of  this  account  will  show  the  par  value  of  the 
authorized  capital  stock  of  the  company. 

The  Capital  Stock  Unissued  account  is  debited  with  the  par 
value  of  the  stock  which  the  corporation  is  originally  authorized 
to  issue,  and  with  any  subsequent  increases  in  the  amount  of 
that  authorization.  It  is  credited  with  the  par  value  of  all  cer- 
tificates issued,  and  with  the  amounts  of  any  reductions  in  the 
authorized  capital.^  The  net  debit  balance  of  the  account  will 
shbw  the  par  value  of  the  authorized  stock  not  yet  issued. 

The  difference  between  the  net  balances  of  the  Capital  Stock 
Authorized  account  and  the  Capital  Stock  Unissued  account  will 
show  the  par  value  of  the  stock  which  is  actually  outstanding. 

The  Capital  Stock  Subscribed  account  is  credited  with  the 
par  value  of  all  subscriptions  accepted  by  the  company.  It  is 
debited  with  the  par  value  of  all  stock  certificates  issued.  This 
account's  net  credit  balance  will  show  the  par  value  of  the  capital 
stock  which  has  been  subscribed  for  but  has  not  yet  been  issued. 

The  Subscriptions  to  Stock  account  is  debited  with  the 
amount  of  money  to  be  paid  on  each  subscription  for  capital 
stock.  It  is  credited  with  the  amounts  of  all  payments  made  on 
those  subscriptions,  whether  in  cash  or  other  assets.  The  net 
debit  balance  of  the  account  will  show  the  amount  due  on  stock 
subscriptions  which  have  been  accepted  by  the  company. 

§  52.    Summary  of  Journal  Entries  mmmuii    .ig  ^ 

.  ■  The  related  journal  entries  used  in  connection  with  these 
accounts  are  as  follows: 

1.  To  show  the  authorized  capital  stock  of  the  corporation: 

Capital  Stock  Unissued 

To  Capital  Stock  Authorized 

2.  To  show  subscriptions  received  for  capital  ^tock: 

Subscriptions  to  Stock 

To  Capital  Stock  Subscribed 


'  But  see  Ch.  IX,  "Treasury  Stock  with  a  Par  Value." 

ofl  oela  ;et  ; 


Ch.  6]  PAR-VALUE  STOCK  OF  ORIGINAL  ISSUE  1085 

3.  To  show  cash  payments  on  stock  subscriptions: 

Cash 

To  Subscriptions  to  Stock 

4.  To  show  the  issuance  of  certificates  of  stock: 

Capital  Stock  Subscribed 

To  Capital  Stock  Unissued 


i  fii  bseu  od  oJ  ei  tbiriw  iauom^  orb  e»d  ilhv  .ijunuot  noh 


_>  brrr.  t\ 


CHAPTER  VII 

STOCK  SUBSCRIPTION  SYSTEM 

§  53.    Subscription  Joumali 

As  subscriptions  to  stock  are  received  by  a  large  corporation 
they  are  entered  on  a  subscription  journal,  which  shows  date, 
subscription  number,  name  and  address  of  the  subscriber, 
number  of  shares  of  preferred  stock  subscribed  for,  number  of 
shares  of  common  stock  subscribed  for,  amount  of  money  to  be 
paid  for  the  stock,  name  of  salesman,  if  any,  and  the  commission 
to  which  the  latter  will  be  entitled.  The  total  amount  of  the 
subscriptions  accepted  each  month,  as  shown  by  the  subscrip- 
tion journal,  will  be  the  amount  which  is  to  be  used  in  the  second 
journal  entry  of  the  preceding  section;  i.e., 

Subscriptions  to  Stock 

To  Capital  Stock  Subscribed 

This  entry  is  made  monthly  on  the  journal,  from  which  it  is 
posted  to  the  general  ledger. 

From  the  subscription  journal  the  amounts  receivable  on 
these  subscriptions  are  posted  to  the  subscription  ledger,  in 
which  an  account  is  opened  with  each  subscriber.  In  this  way 
the  total  amount  of  the  subscriptions  entered  on  the  subscription 
ledger  will  necessarily  be  the  total  amount  of  the  subscriptions 
shown  on  the  general  ledger.  An  error  can  be  due  only  to  the 
failure  to  enter  on  the  subscription  ledger  a  subscription,  or  the 
proper  amount  of  a  subscription. 

§  54.    Pajrments  on  Subscriptions 

Payments  made  on  subscriptions  are  entered  on  the  cash 
book  as  debits  to  Cash  and  credits  to  Subscriptions  to  Stock. 

«  See  Book  IV,  Form  254. 

1086 


Ch.  7]  STOCK  SUBSCRIPTION  SYSTEM  1087 

From  the  cash  book,  which  is  provided  with  a  column,  Receipts 
from  Subscriptions,  the  monthly  total  is  posted  to  the  general 
ledger.  From  the  cash  book  these  payments  must  be  posted 
in  detail  to  the  subscription  ledger,  in  which  the  date,  cash 
book  folio,  and  amount  are  shown  in  the  proper  columns.  In 
this  way  the  Subscriptions  to  Stock  account  on  the  general 
ledger,  which  had  previously  been  debited  in  totals  with  the 
amount  of  subscriptions,  is  now  credited  in  totals  with  the 
payments  and  must  necessarily  show  as  a  resulting  debit  balance 
the  amount  still  due.  In  the  same  way,  the  total  of  the  indi- 
vidual subscriptions  entered  on  the  detailed  subscription  ledger 
less  the  payments  which  have  been  recorded  thereon,  will  be  the 
amount  of  subscriptions  still  unpaid,  shown  in  detail  for  each 
subscriber,  the  total  of  all  the  detail  balances  agreeing  with  the 
"control,"  i.e.,  the  Subscriptions  to  Stock  account,  in  the  general 
ledger. 

§  55.    Issuance  and  Transfer  of  Certificates' 

Whenever  a  certificate  is  given  representing  stock  previously 
unissued,  i.e.,  an  original  issue,  the  number  of  shares  and  cer- 
tificate number  are  entered  from  the  certificate  stub  to  the  stock 
ledger.  The  total  number  of  shares  represented  by  all  certifi- 
cates issued  and  outstanding  is  added  on  the  certificate  stubs, 
and  the  following  journal  entry  is  made  monthly : 

Capital  Stock  Subscribed 

To  Capital  Stock  Unissued 

When  stock  is  transferred  from  one  owner  to  another,  the 
transfer  is  entered  in  the  transfer  register,^  no  entry  being  made 
in  the  general  journal.  All  transfers  must  be  posted  from  the 
transfer  register  to  the  stock  ledger,  in  the  accounts  of  both 
the  person  transferring  the  stock  and  the  person  to  whom  the 
stock  is  transferred. 


•See  Book  I,  Part  VIII,  "Stock  Records  and  Stock  Transfers";  alsc  Book  IV,  Ch.  VI, 
"Stock  Certificates,"  and  Ch.  VII,  "Stock  Books." 
•  See  i43;  also  Book  IV,  Form  256. 


lo88  CORPORATE  ACCOUNTING  [Bk.  III- 

§  56.    Transfers  and  Cancellations  of  Subscriptions  ,  1 

Transfers  of  stock  subscriptions  are  entered  in  the  subscrip- 
tion transfer  journal,  or  more  simply  in  the  Unissued  column  of 
the  transfer  register,  in  the  same  manner  as  are  transfers  of 
certificates,  recording  name  of  the  subscriber  to  whom  the  sub- 
scription is  transferred,  the  subscription  number,  and  the 
number  of  subscribed  shaies.  Such  transfers  are  posted  to  the 
respective  individual  accounts  in  the  subscription  ledger,  :;g 

If  a  subscription  is  canceled,  no  payment  having  been  made, 
a  red  ink  entry  is  made  on  the  subscription  journal  giving  the 
same  information  as  was  required  at  the  time  of  entering  the 
subscription.  The  red  ink  entry  is  considered  to  have  an  effect 
opposite  to  that  of  a  black  ink  entry,  being  deducted  instead  of 
added  in  obtaining  the  monthly  totals,  and  being  posted  as  a 
credit  on  the  subscription  ledger.  If  only  a  part  of  a  sub- 
scription is  canceled,  the  same  procedure  is  followed  for  the  can- 
celed part  as  is  outlined  above, 

:3  J  \o  idianjstl  bus  boomuzzI     .gg  § 

§  57.    Reconciliations  Required 

At  the  end  of  each  month  the  shares  shown  as  outstanding 
in  the  stock  ledger  are  added.  This  total  must  agree  with  the 
control  in  the  general  ledger;  namely,  the  difference  between 
the  Capital  Stock  Authorized  and  Capital  Stock  Unissued 
accounts.  The  total  of  all  the  balances  due  as  shown  by  the 
subscription  ledger  is  then  compared  with  the  balance  of  the 
Subscriptions  to  Stock  account  on  the  general  ledger. 

The  par  value  of  the  shares  represented  by  subscriptions  on 
which  the  stock  has  not  yet  been  issued,  is  found  and  compared 
with  the  balance  of  the  Capital  Stock  Subscribed  account  of 
the  general  ledger.  '  .  • 

§58.    The  Instalment  Book  '^ 

Stock  is  sometimes  paid  for  in  instalment  payments  arranged 
for  each  individual  case,  or  the  subscription  contract  may  pro- 
vide that  certain  percentages  uniform  for  all  subscriptions  shall 


Ch.  7]  STOCK  SUBSCRIPTION  SYSTEM  1089 

If 

come  due  on  predetermined  dates,  or  upon  call  of  the  board  of 
directois.  The  instalment  book  is  used  when  an  instalment  of 
the  latter  class  falls  due,  or  when  a  call  or  assessment  is  decided 
upon  by  the  board  of  directors. 

As  will  be  seen  by  reference  to  the  form,*  this  book  contains  a 
list  of  the  subscribers,  the  number  of  shares  subscribed  by  each, 
and  the  amount  of  the  instalment  due,  together  with  other  infor- 
mation relating  to  the  particular  instalment.  A  new  page  or 
sheet  is  made  out  for  each  call  or  instalment.  Instead  of  re- 
writing the  names  foi  each  of  these,  the  same  list  may  be  utilized 
by  ruling  up  the  page  with  groups  of  columns,  each  group  adapted 
for  one  instalment;  or  by  the  use  of  short  pages  after  the  first. 
This  arrangement  may  cause  some  little  inconvenience  in  case 
subscription  rights  and  instalments  are  transferred,  thereby 
necessitating  changes  of  names. 

Various  methods  of  handling  the  instalment  book  are  in  use, 
but  that  which  is  most  accepted  seems  to  be  to  consider  it  as  a 
subsidiary  ledger  to  the  Instalment  account,  discussed  in  the 
next  section  where  the  relation  of  the  instalment  book  to  the 
other  records  is  explained. 

The  number  in  the  first  column  of  the  instalment  book  indi- 
cates the  folio  of  the  subscription  ledger  in- which  the  subscriber's 
account  is  recorded.  The  figure  in  the  last  column  preceding 
the  Remarks  column  indicates  the  cash  book  folio  to  which  the 
payments  may  be  carried  in  total  each  day,  these  payments  being 
credited  to  Instalment  account.  Since  instalments  on  subscrip- 
tions are  not  necessarily  paid  on  their  due  date,  it  is  advisable 
to  carry  the  total  of  each  day's  receipts  to  the  cash  book,  instead 
of  waiting  until  all  are  paid.  It  is  obvious  that  an  Instalment 
account  must  be  opened  in  the  general  ledger  and  charged  with 
the  aggregate  amount  of  subscriptions  due  at  that  particular 
date.  The  same  procedure  is  required  for  each  succeeding 
instalment. 

The  instalment  book  is  compiled  from  the  subscription  ledger 

*  See  Bpok  IV.  Form  255. 


lOQO  CORPORATE  ACCOUNTING  [Bk.  HI- 

or  from  the  various  subscription  sheets  or  individual  subscription 
blanks,  and  may  be  either  a  bound  or  loose-leaf  book.  Loose 
sheets  serve  the  purpose  nicely,  since  they  can  afterward  be 
bound  together  for  fihng. 

When  subscribers  to  stock  are  few  in  number,  the  instalment 
book  may  be  dispensed  with;  and  cash -received  on  instalments 
may  be  entered  directly  in  the  cash  book,  and  thence  posted  to 
the  respective  subscribers'  accounts  in  the  subscription  ledger 
and  in  total  to  the  proper  account  in  the  general  ledger. 

itV/ 

§  59.    The  Instalment  Account 


Debit:  •  Credit:  If 

With  the  amount  of  instalments  due  With     payments     on     account     of 

by  subscribers  to  shares  of  stock,  the      instalment  subscriptions, 
offsetting  credit  being  to  Subscriptions 
to  Stock  account. 

u6 
This  account  is  employed  only  when  a  considerable  amount 
of  stock  has  been  subscribed — usually  at  the  time  the  corpora- 
tion is  organized — and  payment  therefor  is  to  be  made  in  instal- 
ments in  fixed  amounts  and  at  fixed  times  or  on  call. 

The  account  is  opened  afresh  each  time  an  instalment  falls 
due.  As  each  instalment  is  due  a  credit  is  made  to  Subscriptions 
to  Stock,  and  a  debit  to  the  particular  instalment,  as  "Instal- 
ment No.  I,  25%,"  "Instalment  No.  2,  25%,"  and  so  on,  as  the 
case  may  be.  It  shows  a  debit  balance  and  remains  open  only 
until  payments  on  the  particular  instalment  are  made.  a  enorJ 
In  the  case  of  a  close  corporation,  where  the  number  of  indi- 
vidual subscribers  is  small,  it  is  often  the  practice  to  debit  their 
individual  accounts  on  the  general  ledger  when  the  subscriptions 
are  originally  made  (instead  of  opening  a  Subscriptions  to  Stock 
account),  or  to  debit  their  accounts  with  the  amount  of  each 
instalment  as  the  call  is  made  (instead  of  opening  an  Instalment 
account) .  If  there  are  many  subscribers,  this  plan  is  objection- 
able as  encumbering  the  general  ledger  with  a  large  number  of 


Ch.  7]  STOCK  SUBSCRIPTION  SYSTEM  tO^l 

stockholders'  accounts  which  could  better  be  contained  in  a 
subscription  ledger. 

When  the  Instalment  account  is  used,  its  balance  must  be 
added  to  the  balance  in  the  Subscriptions  to  Stock  account  to 
ascertain  the  amount  due  on  subscriptions.  The  instalment 
book  is  a  ledger  subsidiary  to  the  Instalment  account;  the  sub- 
scription ledger  is  subsidiary  to  the  Subscriptions  to  Stock 
account.  When  an  instalment  is  to  become  due,  an  entry 
debiting  Instalment  and  crediting  Subscriptions  is  made  on  the 
books  for  the  total  amount  of  the  call.  This  must  be  credited 
to  the  accounts  of  all  the  subscribers  against  whom  it  applies, 
thereby  keeping  the  subscription  ledger  in  reconciliation  with  its 
controlling  account.  Subscriptions  to  Stock. 

The  entry  of  the  charges  for  the  instalment  in  the  instalment 
book  makes  the  total  as  shown  by  that  book  equal  the  total  as 
shown  by  the  Instalment  account  on  the  general  ledger.  The 
payments  of  the  subscribers  are  credited  to  Instalment  account 
in  total,  and  in  detail  to  their  accounts  on  the  instalment  book, 
maintaining  the  reconciliation  between  the  instalment  book 
(subsidiary  ledger)  and  Instalment  account  (control). 

§  60.    Stock  Sold  on  Instalments  (Plan  i)     '^  '-^-  xij.ijiid 

The  Lancaster  Cement  Company  was  organized  June  i, 
1922,  with  a  capital  stock  of  $1,000,000,  one-half  of  which  was 
subscribed  for  as  follows:  hiz  ifrt^ffii^rtf  '4rT^  \fji3b 

Ronald  Logan 1,000  shares 

li.    .'!',i    Samuel  Bennett ;  ...'i.  .';...■... .  1,000      " 

I »n ^) n '^ij   '^•W- Thompson :^iUj^.m4i. :i'ii.  ■  ■  1,000      " 

.J.H.Connor >  .- .,  .i..".  ,,rt,n, 1,000      " 

Oliver  Ferguson 1,000 

The  terms  of  subscription  are  10%  down,  30%  on  June  21, 
and  the  remainder  in  two  instalments  as  shown  by  the  agreement. 

The  instalment  book  shows  the  method  of  recording  calls 
for  instalments.  The  first  call  was  made  by  the  trustee  June  i; 
the  second  presumably  upon  final  incorporation. 


I092  CORPORATE  ACCOUNTING  [Bk.  III- 

As  one-half  of  the  stock  was  subscribed  at  the  time  of  organ- 
ization, this  amount  may  at  once  be  entered  upon  the  books  as 
an  asset,  since  it  represents  definite  obUgations  due  the  company. 

First  Entry: 

June  I,   1922 

Capital  Stock  Unissued $i,ooo,ocx3 

To  Capital  Stock  Authorized. . .  .„  .:<yYf* $1,000,000 

Second  Entry: 

Subscriptions  to  Stock $500,000 

To  Capital  Stock  Subscribed $500,000 

The  Lancaster  Cement  Company  was  organized  on 
this  date  with  capital  stock  of  $1,000,000,  divided 
into  10,000  shares  of  the  par  value  of  $100  each, 
one-half  of  which  has  been  subscribed  as  per  the  ..'. 

following  list.     Terms  of  subscription  are  10%  on 
Ul     June  I,  1922,  30%  on  June  21,  and  the  remainder  in 

two  instalments  as  per  agreement.  ^(  k  ,<  1 

Ronald  Logan 1,000  shares  yroK?; 

Samuel  Bennett 1,000      " 

J '  ^     A.  W.  Thompson 1,000      " 

J.  H.  Connor 1,000      *' 

OUver  Ferguson 1,000      " 


5.000 

§  61.    Entries  for  the  Instalments 

The  amount  subscribed  being  now  entered  upon  the  books, 
the  next  step  is  to  make  entries  for  the  instalments  as  they  come 
due,  the  Instalment  account  being  debited  and  Subscriptions 
credited.  The  accounts  of  subscribers  must  be  shown  either  in 
the  subscription  ledger,  the  instalment  register,  or  the  general 
ledger.  Sometimes  they  are  placed  in  the  back  of  the  general 
ledger,  but  if  they  are  numerous  it  is  advisable  to  place  them  in  a 
separate  book.  Of  course,  the  total  of  the  balances  of  these 
accounts  must  agree  with  the  balance  of  the  Subscriptions 
account  in  the  general  ledger,  which  is  the  controlling  account. 
If  the  number  of  subscribers  is  large,  an  instalment  sheet  is  made 
out.5 


•  See  Book  IV,  Form  255. 


Ch.  7]  STOCK  SUBSCRIPTION  SYSTEM  IO93 

Third  Entry: 

June  I,   1922 

Instalment  No.  i $50,000 

To  Subscriptions  to  Stock $50,000 

First  instalment  for  10%  of  $500,000  subscriptions,  as  per 
subscription  list  and  instalment  book. 

As  the  payments  are  made  they  are  credited  to  the  Instalment 
account.  The  following  entries  assume  that  all  the  subscribers 
pay  the  instalment.  If  this  is  not  the  case,  the  actual  amount 
received  will  be  entered,  leaving  a  balance  due  in  Instalment 
No.  I. 

Fourth ErUry:  ,    ,,,,^ 

June  I,  1922 

Cash $50,000 

To  Instalment  No.  1 $50,000 

For  payment  of  first  instalment  of  10%. 

Fifth  Entry: 

June  21,  1922 

Instalment  No.  2 $150,000 

To  Subscriptions  to  Stock $150,000 

For  second  call,  30%  on  total  subscriptions  of  $500,000. 

Sixth  Entry 

June  21,  1922 

Cash $150,000 

To  Instalment  No.  2 $150,000 

For  payment  of  second  instalment  of  30%.  , , , , 

'  ■   "!  ■'! 

§  62.    Stock  Sold  on  Instalments  (Plan  i) — Ledger  Accounts 

The  general  ledger  accounts  resulting  from  the  foregoing 
entries  are  as  follows : 

Capital  Stock  Authorized 


1922 

June  I     Authorized $1,000,000 


Capital  Stock  Unissued       'oR  -f-r' 


1922 

June  1     Authorized $1,000,000 


1094 


CORPORATE  ACCOUNTING 
Capital  Stock  Subscribed 


[Bk.  m- 


1922 

June  I     Subscriptions.  ...     $    500,000 

Subscriptions  to  Stock 


1922  1922 

June  I     Subscribed $    500,000     June    i     Instalment  No.  i .    $     50,000 

21     Instalment  Nq.  a.         150,000 

'  ■Drill    .■ 

Instalment  No.   i — 10%  '' 


1922 


June  I     Subscriptions. ...     $     50,000 


1922 

June  I     Cash 

(If  not  all  paid  a 
balance  will  re- 
sult.) 


$     50,000 


Instalment  No.   2 — 30% 


1922 

June  21     Subscriptions. . 


$    150,000 


1922 

June  21     Cash 

(If  not  all  paid 

a  balance  will 

result.) 


$    150,000 


Cash 


1922 

June  I     Instalment  No.  I.    $      50,000 
21     Instalment  No.  2.  150,000 


If  the  names  are  not  too  numerous  or  the  instalments  too 
frequent,  each  instalment  account  might  include  on  the  debit 
side  the  names  of  subscribers  and  the  amount  due  from  each; 
though  this  is  not  necessary,  as  all  this  information  is  clearly  set 
forth  on  the  instalment  sheet  or  book. 


§  63.     Stock  Sold  on  Instalments  (Plan  2) 

Under  the  plan,  in  which  a  Capital  Stock  account  takes  the 
place  of  the  Capital  Stock  Authorized  and  Capital  Stock  Unis- 


Ch.  7]  STOCK  SUBSCRIPTION  SYSTEM  1095 

sued  accounts,6  the  entries  suggested  below  would  be  made.  It 
will  be  recalled  that  in  this  case  Capital  Stock  account  exhibits 
only  the  capital  actually  contributed,  being  increased  for  each 
instalment  paid  in,  and  also  for  any  subsequent  sales  of  stock  of 
original  issue.  The  entry  of  unissued  stock  is  manifestly  out  of 
the  question  under  this  plan  of  entry. 

June  I,  1922  -iJOiti      ^.>>  ^ 

Subscribers $50,000 

To  Capital  Stock $50,000 

The  Lancaster  Cement  Company  was  organized  on  this 

date  with  capital  stock  of  $1,000,000,  divided  into 

10,000  shares  of  the  par  value  of  $100  each,  one-half 

,       of  which  has  been  subscribed  as  per  the  list  given  below. 

Terms  of  subscription  are  10%  on  June  i,  1922,  30%  on 

'        June  21,  and  the  remainder  in  two  instalments  as  per 

'       agreement.     First  instalment,  10%  on  $500,000,  now  olij; 

due. 

{List  of  Subscribers) 

June  I,  1922 

Cash .1 $50,000 

'         To  Subscribers $50,000 

• .   For  payment  of  first  instalment. 

June  21,  1922 

Subscribers $150,000 

To  Capital  Stock $150,000 

For  second  call,  30%  of  $500,000. 

June  21,  1922 

Cash $150,000 

To  Subscribers .,4.^^.j^,.-jji ,  $150,000 

Payment  of  second  instalment  of  30%.  ^  ' 

If  thought  advisable,  the  journal  entries  might  be  omitted 
and,  the  Subscribers  account  being  eliminated,  only  cash  book 
entries  be  made,  crediting  Capital  Stock;  but  this  does  not  per- 
mit the  full  explanations  which  can  be  so  conveniently  placed  in 
the   journal. 

•  See  f  36. 


CHAPTER  VIII 

SALE  OF  STOCK  BELOW  OR  ABOVE  PAR 

§  64.    Stock  Sold  Below  Par 

Stock  is  sometimes  sold  on  original  issue  at  less  than  par 
regardless  of  the  liability  for  the  unpaid  balance  which  attaches 
to  such  stock  so  long  as  it  is  in  the  hands  of  the  original  pur- 
chasers or  those  who  purchase  from  them  with  knowledge  of  the 
conditions.  Attention  should,  however,  be  called  to  the  fact 
that  there  is  a  difference  between  selling  stock  below  par  and 
allowing  a  commission  on  the  sale  of  stock,  whereby  the  amount 
the  corporation  receives  is  also  reduced.i 

To  illustrate  the  entries  in  cases  where  stock  is  sold  below  par, 
assume  that  on  August  15,  1921,  $100,000  of  the  unissued  stock 
of  the  Harvard  Milling  Company  is  sold  to  Henry  Jones  for 
$80,000,  payable  $40,000  on  date  of  purchase,  and  the  balance 
in  one  month.  For  the  purpose  of  presenting  another  method  of 
handHng  the  accounts,  it  is  assumed  in  this  example  that  no 
more  sales  of  stock  to  outsiders  are  to  be  made,  or  that  such 
sales  are  going  to  be  so  few  that  the  corporation  prefers  the  use  of 
individual  general  ledger  accounts  to  the  opening  of  a  subsidiary 
ledger.     The  entries  are  as  follows : 

August  15,  1921 

Henry  Jones .0  'i'Vnili'.i'  1'^ •      $80,000 

Discount  on  Stock 20,000 

To  Capital  Stock  Subscribed $100,000 

For  sale  of  1,000  shares  of  unissued  stock  to  Henry  Jones 
Hi     at  $80  per  share,  payable  $40,000  down  and  the  balance 
in  one  month. 

Cash $40,000 

To  Henry  Jones $40,000 

First  payment  on  subscription  to  1,000  shares  of  stock. 

>  See  {  loS. 

iog6 


Ch.  8]  SALE  OF  STOCK  BELOW  OR  ABOVE  PAR  1097 

September  15,  1921 

Cash $4o,ooc 

To  Henry  Jones $40,000 

Balance  of  payment  on  subscription  of  1,000  shares  of 
stock. 

Capital  Stock  Subscribed $100,000 

To  Capital  Stock  Unissued $100,000 

Certificate  No.  11  issued  to  Henry  Jones  upon  full  pay- 
ment of  his  subscription. 

§  65.    Discount  on  Stock  Account 


Credit: 


With  any  transfer  from  this  account, 
by  amortization  or  otherwise,  to  Surplus 
or  any  other  account. 


Debit: 

With    the    discount   on    stock    sold 
below  its  par  value. 

•v'  The  debit  balance  of  this  account  shows  the  amount  of  dis- 
count not  written  off.  Discount  on  sales  of  capital  stock  may  be 
considered  a  loss,  in  which  case  it  is  of  course  a  capital  loss  rather 
than  a  loss  from  operations;  or,  as  it  is  a  cost  of  developing  the 
business  which  remains  as  one  of  the  things  on  which  a  selling 
price  might  theoretically  be  based,  it  may  be  considered  an 
intangible  asset  partaking  somewhat  of  the  nature  of  good-will, 
i  .  Under  the  first  point  of  view  the  practice  has  beento  amortize 
such  discounts  over  a  term  of  five  or  ten  years  by  annual  debits 
to  Surplus  or  monthly  or  annual  debits  to  Profit  and  Loss — 
preferably  by  the  debits  to  Surplus.  In  some  cases  the  directors 
close  the  Discount  account  immediately  into  Surplus,  considering 
it  best  to  remove  from  the  balance  sheet  what  may  be  considered 
an  undesirable  item.     The  following  entry  shows  such  a  transfer: 

Surplus $20,000 

To  Discount  on  Stock $20,000 

To  close  Stock  Discount  account  into  Surplus — entry  made 
by  order  of  the  Board  of  Directors. 

The  above  entry  will  suffice,  perhaps,  in  case  the  profits  are 
ample  to  take  care  of  the  discount,  but  nothing  is  gained  if  by 
this  disposition  a  deficit  is  created  in  the  Surplus  account. 

Under  the  other  point  of  view,  that  the  discount  is  not  to 


ioqS       h/M  ;IV corporate  accounting  [Bk.  iii- 

be  charged  off,  it  would  continue  to  be  carried  as  an  asset, 

although  the  account  might  perhaps  be  merged  into  some  other 

by  such  an  entry  as:  ^   ,  .,.     ,  ; 

Cost  of  Development ■ $20,000 

To  Discount  on  Stock $20,000 

To  close  the  latter  account. 

§  66.     Stock  Sold  Above  Par 

When  a  corporation  sells  its  stock  at  a  premium,  the  proceeds 
in  excess  of  the  par  value  are  credited  either  to  Premium  account 
or  to  Paid-in  Surplus  account,  and  represent  gains,  but  these, 
like  the  losses  on  stock  sold  at  a  discount,  are  not  due  to  the 
operation  of  the  business  and  must  not  be  confused  on  the 
books  with  operating  profits.  The  former  practice  was  to 
amortize  such  premiums  over  a  period  of  five  or  ten  years  by 
monthly  or  yearly  credits  to  Profit  and  Loss,  but  on  account  of 
income  tax  laws  it  is  desirable  to  avoid  any  plan  which  will 
make  it  less  easy  to  determine  the  sources  of  surplus.  The 
preferred  present  practice  is  to  retain  the  Premium  account  a»  a 
classification  of  Surplus, 2  or  to  credit  the  entire  balance  in  the 
account  to  Surplus  at  one  time,  usually  when  all  the  stock  which 
is  being  offered  has  been  sold.  The  latter  practice  is  general 
in  banks  and  other  corporations  where  it  is  the  practice  to  sell 
stock  at  a  premium  even  at  the  time  of  organization.s 

The  Premium  on  Capital  Stock  account  is  the  same  account 
which  was  earlier  discussed  and  its  functions  given  under  the 
name  of  "Paid-in  or  Contributed  Surplus. "*  Discounts  on  sales 
of  capital  stock,  if  less  than  the  amount  of  premium  earned  on 
other  sales,  should  eventually  be  closed  from  the  Discount  ac- 
count into  this  account. 

In  case  the  Premium  account  is  closed  into  Surplus,  when, 

as  is  the  case  with  banks,  surplus  means  premium,  or  when,  as 

in  many  other  institutions,  the  advisability  of  maintaining  the 

10  '>i/>'j  aajjj  oj 


'  See  Ch.  IV,  "Classification  of  Surplus.'' 
'  See  also  §  68. 
«  See  i  24. 


Ch.  8]  SALE  OF  STOCK  BELOW  OR  ABOVE  PAR  IO99 

surplus-classification  accounts  has  not  been  realized,  or  in  case 
it  is  closed  by  the  older  method  into  Profit  and  Loss,  Premium 
account  would  of  course  be  debited  and  the  account  to  which 
it  is  transferred  be  credited. 

§  67.    Accounting  Treatment  of  Premiums 

To  illustrate  the  accounting  treatment  of  premiums,  assume 
that  $100,000  face  value  of  the  unsubscribed  stock  of  the  Harvard 
Milling  Company  has  been  sold  November  i,  192 1,  to  George 
Bowers  for  $120,000,  payable  $50,000  at  date  of  purchase  and 
the  balance  in  one  month.  The  entries  for  the  transaction 
would  be  as  follows: 

November  I.  1921   ..^^  ^y-, 

George  Bowers  (or  Subscriptions) $120,000 

To  Capital  Stock  Subscribed .\  1  $100,000 

Stock  Premium 20,000 

^.  The  Harvard  Milling  Company  has  this  day  sold  to      ff'n;?  v 
George   Bowers   $100,000   of   its   unissued   stock   for 
$1 20,000;  $50,000  is  payable  on  the  day  of  purchase,  and 
the  balance  in  30  days. 

Cash $50,000 

To  George  Bowers $50,000 

First  payment  on  account  of  subscription  to  stock. 

December  i,  192 1 

Cash $70,000 

To  George  Bowers $70,000 

Balance  due  on  account  of  subscription  to  stock. 

§  68.     Stock  Issued  at  a  Premium  to  Create  a  Surplus 

In  the  previous  illustration  the  stock  of  an  estabUshed 
company  was  sold  at  a  premium.  As  already  stated,  it  is  not 
unusual  for  a  corporation  to  sell  its  stock  above  par  at  the  time 
bi  incorporation,  for  the  purpose  of  creating  a  surplus — a  practice 
which  is  usually  followed  by  insurance  companies,  banks,  trust 
companies,  and  other  financial  institutions.  A  company  with  a 
substantial  surplus  is  more  likely  to  possess  the  confidence  of 


IIOO  CORPORATE  ACCOUNTING  [Bk.  lU- 

the  public  than  one  that  has  none;  and  by  selling  stock  at  a 
premium  a  more  or  less  substantial  surplus  or  margin  is  provided 
at  the  outset,  which  may  be  drawn  upon  to  meet  organization 
expenses,  and  carry  the  company  and  give  it  solidity  until  it 
becomes  firmly  established. 

When  stock  is  thus  sold  at  a  premium,  the  entries  are  the 
same  as  in  any  other  sale  above  par.  For  example,  if  a  share 
of  stock  is  sold  for  $150,  its  par  value  of  $100  might  be  credited 
to  Unissued  Stock  or  Capital  Stock,  and  the  $50  to  Premium 
or  Surplus.  tl 

There  are  material  advantages  in  this  plan  of  selling  stock, 
especially  in  the  case  of  a  national  bank,  where  a  double  liability 
is  attached  by  statute  to  every  share  of  its  stock.  If  the  stock 
is  sold  at  a  premium  sufficient  to  meet  the  statutory  liability, 
not  only  is  this  liability  provided  against,  but  the  bank  is  given 
a  substantial  and  desirable  addition  to  its  working  capital. 

In  any  such  case  the  premium  is  credited  to  Surplus.  Thus, 
assume  that  the  Second  National  Bank  of  Shawmut  has  been 
incorporated  with  a  capital  stock  of  $250,000,  all  of  which  has 
been  sold  at  a  premium  of  50%.  The  book  entry  would  appear 
as  follows: 

Cash $375t000 

To  Capital  Stock $25o,cxx> 

Surplus 125,000 

The  Second  National  Bank  of  Shawmut,  incorporated 
with  capital  stock  of  $250,000,  has  on  this  date  sold  it  at 
a  premium  of  50%. 

This  contributed  surplus  remains  on  the  books  as  a  credit 
to  Surplus  account. 

lit  i     ;  (I 


CHAPTER  IX 


nu   //oiiJ^EA^U^Y  STOCK  WITH  A  PAR  VALUE 

§  69.    Definition 

The  term  "treasury  stock"  is,  strictly  speaking,  limited  to 
stock  which  has  once  been  issued  for  value  and  which  through 
purchase  or  gift  has  been  returned  to  the  possession  of  the 
issuing  company.  The  unissued  stock  of  a  corporation  should 
not  be  called  treasury  stock.i 

§  70.    Treasury  Stock  Account  2 


Debit: 

With  the  par  value  of  stock  issued  by 
a  corporation  and  subsequently  repur- 
chased by  it. 


Credit: 

With  the  par  value  of  treasury  stock 
sold  or  retired  by  a  reduction  in  the 
amount  of  authorization. 


Although  the  practice  was  formerly  different,  the  principle 
seems  now  to  be  accepted  that  the  debit  to  Treasury  Stock 
account  for  the  repurchase  of  a  corporation's  own  stock  should  be 
for  the  par  value  of  the  stock  irrespective  of  the  purchase  price. 
The  necessary  entries  are  shown  below.  Although  the  balance 
of  the  Treasury  Stock  account  is  a  debit,  treasury  stock  cannot 
be  considered  an  asset  similar  to  stock  of  another  corporation. 
The  acquirement  of  treasury  stock  is  a  reduction,  for  the  time 
at  least,  of  the  amount  of  capital  stock  outstanding,  and  should 
be  shown  on  the  balance  sheet  as  a  deduction  from  capital;  thus: 

Ifcjff/j/i'if:      _  inn  ')A£i  bimy)  J m.ui: 

Capital  Stock ,........< $200,000 

Less  Stock  in  Treasury 25,000 


Outstanding .  . . .j^^r^ ife^JHiiJii -ijf 


$175,000 


'  For  technical  discussion  of  treasury  stock,  see  Book  I,  Ch.  XIII,  "Treasury  Stock." 
'  Separate  account  for  each  class  of  treasury  stock  owned. 


II02  CORPORATE  ACCOUNTING  (Bk.  fll- 

When  treasury  stock  is  carried  on  the  books  in  any  other 
way  than  at  par,  this  offset  cannot  be  made  without  taking 
into  consideration  facts  not  shown  in  the  trial  balance.  If  the 
above  treasury  stock  with  a  par  value  of  $25,000  had  been 
purchased  for  $20,000  and  entered  on  the  books  at  cost,  the 
deduction  of  $20,000  from  the  capital  stock  would  show  an 
erroneous  amount  of  outstanding  stock. 

Treasury  stock  includes  donated  stock,  which  is  discussed 
separately  in  the  following  chapter.  In  the  present  chapter 
only  repurchased  stock  is  considered. 

§  71.    Entries  for  Purchase  at  Par  or  at  a  Discount  ' 

To  illustrate  the  accounting  treatment  of  purchases  of  a 
company's  own  stock,  suppose  that  it  repurchases  at  par  500 
shares  of  its  fully  paid  stock.  If  par  is  $100  per  share,  the 
entry  will  be : 

Treasury  Stock $50,000 

To  Cash $50,000 

500  shares  of  this  company's  stock  purchased  from  H.  T. 
Jeffries,  certificates  Nos.  123  and  124  being  surrendered.     u^WOfLllA 

'.d  ; Transatctions  in  treasury  stock  when  the  purchase  price  is, 
not  par  involve  certain  complications.  The  mere  fact  that  a 
corporation  repurchases  its  stock  at  a  discount  does  not  imply 
that  a  profit  has  been  made  and  that  Surplus  should  be  credited 
with  the  amount  of  the  discount.  Until  the  stock  is  sold  at  a 
higher  price  than  that  which  is  paid  there  is  no  realized  profit, 
and  unless  the  stock  can  be  shown  to  be  unquestionably  worth 
more  than  it  cost,  the  discount  does  not  represent  any  profit  at 
all  of  which  an  accountant  could  take  note.  The  best  treatment 
of  the  discount  is  to  credit  it  to  an  account  known  as  "Con- 
tingent Profit  on  Stock,"  or  by  some  other  name  which  will 
clearly  indicate  that  it  is  not  a  realized  or  even  a  certain  profit. 
The  proper  entry,  then,  for  the  purchase  for  $10,000  of  stock 
with  a  par  value  of  $15,000,  would  be: 


Ch.9] 


TREASURY  STOCK  WITH  A  PAR  VALUE 


1 103 


Treasury  Stock $15,000 

To  Cash , , ,.  $10,000 

Contingent  Profit  on   Stock.  !^l!?.^^m3^^'P-  5,000 

{with  the  necessary  explanation.)  ;  r; i  w 


§  72.     Contingent  Profit  on  Stock  Account 


•uVJ 


Debit: 

With   the   amount   credited   to   this 
account  at  the  time  of  the  purchase  of 
treasury  stock,  this  entry  to  be  made  at 
tke  time  of  selling  the  stock. 

Credit: 

With  the  discount  at  which  treasury 
stock  is  bought. 

flia 

The  credit  balance  of  the  account  shows  the  difference  be- 
tween the  par  value  and  the  purchase  price  of  stock  repurchased 
at  a  discount  and  still  held.  To  maintain  this  condition  on  the 
books  it  is  necessary,  at  the  time  of  every  sale  of  treasury  stock, 
to  debit  Contingent  Profit  on  Stock  with  the  amount  creditec| 
to  the  account  at  the  time  of  making  the  purchase. 


>ji.),Oi'S>     iOi 


§  73.    Entries  for  Sale  of  Treasury  Stock  Purchased  at  a  Discount 

If  the  $15,000  par  of  stock  shown  above  as  having  been 
purchased  for  $10,000  were  sold  for  $10,000,  the  entry,  just  the 
reverse  of  that  previously  made,  would  be : 

Cash $10,000 

Contingent  Profit  on  Stock S,ooo 

To  Treasury  Stock $15,000 


If  it  were  sold  for  par  the  entry  would  be : 


rr 


•K 


Cash $15,000 

Contingent  Profit  on  Stock ^*.  »'i  i  v .  ^ '.  v  *  J  i  i>i<>(, .  ,  ,5,900  i  /  r 

To  Treasury  Stock > .  y,  ,u  ^.  $15,000 

Surplus ,           "  5,000 

'The  contingent  profii:  would  be  fully  realized  by  this  sale 
and  should  be  credited  to  Surplus  or  Profit  and  Loss,  preferably 
the  former,  as  the  profit  is  not  one  from  normal  operations  and 
is  not  an  item  which  enters  into  taxable  income. 

If  the  selling  price  were  $12,500,  a  gain  of  $2,500  would  be 


II04  CORPORATE  ACCOUNTING  [Bk.  UI- 

made  on  the  sale,  and  this  would  be  set  up  as  a  real  profit  now 
credited  to  Surplus  instead  of  the  $5,000  previously  set  up  in  the 
contingent  account.  ,, 

Cash .; $12,500 

Contingent  Profit  on  Stock V^v. I\H 5,000 

To  Treasury  Stock $15,000 

Surplus 2,500 

'If  half  the  stock  were  sold  for  $6,250,  the  facts  would  be 
similarly  recorded.  In  that  case  the  contingent  profit  on  that 
much  would  be  $2,500;  the  actual  profit,  $1,250.     The  entry  is: 

Cash -j'jTyK  .  ii'.]. . .-fn^-Jy.  jftt.;^.,,.. , $6,250 

Contingent  Profit  on  Stock 2,500 

To  Treasury  Stock $7,500 

^•-  ■  Surplus t".^*!. ■.(..i>»-^'^<i;kX>.. .  .  1,250 

If,  on  the  other  hand,  the  entire  block  of  stock,  purchased 
for  $10,000,  was  sold  for  $9,000,  not  only  would  there  be  a 
failure  to  lealize  the  contingent  profit,  but  there  would  be  an 
actual  loss.  This  would  necessarily  be  a  debit  to  Surplus. 
It  is  not  in  any  way  akin  to  the  selling  of  stock  of  original 
issue  at  a  discount  to  obtain  working  capital.  The  treasury  stock 
now  disposed  of  had  once  been  sold,  but  was  repurchased  by  the 
company  and  sold  at  a  less  figure.     The  entry  would  be : 

Cash $9,000 

Contingent  Profit  on  Stock 5,000 

.Surplus 1,000 

To  Treasury  Stock $15,000 

§  74.    Repurchase  of  Stock  at  a  Premium 

When  a  corporation's  stock  is  repurchased  at  a  price  above 
par,  the  excess  is  a  distribution  of  surplus.  Each  stockholder  in 
a  corporation  has  an  interest  in  surplus  to  the  extent  of  his 
pro  rata  part  of  the  capital  stock  of  the  corporation.  The  net 
worth  of  the  corporation  is  represented  on  the  books^  by  the 
capital  stock  and  surplus  groups  of  accounts.    When  the  stock- 

'See|4. 


Ch.yj  TREASURY  STOCK  WITH  A  PAR  VALUE  1105 

holder  surrenders  his  stock  he  should — were  sale  prices  not  based 
on  supply  and  demand,  previous  agreements,  etc.,  as  well  as  the 
equities — receive  therefor  the  par  value  of  the  stock  plus  his 
share  of  the  accumulated  surplus.  Whatever  he  leceives  above 
par,  however,  is  deducted  from  surplus  and  if  stock  of  a  par 
value  of  $15,000  is  bought  for  $20,000,  the  entry  will  be: 

Treasury  Stock $15,000 

Surplus i". .'.',; ......        S,ooo 

To  Cash » $20,000 

§  75.    Sale  of  Treasury  Stock  Bought  at  Par  or  at  a  F>remium 

Just  as  in  the  case  of  treasury  stock  bought  at  a  discount, 
such  stock  when  bought  at  a  premium  or  at  par  is  carried  on  the 
books  at  par,  Surplus  being  debited  if  the  purchase  was  made 
at  a  premium.  If  it  is  sold  below  par,  the  difference  is  a  debit 
to  Surplus,  which,  whether  the  stock  was  purchased  at  par  or 
at  a  premium,  is  thus  reduced  by  the  entire  loss  between  the 
purchase  and  sale  prices. 

If  the  stock  is  sold  at  a  premium  the  excess  above  par  is 
credited  to  Surplus.  In  the  case  of  stock  purchased  at  par  and 
sold  above,  Surplus  thus  reflects  the  gain.  In  the  case  of  stock 
purchased  and  sold  at  a  premium,  Surplus  is  first  debited  with 
the  difference  between  the  purchase  price  and  par,  and  later 
credited  with  the  difference  between  the  selling  price  and  par, 
so  that  the  net  result  is  that  Surplus  reflects  the  net  gain  or  loss. 

The  entries  for  sale  of  treasury  stock  as  summarized  are: 

,  For  sale  below  par: 

Cash  (selling  price) 

Surplus  (deficiency  below  par) 

To  Treasury  Stock  (par  value)  '  '' 

For  sale  at  par: 

Cash  (selling  price)  ',)^fl65I  .  -VV  ^ 

To  Treasury  Stock  (par  value) 
For  sale  above  par: 

Cash  (selling  price) 
•■  To  Surplus  (excess  above  par) 

Treasury  Stock  (par  value) 


?,OU  .'-Fl.i. 

CHAPTER  X  ^^^1=^ 

'  '   /Ilia 

PAR-VALUE  DONATED  STOCK 

§  76.    General  Conditions 

In  speculative  companies,  donations  of  stock  to  the  treasury 
are  customary,  and  give  rise  to  some  of  the  most  unsatisfactory 
entries  of  corporate  bookkeeping. 

Any  donation  to  a  commercial  undertaking  is  anomalous, 
but  when  it  takes  the  form  of  stock  just  issued  (and  hence  of 
unknown  value)  by  the  very  corporation  to  which  it  is  donated, 
the  transaction  is  entirely  outside  the  realm  of  ordinary  business 
and  its  proper  entry  is  difficult.  The  usual  object  of  such  a 
donation  of  stock  is  to  furnish  the  newly  organized  company 
with  stock  which  can  be  sold  below  par  without  carrying  with  it  a 
liability.  Treasury  stock  supplies  this  need,  and  so  long  as  the 
laws  relating  to  full-paid  stock  exist  in  their  present  form, 
so  long  will  transactions  in  donated  stock  continue.^ 

When  a  corporation  reacquires  its  own  stock  by  donation, 
this  stock  becomes,  from  the  accounting  standpoint,  an  asset 
of  a  type  exactly  similar  to  repurchased  stock,2  and  is  frequently 
debited  to  Treasury  Stock  account.  Many  authorities,  how- 
ever, consider  it  advisable  to  separate  on  the  books  the  trans- 
actions in  stock  purchased  and  stock  donated,  and  recommend 
carrying  the  latter  in  a  Donated  Stock  account.  There  is, 
however,  no  really  serious  objection  to  the  other  practice. 

§  77.    Reasons  for  Donation  of  Stock 

There  are  two  principal  reasons  for  the  donation  of  a  corpora- 
tion's own  stock  to  it  by  its  stockholders.     These  are:  (i)  that 

•  Under  the  laws  permitting  corporations  to  issue  stock  without  par  value,  stock  so 
issued  may  by  proper  procedure  be  sold  at  any  desired  price  without  liability.  See  Book  I, 
Ch.  XII,  "Full-Paid  Stocky"  and  Ch.  XV,  "Advantages  of  No-Par-Value  Stock." 

»  See  i  70. 

1 106 


Cn.  lo]  PAR- VALUE  DONATED  STOCK  I107 

it  may  sell  all  or  part  of  the  donated  stock  and  thus  provide 
working  capital  with  which  to  operate  a  business;  and  (2)  to 
cover  losses  that  have  already  been  sustained,  thus  wiping  out  a 
deficit  or  changing  it  into  a  surplus. 

The  first  condition  arises  from  the  fact  that  when  a  mine, 
an  oil  well,  or  some  similar  property  is  turned  over  to  a  corpora- 
tion by  a  promoter,  it  is  a  common  practice  to  issue  to  the 
promoter  the  entire  capital  stock  of  the  corporation  in  full 
payment  for  the  property.  The  corporation  then  has  no  more 
stock  to  sell  for  the  purpose  of  providing  working  capital  and 
developing  the  property,  but  as  the  promoter's  stock  will  have 
no  sale  value  unless  the  property  is  developed,  he  donates  to  the 
corporation  a  part  of  the  stock  which  had  been  issued  to  him. 
This  stock  is  sold  as  a  means  of  raising  working  capital.  The 
stock  so  donated  back  was  fully  paid  by  the  transfer  of  the 
property  from  the  promoter  to  the  corporation,  but  if  the  prop- 
erty acquired  with  the  stock  had  really  been  worth  the  par  value 
of  the  stock,  the  donation  would  represent  a  profit  and  would  be 
a  legitimate  credit  to  Surplus.  The  fact  that  the  promoter  im- 
mediately donates  back  a  part  of  the  stock  given  him  shows, 

,  ,  .  .  °M.li!.;:;     '     il'i!  /.  I'M? 

however,  that  the  price  was  excessive.  a    -A  •  , 

Stock  is  also  donated  back  to  the  corporation  at  times 
when  the  business  has  been  operated  at  a  loss  with  a  resulting 
deficit.  The  stockholders  may  agree  to  an  assessment,  or  those 
most  heavily  interested  may  make  a  donation  which  is  not 
pro  rata  against  all  the  stockholders.  In  either  case  the  gift  of 
stock  may  be  sold  immediately  if  the  business  needs  ready 
money,  or  it  may  be  held  as  treasury  stock  until  the  operating 
profits  justify  its  return  by  a  stock  dividend. 

The  present  practice  is  to  carry  donated  stock  on  the  books 
at  par,  for  the  same  reasons  for  which  other  treasury  stock  is 
carried  at  par.«  The  former  rule  of  estimating  its  market  value 
and  carrying  it  at  that  figure  has  come  into  disfavor. 

•  See  I  70. 


llo8  CORPORATE  ACCOUNTING  [Bk.  III_ 

§  78.    Donated  Stock  Account  * 


Debit: 

With  the  par  value  of  shares  donated 
to  the  treasury. 


•t; 


'ft 


Credit: 

With  the  par  value  of  shares  of 
donated  stock  sold,  or  retired  by  a 
reduction  in  the  amount  of  capital  stock 
authorized. 


As  has  been  said  earlier  in  the  chapter,  the  functions  of  this 
account  may  be  included  in  the  scope  of  the  Treasury  Stock 
account,  instead  of  opening  a  Donated  Stock  account. 


IMll,    IK 


§79.    Donated  Surplus  Account 


Credit: 

With  the  par  value  of  stock  donated 
back  to  the  company,  the  offsetting 
debit  being  to  Donated  Stock  account. 

With  the  excess  when  donated  stock  is 
sold  for  more  than  the  value  at  which  it 
was  credited  to  this  account. 


Debit: 

With  the  discount  on  donated  stock 
sold  below  the  value  at  which  it  was 
credited  to  this  account,  and  with  any 
expense  in  connection  with  such  sale. 

With  the  amount  transferred  at  any 
time  to  a  general  Surplus  account,  as  a 
result  of  gain  by  sale  of  stock  donated 

The  balance  of  this  account — also  known  as  Donation  or 
Working  Capital  Donated  account — is  always  on  the  credit  side 
and  is  an  offset  to  Donated  Stock  account.  Donated  Surplus 
is  credited  with  the  par  value  of  donated  stock  in  the  entry 
in  which  Donated  Stock  is  debited. 

As  donated  stock  is  sold  and  the  amount  of  the  donation 
realized  thereby,  such  profit,  after  deducting  any  expenses,  may 
be  carried  to  Profit  and  Loss  or  to  a  general  Surplus  account, 
or  else  be  permitted  to  remain  in  Donation  account  until  all  of 
this  stock  is  disposed  of.  It  may  then  be  closed  off  as  suggested, 
or  be  permitted  to  stand  as  a  credit  balance  to  the  account,  s 

§  80.    Entries  for  Donated  Stock  (First  Method)     ^^  it)'  .tsq  jj; 

If  a  corporation  is  organized  with  a  capital  stock  of  $75^000, 
all  of  which  is  issued  in  payment  for  property,  and  stock  of  the 

*  Separate  account  for  each  class  of  stock  donated. 

•  See  {  28. 


Ch.  lo]  PAR-VALUE  DONATED  STOCK  liog 

face  value  of  $10,000  is  returned  to  the  company  to  be  sold  to 
secure  operating  capital,  the  entries  will  be  as  follows:  id  A'jniy. 

Donated  Stock i.w  .  A''Ji)^.i'ii  .i-'.i-l'a  .i-iVAVii  Ais  . . .    $10,000 

To  Donation.  .  . ... ...  J; ..'.".'.  i..,. . .'.;.. .  $10,000 

Stock  donation  of  100  shares  to  be  sold  to  provide  working 
capital. 

If  the  stock  is  sold  at  par  the  following  entry  is  required: 

Cash $10,000 

To  Donated  Stock $10,000 

For  100  shares  of  treasury  stock  sold  at  $100  per  share. 

The  Donation  account  may  then  be  closed  into  a  general 
Surplus  account  as  follows:  ,,^  ^^.^^^  „^,|^i  vti-^amn 

Donation $10,000  • 

To  Surplus $10,000 

Closing  Donation  account  into  Surplus.  -.'  ■      ^ 

If,  however,  the  stock  when  sold  produced  more  than  par, 
say  $110  per  share,  the  cash  entry  would  be  as  follows:   ,    ;  1 

Cash ,...,..,.,,,,.„,..,.,,,.,,,.,..,.,, ,.,,^.  $11,000-   '  :     . 

To  Donated  Stock -  ...t-.., »/  — •  $10,000 

Donation 1,000 

For  100  shares  of  stock  donated  to  treasury  and  sold  at  I'OUb'-'i  ) 

$110  per  share.  , 

This  gives  a  total  credit  in  Donation  account  of  $11,000, 
which  is  the  amount  actually  realized  on  the  donated  stock. 
Donation  account  may  then  be  closed  into  Surplus  by  a  journal 
entry. 

If  on  the  other  hand  the  treasury  stock  is  sold  at  less  than 
par,  say  for  instance,  $40  per  share,  the  cash  entry  would  be 
as  follows: 

Cash $4,000  ' 

Donation 6,000 

To  Donated  Stock $10,000 

For  100  shares  donated  to  treasury  and  sold  at  $40  per  share. 

'  t  This  shows  a  credit  balance  in  Donation  account  of  $4,000, 
which  is  the  real  value  of  the  stock  donated,  and  the  account 
may  then  be  closed  into  Surplus.  *.....  . 


mo  CORPORATE  ACCOUNTING  [Bk.  III- 

t)J  iThe  objection  to  the  above  method  of  recording  -donated 
stock  lies  in  the  fact  that  it  shows  an  apparent  profit  before 
active  corporate  operations  have  begun,  or  even  before  the 
company  has  become  well  established.  At  this  stage,  when 
the  corporation's  sole  assets  are  the  property  taken  over  and 
the  stock  which  has  been  donated  to  it  (the  value  of  which  really 
rests  upon  this  same  property),  any  profits  shown  could  hardly 
be  other  than  fictitious;  certainly  not  unless  the  property  for 
which  the  stock  was  originally  issued  was  actually  worth  as  much 
as  or  more  than  the  face  value  of  the  stock,  in  which  case  a  real 
profit  from  donated  stock  would  result.  In  practice,  the  value  of 
property  taken  over  by  a  corporation  for  stock  is  seldom  con- 
servatively estimated,  and  the  apparent  profits  from  donated 
stock  are  usually  fictitious  and  misleading. 

§  8i.    Entries  for  Donated  Stock  (Second  Method)         "'     ' 

Under  the  second  method  of  entry,  the  donation  of  stock  is 
considered  as  a  concession  on  the  price  of  the  property  for  which 
it  was  issued,  and  the  value  of  the  returned  stock  is  accordingly 
credited  to  this  same  property  account.  This  reduces  the  book 
cost  of  the  property  to  the  corporation,  but  does  not  show  the 
immediate  and  usually  fictitious  profit  that  is  shown  by  the  first 
method  of  entry.  The  method  is  therefore  more  conservative 
than  the  one  first  presented,  and  is  to  be  preferred  as  putting  on 
the  books  a  more  correct  valuation  of  the  assets  secured  for  the 
stock.  Thus,  if  a  corporation  is  formed  with  a  capital  stock  of 
$100,000,  all  of  which  is  issued  in  payment  for  patent  rights,  the 
entry  would  be  as  follows: 

Patent  Rights $100,000 

To  Capita]  Stock $100,000 

Entire  capital  stock  issued  in  exchange  for  patent  rights. 
See  page  ....  of  minute  book. 

If  $25,000  face  value  of  this  stock  is  then  returned  to  the 
treasury,  it  is  credited  to  Patent  Rights  at  par,  the  entry  being 
as  follows: 


Qi.  lo]    ,  PAR- VALUE  DONATED  STOCK  nil 

Donated  Stock .>wJyK*393.i«i.i!-sn.t«0.  wii  -iiOflt  •  •    $25,000 

To  Patent  Rights. .- .- /.-....  $25,000 

For  250  shares  of  stock  donated  to  treasury  for  purposes  of 
the  corporation. 

If  this  stock  Is  sold  at  par  the  cash  entry  would  be  as  follows : 

Cash $25,000 

To  Donated  Stock $25,000 

For  250  shares  of  donated  stock  sold  at  par. 

If,  however,  the  stock  should  sell  at  more  than  par,  say  at 
$110  per  share,  the  excess  must  go  to  Patent  Rights  in  order 
to  show  the  true  rebate  or  concession  made  on  the  price.  The 
entry  would  therefore  be  as  follows: 

Cash $27,500 

To  Donated  Stock $25,000 

Patent  Rights 2,500 

For  250  shares  of  donated  stock  sold  at  $110  per  share. 
Originally  credited  to  Patent  Rights  at  par. 

Likewise,  if  the  stock  sold  at  less  than  par,  say  at  $40,  the 
deficiency  is  debited  to  Patent  Rights,  as  follows: 

Cash $10,000 

Patent  Rights 15,000 

To  Donated  Stock $25,000 

For  250  shares  of  donated  stock  sold  at  $40  per  share, 
originally  credited  to  Patent  Rights  at  par. 

By  this  method  the  book  value  of  the  intangibles  for  which 
the  stock  was  originally  issued  is  reduced  by  the  amount  realized 
from  the  sale  of  the  stock  donated  back  to  the  company. 

§  82.    Entries  for  Donated  Stock  (Third  Method) 

1 !  There  is  a  third  method  of  handling  such  transactions  as  this, 
which  in  theory  is  a  compromise  between  the  other  two.  By  it 
Patent  Rights  would  first  be  credited  with  the  par  value  of  the 
donated  stock,  but  the  sale  of  the  donated  stock  is  treated  as 
would  be  any  other  sale  of  treasury  stock,  no  further  change 
being  made  in  the  value  of  the  Patent  Rights  on  account  of  the 
donation. 


1112  CORPORATE  ACCOUNTING  [Bk.  III- 

Under  this  method  the  entries  for  recording  the  first  issuance 
and  donation  which  we  have  just  considered  would  be,  as 
before : 

Patent  Rights. ;Yf^V<fVf*1-'if^v-f  .Vf  Vf^^lV  ' ' " '  ^^°°'°°° 

To  Capital  Stock.  .  .- :'. $100,000 

Entire  capital  stock  issued  in  exchange  for  patent  rights. 
See  page  ....  of  minute  book. 

Donated  Stock $25,000 

To  Patent  Rights $25,000 

For  250  shares  of  stock  donated  to  treasury  for  purposes  of 
the  corporation. 

The  entries  for  the  sale  of  the  stock  would  be  as  follows:       • ) 

//  sold  at  par: 

Cash $25,000 

To  Donated  Stock $25,000 

If  sold  at  $80:  > 

Cash $20,000 

Discount  on  Donated  Stock S.ooo 

To  Donated  Stock $25,000 

//  sold  at  $120:  ' 

Cash $30,000 

To  Donated  Stock $25,000 

Surplus SiOoo 

§  83.    Advantage  of  Second  and  Third  Methods 

The  advantage  of  the  second  and  third  methods  of  handling 
donated  stock  lies  in  their  more  conservative  presentation  of  the 
cost  of  the  intangibles.  The  objection  is  urged  against  these 
methods,  however,  that  the  entry  may  by  inference  cast  some 
reflection  upon  the  directors'  usual  statement  in  their  resolution 
of  acceptance,  that  the  property  "is  of  the  reasonable  value  of 
the  stock  issued  therefor."  This  is  a  matter  for  the  treasurer 
of  the  corporation  and  the  directors  to  consider  and  decide  for 
themselves. 


;  )  1  i 


BxiJwJii  ion  -ya;  i^[o3ibuii  baa  ,;-!n);tflM  ;  jh'id'N 

CHAPTER  XI 

^  CAPITAL  STOCK  WITHOUT  PAR  VALUE"^  ^'"^'"^ 

§  84.    Using  a  Nominal  Value  for  No-Par  Stock   V>  ifi'vmifutrni 

'  The  nature  and  advantages  of  no-par-value  stock  and  the 
law  governing  its  issue  have  been  discussed  earlier  in  this  work.i 
In  introducing  the  accounting  for  stock  of  this  kind  it  is  necessary 
to  call  attention  to  a  frequent  but  mistaken  practice  of  giving  no- 
par  stock  a  nominal  value  for  book  purposes,  by  which  nothing  is 
gained  and  many  of  the  advantages  of  this  kind  of  stock  are  lost. 

The  practice  of  entering  no-par  shares  on  the  books  at 
a  specified  value  is  probably  the  result  of  habit  formed  in  dealing 
with  par-value  shares.  The  same  tendency  appears  when  a 
"minimum  stated  value"  is  required  by  statute,  as  is  the  case 
in  some  states,  and  also  when  a  "declared  value"  has  been  fixed 
in  the  company  minutes.  Often  a  nominal  value  is  adopted 
when  there  is  no  semblance  of  authority  or  reason  for  so  doing, 
and  no  basis  for  it  except  the  price  at  which  the  incorporators' 
or  other  early  shares  were  sold.  '^^^^  '^'^^  'niqnm 

Stock  which  is  issued  without  par  value  should  be  entered 
on  the  books  at  the  sale  price,  irrespective  of  any  other  factor. 
The  Capital  Stock  account  will  thus  show  the  amount  of  capital 
invested  in  the  business,  just  as  would  the  capital  accounts  of 
individual  proprietorships  or  partnerships  when  profits  are 
handled  through  an  undivided  profits  account  instead  of  being 
carried  to  the  capital  accounts.  The  fallacy  of  carrying  the 
capital  stock  at  the  meaningless  figure  of  a  stated  value  should 
be  readily  apparent. 

When,  however,  it  is  insisted  that  no-par  stock  be  carried  in 
the  accounts  and  on  the  balance  sheet  at  a  stated  value  (a  demand 


1  Pee  Book  I.  Chs.  XIV-XVI. 

III3 


1 1 14  CORPORATE  ACCOUNTING  (Bk.  Ifl- 

which  bookkeepers,  accountants,  and  auditors  are  not  always 
able  to  refuse)  the  excess  for  which  the  stock  was  sold  over  that 
stated  value — which  excess  might  be  called  the  "premium" — 
should  be  shown  as  capital  surplus  and  carefully  kept  distinct 
from  surplus  from  any  other  source.  It  is  a  part  of  the  original 
capital  of  the  corporation  and  any  distribution  of  it  would  be  an 
impairment  of  capital  from  the  standpoint  of  good  business. 
As  to  whether  the  directors  would  be  liable  on  account  of  such 
an  impairment  of  capital  is  a  matter  which  the  courts  have  not 

yet  passed  upon.  ,  „„;trnuv>'»H  Mfit  xinhiibminr  rrl 

The  principles  involved  in  handling  the  capital  stock  accounts 
when  no-par  stock  is  entered  on  the  books  at  a  stated  value  or  at 
a  uniform  price,  are  no  different  from  those  governing  the 
accounting  for  stock  with  a  par  value,  and  the  entries  need  not 
be  again  discussed.  ^^  ^iuiiJoiq  rA  t^uliiv  i>jilio;.q^  a 

§8^.    Entries  at  Actual  Value  •  •  <■.     ,       r    .  •   :^>' 

If  the  stock  is  to  be  handled  through  the  books  at  the  amount 
which  it  actually  brings  to  the  company — if,  in  other  words,  the 
Capital  Stock  account  is  to  show  the  amount  of  capital  actually 
invested — the  handling  of  transactions  in  no-par  stock  is  much 
simpler  than  that  of  dealings  in  stock  with  a  par  value.  There 
is,  in  the  first  place,  no  need  of  the  Capital  Stock  Authorized  and 
Capital  Stock  Unissued  accounts.  Certificates  of  stock  without 
par  value  indicate  simply  the  undivided  interest  of  the  holder  in 
the  net  worth  of  the  corporation,  according  to  the  number  of 
shares  held,  and  it  is  the  ratio  of  the  number  of  shares  held  by  the 
individual  to  the  total  number  outstanding  which  indicates  his 
proportionate  share.  The  general  books,  however,  deal  in  money 
values  and  not  in  shares  or  ratios,  so  that  the  Capital  Stock 
account2  shows  in  its  money  columns — which  alone  enter  into  the 
trial  balance — only  the  amount  paid  in  on  stock  and  deductions 
therefrom.     The  functions  of  the  account  are:  ■,  ^iur.  ^jiuj^- j  ;j.  -;. 

'Cf.l36. 


Ch.  ii]  CAPITAL  STOCK  WITHOUT  PAR  VALUE 

-c      :?  Capital  Stock 


1115 


Debit: 

Credit: 

With  the  price  at  which  shares  retired 

With  the  sale  price  of  the  shares 

were  credited   to  this   account    when 

issued.     The  corresponding  debit  is  to 

sold. 

Cash,  to  the  proper  property  account. 

or  to  Subscriptions  to  Stock,  as  the  case 

may  be. 

§  86.     Opening  Entries 

For  the  reason  that  it  is  impossible  in  the  case  of  no-par  stock 
to  indicate  the  authorized  capital  of  the  corporation  by  such  a 
journal  entry  as  is  used  in  setting  up  the  authorization  for  par- 
value  stock,  a  pro  forma  statement^  is  really  of  more  value  with 
no-par  than  with  par-value  stock.  The  opening  journal  entry 
will  show  the  subscriptions  for  stock  first  received. 

The  Mohawk  Automobile  Company  was  incorporated  on 
March  i,  1922,  with  an  authorized  capital  of  100,000  shares 
without  par  value.  At  the  time  of  incorporation  10,000  shares 
were  subscribed  for  at  $20  per  share,  of  which  one-half  was  paid 
down  in  cash  and  the  balance  two  months  later.  On  May  i, 
10,000  additional  shares  were  sold  for  cash  at  $25  per  share. 

The  first  entries  to  be  made  on  the  books  of  the  company  will 
show  the  subscriptions  to  stock.  The  credit  will  be  given  to 
Capital  Stock  if  the  subscriptions  are  paid  in  full,  or  to  Capital 
Stock  Subscribed  if  they  are  paid  only  in  part  and  the  certificates 
are  not  to  be  issued  immediately.    The  entries  are  as  follows: 


March  i,  1922 

Subscriptions  to  Stock $200,000 

To  Capital  Stock  Subscribed 

The  Mohawk  Automobile  Company  has  this  day  been 
organized  with  an  authorized  capital  of  100,000  shares 
without  nominal  or  par  value.  Subscriptions  for 
10,000  shares  at  $20  each,  payable  one-half  down  and 
the  balance  in  two  months,  have  been  received  from: 
(list). 


$200,CX30 

'J  fit 


■>)i?.  iKrj-on  n'f 


*  See  I  33. 


ill6                                CORPORATE  ACCOUNTING        t/.  >  [Bk.  Ill- 
Cash $100,000 

To  Subscriptions  to  Stock $100,000 

(Full  explanation  here.) 

May  I,   1922  ,. 

Cash.  . , ,,, , $100,000 

To  Subscriptions  to  Stock .j .  iW.  i  .VVl'^^^V.  $100,000 

(Full  explanation  here.) 

Capital  Stock  Subscribed $200,000 

To  Capital  Stock $200,000 

Certificates  Nos issued  to   ,  their 

subscriptions  having  been  paid  in  full. 

Cash 1 . . .  • . .    $250,000 

To  Capital  Stock $250,000 

For  sale  and  issuance  of  10,000  shares  of  the  remaining 
stock  at  $25  per  share  cash. 

The  later  subscription  might  if  desired  have  been  passed 
through  the  Subscriptions  account,  like  the  former,  but  the  only 
advantage  would  be  uniformity  in  practice.  There  is  also  no 
need  of  carrying  it  through  the  Capital  Stock  Subscribed  account, 
as  the  stock  is  immediately  issued. 

There  are  now  20,000  shares  of  stock  outstanding  on  which 
$450,000  has  been  paid,  giving  each  an  average  book  value  of 
$22.50  notwithstanding  the  fact  that  one-half  were  sold  at  $20 
per  share  and  the  remainder  at  $25.  Each  share  of  no-par-value 
stock  is  "equal  to  any  other  share  of  such  stock  subject  to  prefer- 
ences given  to  the  preferred  stock  if  any  authorized  be  issued."* 
This  is  as  it  should  be,  because  the  original  purchasers  of  stock 
have  to  take  the  chance  of  winning  or  losing  in  a  newly  organized 
corporation,  and  when  a  surplus  has  been  accumulated  the  in- 
coming stockholders  should  be  required  to  pay  therefor.  The 
sale  price  is  by  the  laws  of  most  states  left  to  the  directors,  or 
the  stockholders,  or  is  fixed  by  the  law  of  supply  and  demand. 

§  87.     Subsidiary  Records 

The  same  records  are  used  in  a  subsidiary  way  for  transactions 
in  no-par  stock  as  for  transactions  in  stock  with  a  par  value.     The 

♦Laws  of  1912.  N.  Y.,  Sec.  19. 


Ch.  ii] 


CAPITAL  STOCK  WITHOUT  PAR  VALUE 


ttfj 


certificate  stubs,  the  stock  ledger,  the  subscription  ledger,  the 
instalment  sheets — all  these  have  their  functions  and  are  used  in 
the  same  manner. 

Corporations  with  par- value  stock  are  able  to  tell  the  number 
of  outstanding  shares  by  subtracting  the  debit  balance  of  the 
Capital  Stock  Unissued  account  from  the  credit  balance  of  the 
Capital  Stock  Authorized  account,  and  dividing  the  difference 
by  the  par  value  of  the  stock.  But  that  is  impossible  with  stock 
of  no  par  value.  In  the  case  just  considered  the  Capital  Stock 
account  shows  a  balance  of  $450,000,  the  amount  received  for 
the  stock  outstanding.  To  find  out  how  many  shares  this  repre- 
sents it  is  necessary  to  trace  back  the  individual  transactions, 
unless  there  is  accumulated  on  the  ledger  page  of  the  Capital 
Stock  account  not  only  the  amounts  of  money  received  for  the 
stock,  but  also  the  number  of  shares  issued  therefor,  in  some  such 
manner  as  the  following: 

Capital  Stock 


1922 

Mar.  (Authorized  100,000 
shares,  no  nominal 
or  par  value) 

May  10,000  shares  at  $20 . . . 
10,000  shares  at  $25 . . . 


$200,000 
250,000 


The  aggregate  of  shares  thus  issued  is  the  control  for  the 
certificate  stubs.  The  same  plan  might  be  followed  with  the 
Capital  Stock  Subscribed  account,  in  which  the  diflference 
between  the  share  totals  would  show  the  amount  of  stock 
reserved  for  subscribers  and  not  issued.  In  the  present  instance 
the  ledger  sheet  of  this  account  would,  for  the  first  transaction, 
show  the  following  information: 

Capital  Stock  Subscribed 


1922 

May  I  Issued,  10,000  shares.   $200,000 


1922 
Mar.  I  Subscribed,   10,000 

shares -  •    $200,000 


IIj8  CORrORATE  ACCOUNTING  [Bk.  III- 

§  88.    Earned  Surplus  of  Corporations  with  No-Par  Stock 

The  earnings  of  corporations  with  no-par  stock  should  be 
carried  through  the  Surplus  account  just  as  are  the  earnings  of 
corporations  whose  stock  has  a  par  value.  As  stated  earlier  in 
the  chapter,  when  the  practice  of  giving  the  stock  a  stated  value 
is  followed,  this  surplus  should  be  carried  in  an  account  distinct 
from  the  capital  surplus  resulting  from  the  sale  of  stock  at  a 
price  above  its  stated  value. 

It  was  formerly  argued  that  when  stock  is  issued  without  par 
value  and  there  is  only  one  class  of  stock,  all  outstanding,  there 
is  no  necessity  for  making  a  division  between  the  Capital  Stock 
and  Surplus  accounts,  since  both  the  proceeds  of  the  sale  of 
stock  and  the  net  profits  of  each  fiscal  period  might  be  entered 
in  a  Capital  account.  Such  an  account  would  thus  be  credited 
with  the  amount  of  capital  paid  in  and  the  accumulation  of 
profits,  and  be  debited  with  the  distribution  of  dividends.  The 
theory  underlying  this  argument  is  that  the  very  purpose  of  no- 
par  stock  is  to  avoid  artificial  valuations  on  the  books,  showing 
a  true  value  instead  of  separating  the  paid-in  capital  and  the 
earnings.  Under  this  plan  the  Capital  account  would  change 
from  year  to  year,  or  each  time  the  books  are  closed,  like  the 
capital  of  a  partnership.  The  net  amount  credited  to  Capital 
divided  by  the  total  number  of  shares  outstanding  would  give 
the  book  value  per  share. 

It  is  now,  however,  an  accepted  principle  of  no-par-stock 
accounting  that  a  differentiation  should  be  made  between  the 
amount  paid  in  for  no-par  stock  (to  be  credited  to  the  Capital 
Stock  account  just  as  for  stock  of  a  par  value),  and  earnings 
(carried  to  the  Surplus  account).  When  this  is  done  the  book 
value  of  the  stock  is  found  by  adding  the  balances  of  Capital  and 
Surplus  accounts,  and  dividing  the  sum  by  the  total  number 
of  shares  outstanding.  The  separation  of  contributed  capital 
and  surplus  is  valuable  for  statistical  purposes,  and  is  essential 
in  guarding  against  the  impairment  of  capital  by  the  payment 
of  excessive  dividends.    To  avoid  this  it  is  necessary  to  know 


Ch.  ii]  CAPITAL  STOCK  WITHOUT  PAR  VALUE  Itl^ 

how  much  of  the  net  worth  is  the  contributed  capital,  and  how 
much  is  surplus  available  for  dividends. 

In  the  case  of  corporations  which  have  issued  both  stock 
bearing  a  par  value  and  stock  without  par  value,  the  profits 
must  be  shown  separately  because  they  belong  to  both.  For  such 
corporations  the  combination  of  surplus  with  contributed  capital 
on  the  books  would  manifestly  be  unwise. 

In  summary,  then,  it  may  be  said  that  the  Surplus  account 
of  corporations  with  no-par-value  stock  should  be  handled  like 
that  of  corporations  with  par-value  stock. 

§  89.     Some  Accounts  Not  Used  for  No-Par  Stock 

Except  that  a  single  Capital  Stock  account  is  always  used  in 
place  of  the  Capital  Stock  Authorized  and  Capital  Stock  Unis- 
sued accounts,  it  may  be  said  that  the  functions  of  all  the 
accounts  used  in  handling  capital  stock  transactions  are  the  same 
for  no-par  transactions  as  for  those  in  par-value  stock.  But 
there  are  several  accounts  used  in  connection  with  the  proper 
recording  of  par-value  stock  that  are  not  necessary  when  the 
stock  has  no  par  value.  The  Discount  on  Capital  Stock  and 
Premium  on  Capital  Stock  accounts,  for  example,  find  no  use 
in  no-par  accounts  unless  the  stock  is  handled  on  the  books  at  a 
nominal  or  stated  value,  in  which  case  the  transactions  will  be 
entered  just  as  are  transactions  in  par-value  stock. 

§  90.    No-Par- Value  Preferred  Stock 

No-par  preferred  stock  may  be  handled  Just  as  is  no-par 
common  stock,  in  spite  of  the  fact  that  no-par  preferred  shares 
have  a  "declared"  value  more  frequently  than  have  no-par 
common  shares,  due  to  the  fact  that  if  the  preferred  issue  has 
preference  as  to  assets,  the  certificates  for  the  preferred  stock 
must  of  course  show  the  amount  which  the  holder  of  each  share 
of  preferred  stock  is  entitled  to  receive  upon  liquidation. 

While  for  liquidation  purposes  such  a  declared  value  as  that 
above  suggested  is  considered  equivalent  to  a  par  value,  yet  it 


1120  CORPORATE  ACCOUNTING  [Bk.  III- 

is  not  necessary  to  carry  the  stock  on  the  books  at  the  stated 
value.  Such  a  course,  however,  is  more  justifiable  in  the  case  of 
stock  preferred  as  to  assets  than  in  the  case  of  common  or  other 
preferred  stock,  as  the  Preferred  Stock  account  will  thus  show 
the  value  at  which  it  must  be  liquidated,  while  the  Common 
Stock  and  Surplus  accounts  will  show  the  book  value  of  the 
common  stock. 

§  91.    Shares  With  and  Without  Par  Value 

A  company  may  be  authorized  to  issue  par-value  preferred 
stock  in  addition  to  no-par-value  common  stock.  In  such  cases 
the  books  will  handle  the  preferred  under  the  rules  laid  down  for 
par- value  stock,  and  the  no-par  common  like  any  other  no-par 
stock,  just  as  if  there  were  no  complication  on  account  of  par- 
value  preferred.  The  following  example  illustrates  the  incor- 
poration of  a  company  with  par-value  preferred  stock  and  no-par 
common  stock,  part  of  this  stock  exchanged  for  property. 

The  Brazil  Copper  Mining  Company  is  incorporated  with  a 
capital  of  10,000  shares  of  common  stock  without  par  value,  and 
10,000  shares  of  preferred  stock  with  par  value. of  $100  each. 
One  thousand  shares  of  the  common  stock  have  been  sold  for 
$25  each  and  1,000  shares  of  the  preferred  at  par,  both  paid  in 
cash.  The  following  properties  were  purchased  with  the  remain- 
ing unissued  cormnon  stock: 

Mine $200,000 

Construction  and  Equipment. .  '.^f'.XX'^l'll'?^ .-.'. .  50,000 

Development  Costs 27,000 

Materials  and  Supplies 25,000 

Ore  Mined  and  on  Hand 40,000 

The  opening  entries  are  as  follows: 

Cash $25,000 

To  Common  Stock $25,000 

Being  full  payment  in  cash  of  1,000  shares  of  common 

stock  of  the  company  incorporated  this  day  with  an 

authorization  of  10,000  shares  of  common  stock  without 

par  value  and  10,000  shares  of  preferred  stock  with  a  par 

!i   :  value  of  $100  each.  ^^'^  jVia  ^j- 


Ch.  ii]  CAPITAL  STOCK  WITHOUT  PAR  VALUE  112 1 

Cash $icx),ooo 

To  Preferred  Stock $100,000 

Being  full  payment  in  cash  of  1,000  shares  at  $100  each  of 
the  preferred  stock  of  the  company. 

It  now  remains  to  complete  the  transfer  of  the  properties  to 
the  company  in  the  manner  necessary  to  insure  clear  title,  etc., 
and  to  issue  in  full  payment  therefor  the  remaining  9,000  shares 
of  unissued  common  stock.  The  journal  entry  to  record  the 
matter  on  the  company's  books  is: 

Mine $200,000  -.v,  / 

Construction  and  Equipment 50,000 

Development  Costs 27,000 

Materials  and  Supplies *if "K'.-V. .        25,000 

Ore  Mined 40,000 

To  Common  Stock $342,000 

Mine,  construction  and  equipment,  development  costs, 

material  and  supplies,  and  ore  purchased  this  day  by 

the  Company,  in  payment  for  which  there  have  been 

issued  9,000  shares  of  common  stock  of  no  par  value. 

§  92.    Ease  of  Inflation  of  Values 

It  will  be  seen  that  the  stock  issued  in  payment  for  the 
property  is  on  the  basis  of  $38  per  share,  or  a  total  of  $342,000. 
This  is  $13  per  share  more  than  the  sale  price  of  the  original  1,000 
shares.  The  entire  outstanding  common  stock  now  has  an 
average  book  value  of  $36.70  per  share,  or  a  total  of  $367,000. 
Presumably  the  stock  will  be  carried  on  the  books  at  this  figure. 
If,  however,  contrary  to  good  practice,  it  should  be  carried  at  a 
"stated  value"  of,  say,  $25  per  share,  $225,000  would  be  credited 
to  Capital  Stock,  and  $117,000  to  Capital  Surplus. 

The  value  of  assets  purchased  with  par-value  stock  is  pre- 
sumably the  same  as  the  par  value  of  the  stock  issued  in  exchange 
for  them.  This  indication  of  value  is,  however,  wanting  when 
assets  are  purchased  with  no-par  stock — at  least  in  the  case  of  a 
new  corporation  where  the  book  value  of  its  stock  has  not  been 
fixed  by  transactions  with  known  values,  as  where  the  stock  is 
sold  for  cash.    In  any  such  case  no-par  stock  does  not  express 


1 122  CORPORATE  ACCOUNTING  [Bk.  III- 

itself  in  definite  money  amounts,  but  only  in  the  number  of  shares 
issued,  to  which  no  distinct  money  value  is  attached.  Any 
desired  value  can  then  be  placed  on  the  assets  purchased  with 
no-par  stock,  and  the  book  value  of  the  outstanding  no-par 
stock  will  be  fixed  thereby. 

The  ease  with  which  values  can  thus  be  expanded  without 
liability  to  those  holding  the  stock  exchanged  for  such  assets, 
leads  one  to  wonder  whether,  after  all,  the  no-value  shares  are 
not  likely  to  be  used  as  a  convenient  accessory  for  inflating  values. 
Against  this  objection,  however,  it  may  be  asked  how  often 
assets  acquired  with  par-value  stock  are  really  worth  the  par 
value  of  the  stock  issued  therefor. 

§  93.    Change  from  Par-Value  to  No-Par  Stock  (Plan  i) 

The  entries  to  record  on  the  books  of  account  the  change, 
by  charter  amendment,  from  par-value  stock  to  stock  of  no  par 
are  an  interesting  study.    Let  us  consider  the  following  case: 

A  corporation  with  $100,000  of  common  stock  outstanding, 
par  being  $100  per  share,  has  accumulated  a  surplus  of  $75,000, 
of  which  $25,000  was  premium  paid  on  the  stock.  This  cor- 
poration changes  its  charter  so  that  its  authorized  capital 
becomes  10,000  shares  of  no-par  value,  of  which  it  proposes  to 
issue  2,000  pro  rata  to  the  holders  of  its  par- value  stock. 

-    Under  the  first  plan  for  recording  the  transfer  the  entry  would 
be  as  follows: 

Capital  Stock $100,000 

Surplus 25,000 

To  Capital  Stock $125,000 

Entry  made  to  show  the  efifect  of  a  charter  amendment  , , ,  , 

appearing  on  page  ....  of  the  minute  book,  whereby  .  .,j,jprnif> 

the  former  issue  of  capital  stock,  of  a  par  value  of 

$100,000,  which  had  been  sold  with  a  total  premium  of 

$25,000,  is  canceled,  and  2,000  shares  of  the  newly 

authorized   no-par   stock  are   issued  therefor.       The  , , 

former  Capital  Stock  account  is  closed  and  a  new  one  is 

opened  with  the  amount  which  the  corporation  origi- 
nally received  for  the  stock  superseded  by  the  new  issue        •  Htii*^  Un  uHfH 


Ch.  ii]  CAPITAL  STOCK  WITHOUT  PAR  VALUE  1143 

§  94.    Change  from  Par- Value  to  No-Par  Stock  (Plan  2)   .<>'  -.H 

The  entries  under  the  second  plan  for  recording  this  change 
from  par- value  to  no-par  stock  would  be  as  follows :  ■  -^  - 

Capital  Stock $ico,ooo 

To  Capital  Stock $icx5,cx30 

Recording  the  cancellation  of  the  former  issue  of  capital  jiuci 

stock,  and  closing  the  former  Capital  Stock  account  to 

show  the  efifect  of  a  charter  amendment  recorded  on 

page   ....   of  the  minute  book,  and  opening  a  new 

1^'  •       Capital  Stock  account  which  is  credited  with  the  2,000 

rr,       shares  issued  in  exchange  for  the  old.  jfj] 

The  theory  underlying  this  plan  is  that  the  new  stock  exactly 
takes  the  place  of  the  old,  and  that  the  fact  that  a  total  premium 
of  $25,000  had  been  received  on  the  old  does  not  enter  into  the 
case,  the  premium  having  gone  into  Surplus.  The  argument 
applies  especially  to  a  corporation  which  has  sold  its  stock  at  a 
premium  but  which  now,  due  to  the  declaration  of  large  divi- 
dends, has  no  surplus  against  which  to  charge  the  premium 
formerly  received.  In  such  a  case  the  entry  under  the  first 
method  would  show  an  impairment  of  capital  at  the  very  start, 
although  the  declaration  of  dividends  covering  the  premium  did 
not  impair  capital  since  par  had  been  received  for  the  stock. 

The  second  method,  in  such  a  case,  seems  immeasurably  bet- 
ter than  the  first.  The  charter  amendment  creates  new  condi- 
tions, and  it  is  only  proper  that  the  equivalent  legal  conditions 
should  be  applied  to  the  record  of  these  new  conditions.  The 
courts  will  eventually  decide  which  is  the  proper  valuation  to 
place  on  the  stock. 

§  95.    Change  from  Par- Value  to  No-Par  Stock  (Plan  3) 

If,  then,  we  are  going  to  use  a  figure  other  than  the  amount 
which  the  company  actually  received  as  being  the  amount  of  the 
credit  to  Capital  Stock  account  for  the  stock  of  no  par  value 
issued  in  exchange,  why  not,  ask  some,  take  its  book  value? 
Why  not,  in  other  words,  credit  the  Capital  Stock  account  with 


1124  CORPORATE  ACCOUNTING  [Bk.  ID- 

the  book  value  of  the  stock  which  is  being  retired,  namely,  the 
net  worth  of  the  corporation  or  the  sum  of  its  Capital  Stock  and 
Surplus  accounts? 

If  this  were  done  the  entry  would  be : 

Capital  Stock $ick3,ooo 

Surplus 7S,ooo 

To  Capital  Stock $i  75,000 

{Full  explanation  here.) 

The  objection  to  this  method,  which  at  first  glance  may  seem 
the  most  logical,  is  that  by  it  the  amount  of  accumulated  surplus 
is  made  a  part  of  the  capital  of  the  corporation,  and  cannot  there- 
after be  declared  in  dividends  without  having  the  books  show 
an  impairment  of  capital. 

§  96.    Change  from  Par- Value  to  No-Par  Stock  (Plan  4)  ^ 

A  compromise  plan  has  been  suggested,  whereby  the  first 
method  would  be  used  in  all  cases  in  which  a  surplus  existed 
against  which  the  premium  might  be  charged.  Under  this 
plan,  if  the  surplus  was  insufficient  to  cover  the  entire  amount 
of  the  premium,  whatever  there  was  would  be  canceled,  so  that 
the  amount  of  the  credit  to  the  new  Capital  Stock  account 
would  be  the  par  value  of  the  original  stock  plus  the  amount  of 
any  premium  still  left  in  the  company's  possession.  If  a  stated 
value  is  to  be  used,  the  excess  of  the  original  sale  price  over  the 
stated  value,  plus  any  premium  still  undistributed  in  dividends, 
would  be  credited  to  Capital  Surplus.  ./     ,, 

This  method  is  subject,  though  in  a  less  degree,  to  the  same 
objections  as  is  the  third  plan,  in  that  it  removes  from  the  surplus 
available  for  dividends  a  certain  amount.  It  might  often  justly 
be  insisted  that  the  entire  amount  of  the  premium  had  long 
before  been  distributed  as  dividends,  and  that  what  was  now  in 
Surplus  account  was  earned  profits,  which  no  act  of  an  accountant 
could  prevent  from  being  available  for  dividends,  and  which  no 
act  of  an  accountant  should  so  show  as  to  indicate  an  impairment 
of  capital  if  it  was  declared  in  dividends. 


Ch.  ii]  CAPITAL  STOCK  WITHOUT  PAR  VALUE  I125 

§  97.    Increase  or  Reduction  in  Authorization  1  : 

Since,  in  dealing  with  stock  of  no  par  value,  the  amount  of 
the  authorized  capital  stock  is  not  set  up,  no  entries  are  needed 
to  record  an  increase  in  the  amount  authorized  for  issue.  In  the 
same  way  no  entries  are  needed  to  show  the  amount  of  a  reduc- 
tion in  the  authorization,  unless  to  accomplish  the  reduction  it 
is  necessary  to  call  in  and  cancel  outstanding  stock  because  there 
is  more  stock  outstanding  than  is  authorized  after  the  reduction. 
In  the  latter  case  the  methods  laid  down  in  Part  VI  would  be 
followed.  .  'f"'M  3"^'>di: 

§98.    No-Par  Treasury  Stock      '  '■     '  '-^  >     -    i  ,m     n,     -'< 

-''  The  principle  followed  in  the  accounting  for  par- value 
treasury  stocks  was  that  such  stock  should  be  carried  on  the 
books  at  par  in  order  that  it  might  properly  be  offset  against  the 
total  issued  stock  (which  is  also  carried  at  par),  because  the 
repurchase  of  a  corporation's  own  stock  is  in  reality  a  reduction 
of  the  capital,  at  least  temporarily.  Applying  this  same  prin- 
ciple to  no-par  stock,  treasury  stock  should  be  entered  on  the 
books  at  the  price  at  which  it  was  originally  credited  to  the  Capi- 
tal Stock  account. 

Stock  of  no  par  value,  like  par-value  stock,  may  be  repur- 
chased by  the  issuing  corporation  at  a  price  differing  from  that 
at  which  it  was  originally  issued.  If  it  is  repurchased  above 
that  price,  the  difference  will  be  a  reduction  in  the  surplus  avail- 
able for  dividends,  and  will  be  debited  to  Surplus  account  just 
as  in  the  case  of  par-value  stock.  It  is  especially  necessary  in 
the  case  of  no-par  stock  to  exercise  great  care  to  see  that  the 
contributed  capital  is  never  encroached  on  in  distributions  of 
surplus  through  dividends;  and  exact  entries  of  the  purchase 
price  of  treasury  stock  are  vital  on  this  account  in  order  that  the 
Surplus  account  as  well  as  the  Capital  Stock  account  may  reflect 
the  true  conditions. 

No-par  treasury  stock  repurchased  at  less  than  its  original 


1 1 26        :•!    CORPORATE  ACCOUNTING' xn AD     [Bk.  III- 

sale  price  must,  in  the  same  way,  be  carried  on  the  books  at  the 
original  sale  price  in  order  that  the  Capital  Stock  account  may, 
after  the  balance  in  the  Treasury  Stock  account  has  been  offset 
against  it,  show  the  amount  originally  received  for  the  stock 
which  is  outstanding.  The  difference  between  the  original  sale 
price  and  the  repurchase  price,  or  discount  at  which  it  was 
rebought,  may,  as  in  the  case  of  par-value  stock,  be  credited  to 
Contingent  Profit  on  Treasury  Stockj^  pr  may  be  considered  as 
creating  a  paid-in  surplus.     f,;,;|  >hoH^«m  -)rfJ  o«ko  -r'lttfif  f*(H  nT 

The  above  principle  of  entering  treasury  stock  at  the  value 
at  which  it  was  originally  issued  is  in  greatest  favor,  but  there 
is  another  theory  which  has  some  adherents.  If  different 
blocks  of  no-par  stock  are  issued  at  various  prices,  the  Capital 
Stock  account  at  any  time  divided  by  the  number  of  shares 
then  outstanding  gives  the  average  issuance  price  of  all  stock. 
In  the  case  of  the  Brazil  Copper  Mining  Company  this  value  was 
$36.70.  There  are  those  who  favor  bringing  treasury  stock  into 
the  books  at  this  figure.  Since,  however,  more  of  the  unissued 
stocks  might  later  be  sold  at  a  price  which  would  result  in  still 
another  average,  this  method  does  not  stabilize  book  entries  as 
it  might  seem  to  do;  and  whether  such  average  values  should 
be  used  in  the  determination  of  the  effect  on  surplus  of  the 
repurchase  of  stock  or  whether  for  this  purpose  one  should  use 
the  price  at  which  the  particular  shares  reacquired  were  issued 
is  a  debatable  point  which  will  probably  not  be  finally  decid.ed 
until  the  courts  pass  on  some  case  of  impaired  capital.     ;.  .,' . 

The  entries  for  the  sale  of  no-par  treasury  stock  will  be  made 
in  the  same  manner  as  for  the  sale  of  par-value  treasury  stock, 
except  that  the  credit  to  Treasury  Stock  account  will  always  be 
the  amount  at  which  the  stock  sold  is  carried  in  that  account^.,, 

§  99.    No-Par  Donated  Stock 

Donated  stock  of  no  par  value  is  proportionately  of  less 
frequent  occurrence  than  is  the  case  with  par-value  stock  since 

•See  }  72.  „.  .   

'  In  this  particular  example  the  full  authorized  amount  was  issued.  .  .,_ij  * 


Ch.  ii]  CAPITAL  STOCK  WITHOUT  PAR  VALUE  I127 

there  are  not  such  pressing  reasons  for  the  donation  of  stock  to 
no-par  companies. «  For  the  same  reason  the  principles  under- 
lying its  handling  are  somewhat  different.  The  best  practice 
seems  to  be  not  to  enter  the  donation  in  money  terms  until  the 
stock  is  sold,  making  only  those  memorandum  entries  which  are 
necessary  to  keep  track  of  the  shares  donated  back.  Such  an 
entry  would  be: 

Donated  Stock.  .  ^  ,*.  ...l.".yi.i,l.\.'ri«V.. i'.'.i...^..»  i .    $  none 

To  Capital  Stock *     none 

"     Stock  donation  of  100  shares  to  be  sold  to  provide  working 
\\i  ii  capital.  \^^^, 

Vf'"  ^    ^  ' ,,: 

The  number  of  shares  so  donated  would  be  entered  in  the 

description  columns  of  both  the  Donated  Stock  and  Capital 
Stock  accounts. 

^  For  recording  the  sale  of  par-value  donated  stock  we  found 
three  methods  accepted,  only  the  first  two  of  which  will  apply 
to  no-par  stock.  The  proceeds  of  the  sale  of  donated  stock  of  no 
par  value  may  be  credited  either  to  Donated  Surplus  or,  if  the 
stock  was  originally  issued  for  an  intangible  such  as  patent 
rights,  to  the  account  which  was  originally  debited  when  the 
stock  was  issued.  The  latter  plan  is  preferred  when  it  is  appli- 
cable, because  it  places  a  more  conservative  value  on  the  intangi- 
bles, which  were  hardly  worth  the  value  at  which  they  were 
bought  if  the  vendor  donates  back  to  the  company  some  of  the 
stock  he  received  for  them. 


JM  I     ''jj  ij  ji  (-  i;i/ 


•  See  §176, 77.  ^fffrTTt  {ro'/rfj-'Tod  'A  7'3frorn  >ia.'. 

'-si  'jrfJ  fl^jjoirft 


>V-il 


■  di 


'J 


CHAPTER  XII 
NON-STOCK  CORPORATIONS 


§  loo.     General  Nature 

Corporations  whose  capital  is  not  represented  by  shares  of 
stock  are  generally  organized  for  the  attainment  of  special  ends 
which  are  not  financial,  rather  than  for  the  pecuniary  benefit  of 
their  members.  Many  religious,  charitable,  educational,  li- 
brary, social,  and  benevolent  bodies  are  organized  in  this  way. 
These  comprise  churches,  hospitals,  asylums,  homes  of  various 
kinds,  educational  institutions,  clubs,  associations,  etc.  Among 
them  will  be  found  associations  of  a  professional  nature  or  for 
the  betterment  of  their  members,  such  as  fine  arts  clubs,  literary, 
medical,  and  scientific  societies;  or  of  a  philanthropic  or  public 
nature,  such  as  the  Red  Cross  and  other  organizations  which 
became  so  prominent  in  welfare  work  during  the  Great  War.  ;• ' 

Non-stock  corporations  are  usually  organized  and  established 
by  public-spirited  men  and  women  who  contribute  funds  for 
their  establishment.  A  hospital  may  be  established  by  a  single 
individual  or  by  relatives  and  friends  as  a  memorial,  or  it  may 
be  built  up  by  the  contributions  of  many.  The  money  or 
property  subscribed  constitutes  the  capital  of  the  corporation. 
Sometimes  money  is  borrowed  temporarily  or  more  permanently 
through  the  issuance  of  notes  or  mortgage  bonds.  Men  and 
women  frequently  specify  in  their  wills  that  upon  their  death 
certain  legacies  shall  be  paid  over  to  designated  organizations,  or 
that  certain  trusts  shall  be  established  for  the  benefit  of  particular 
activities.  These  are  common  occurrences  in  all  parts  of  the 
country.  Probably  the  greatest  non-stock  organization  of  this 
kind  is  the  Rockefeller  Foundation,  the  object  of  which  is  to 
render  assistance  wherever  it  is  necessary  and  to  study  disease 

1128 


Ch.  12]  NON-STOCK  CORPORATIONS  II29 

for  the  purpose  of  discovering  means  for  its  prevention.  The 
governmental  bodies  known  as  municipal  corporations  are  also 
non-stock  corporations. 

Not  all  "not-for-profit"  corporations  are,  however,  of  the 
non-stock  type.  The  Mercantile  Library  of  Philadelphia  is  an 
example  of  a  stock  corporation  not  organized  for  profit. 

The  management  of  non-stock  corporations  is  usually  in  the 
hands  of  a  board  of  trustees  or  of  directors  who  are  elected  to 
serve  until  the  selection  of  successors.  The  board  of  directors  in 
turn  elects  its  officers  who  are  required  to  look  after  the  imme- 
diate business  of  the  corporation,  very  much  as  in  the  case  of  a 
business  organized  for  profit.  '■'^^  ii>iiuiuji/x  cjuw'i  Jii  i 

§101.    Profits  Cannot  Be  Divided  rrq  >lrfl  lol  b-itimob 

I  To  be  chartered  as  a  non-stock  corporation  it  is  necessary 
that  the  organization  be,  definitely,  "not  for  profit,"  by  which 
it  is  meant  that  any  profits  earned  are  not  distributable  among 
the  members.  Many  of  these  corporations  conduct  businesses 
or  have  business  connections  which  result  in  profits  or  losses 
as  the  case  may  be.  These  include  publication  houses,  religious 
and  social  magazines,  and  other  business  activities  of  churches, 
clubs,  or  other  organizations,  the  profit  from  which  is  for  the 
benefit  of  the  membership  at  large  and  not  for  any  of  the  indi- 
viduals. We  have,  for  example,  the  Presbyterian  Board  of 
Publication,  the  Baptist  Publication  Society,  and  many  other 
like  activities. 

§  102.    Accounting  for  Non-Stock  Corporations 

The  accounting  for  non-stock  corporations  is  not  different 
from  that  of  those  organized  for  profit,  except  that  there  is  no 
Capital  Stock  account,  nor  is  there  any  distribution  of  dividends. 
As  no  stock  is  issued  and  no  profits  are  distributed,  there  is 
usually  no  individual  interest  to  be  determined.  Everything 
contributed  is  for  the  benefit  of  the  institution  as  such,  and 
should  therefore  be  credited  to  Capital  account.    Profits  earned 


1 130  CORPORATE  ACCOUNTING  [Bk.  Ill- 

may  likewise  be  credited  to  Capital  account  unless  it  is  required 
that  profits  be  set  forth  separately,  while  appropriations  for  any 
specific  purpose  are  charged  to  the  same  account.  There  is  no 
objection,  however,  to  crediting  profits  to  a  separate  account, 
such  as  Surplus  or  Unappropriated  Profits,  and  then  making 
transfers  therefrom  as  needed,  either  to  increase  the  Capital 
account  or  to  be  used  in  other  ways.i  on  io  Jnejmagxinijra  odl 

§  103.    Entries  for  a  Hospital 

The  example  which  follows  shows  certain  early  transactions 
of  a  hospital  organized  as  a  non-stock  corporation. 

The  Jones  Memorial  Hospital  is  established  to  conduct  the 
usual  activities  of  a  general  hospital.  Thomas  Jones  has 
donated  for  this  purpose  a  large  residence  in  the  suburbs  of 
Philadelphia  to  be  converted  into  a  hospital.  The  appraised 
value  of  the  property  is  $100,000,  of  which  $34,000  is  the  value 
of  the  grounds  and  $66,000  the  value  of  the  building.  The  entry 
to  record  this  donation  will  be: 

Hospital  Grounds.  ...... ; . ;. ... . .  ;*..■.  .:■, $34,000 

Hospital  Building.  .  ."  ,:./,^.rf.^, !.■.»».  .,/>)..(*<^tj 66,000 

To  Capital $100,000 

''Residence  and  grounds  donated  by  Thomas  Jones,  for  use 
as  a  hospital  to  be  known  as  the  Jones  Memorial  Hospital. 
Full  title  has  been  passed  and  recorded. 

§  104.    Hospital  Trust  Funds 

Eleemosynary  institutions  such  as  this  are  frequently  made 
the  subject  of  gifts  of  money,  the  principal  of  which  is  to  be 
maintained  intact,  only  the  income  being  used.  Such  funds  are 
capital,  but  in  order  to  show  on  the  books  and  financial  state- 
ments the  amount  reserved  from  ordinary  purposes  because  of 
the  limitations  on  the  trusts,  the  credit  is  usually  given  to  a 
reserve  account  instead  of  to  Capital.  Such  a  reserve  is  an 
impounding  of  capital  identical  in  nature  with  the  impounding 
of  surplus.2 

1 ;     » lie  C"'III,  "Reserve  Accounts."  HoblaiiJ  Huotlt 


Ch.  i2l  NON-STOCK  CORPORATIONS  1 13 1 

In  the  present  instance,  Thomas  Jones  has  given  $50,000  to 
the  hospital  as  a  permanent  endowment  fund,  the  income  thereof 
to  be  used  for  general  purposes,  and  different  persons  through 
the  influence  of  Mr.  Jones  have  given  $5,000  each  for  the  endow- 
ment of  hospital  beds.  The  entries  required  in  entering  these 
donations  are  as  follows:  „  ^.v,,  ^l.,..' ..,,...  .. 

Jones  Endowment  Fund  Cash $50,000 

To  Jones  Endowment  Fund  Reserve $50,000 

Cash  received  from  Thomas  Jones  to  be  held  in  trust,  the 
income  only  to  be  used  for  general  purposes.  urTTJTTI/G      .DOT  < 

Beds  Endowment  Fund  Cash .  .  . $50,000 

To  Beds  Endowment  Fund  Reserve $50,000 

For  cash  donated  by  various  persons  as  follows,  for  endow- 
ment of  fifty  beds,  etc.     {Give  name  of  donors.) 

§  105.    Receipts  of  Donations 

An  additional  $50,000  has  been  raised  by  popular  subscrip- 
tion for  general  purposes.  Of  this,  $25,000  has  been  used  for 
purchasing  and  installing  equipment,  and  $15,000  for  the  pur- 
chase of  an  equity  in  a  near-by  residence  (valued  at  $25,000)  to 
be  used  as  a  dispensary.  The  balance  is  to  be  used  for  supplies 
and  initial  expenses.  , , ; . 

Such  donations  are  similar  to  the  first  in  being  donated  capi- 
tal, but  money  so  received  which  is  to  be  used  for  the  operating 
expenses  of  the  institution  is  not  usually  credited  to  Capital 
account  because  the  closing  of  the  books  at  tho  end  of  the  year 
would  cause  an  impairment  of  capital  to  the  extent  of  the  amount 
so  used  for  expenses.  Donations  of  this  nature  are  usually 
credited  to  Donations  Received  account,  and  at  the  end  of  the 
year  the  gain  in  net  worth,  if  any,  is  passed  to  Capital  or  the  loss 
charged  thereto.    The  entries  for  the  above  transactions  would 

General  Fund  Cash ^fi}. bfJfr ytl^fijj .  $50,000 

To  Donations  Received ..*....  .1 ,  $50,9953 

Public  subscriptions  of  funds  to  be  used  for  general  purposes  — 

of  the  hospital.  '  * '"^ ' 


1132  •  CORPORATE  ACCOUNTING  [Bk.  TII- 

Hospital  Equipment $25,000 

To  General  Fund  Cash $25,000 

'  •'  Furniture  and  fixtures  purchased  for  use  of  hospital,  as  per 

ff\-     order  of  the  Board.  .  ' 

Hospital  Buildings . ;  m  .Q9P.'  f^  fT^Vh  :K<'}-^i  f^H^L $25,000 

To  Mortgages  Payable $10,000 

General  Fund  Cash iSiOoo 

Residence  purchased  by  the  Board  for  use  as  dispensary,  the 

price  being  cash  down  $15,000  and  a  mortgage  of  $10,000  .  ,iobn'^l  zanoj. 

due,  etc.                                                       briu'I  in-j.  .ot  oT 

I       .  - '  ■■■-)  ■ 

§  106.    Summary  of  Hospital  Accounts 

In  the  above  instance  the  first  credit  might  if  desired  have 
been  made  to  Capital  for  the  amount  which  was  to  be  expended 
for  capital  assets,  but  the  best  practice  is  to  carry  all  donations 
in  one  account  until  the  end  of  the  fiscal  period,  in  order  that  the 
financial  reports  can  be  made  up  easily.  Indeed  the  donation 
of  ground  and  buildings  in  this  example  might  have  been  credited 
to  Donations  Received  until  the  end  of  the  year. 
"'■  Donations  of  trust  funds,  however,  should  be  credited  to  the 
proper  trust  fund  reserve  account,  in  order  that  the  .books  may 
show  as  a  continued  liability  the  amount  of  the  capital  which 
cannot  be  encroached  upon.  The  Jones  donations  are  divided, 
since  the  second  is  to  be  set  aside  and  invested,  requiring  it  to 
be  earmarked.  General  funds  are  those  to  be  used  for  general 
purposes  or  for  the  general  good  of  the  institution,  in  contra- 
distinction to  those  donated  for  a  specified  purpose. 

Endowment  and  trust  funds  should  be  set  forth  so  as  to  show 
,  clearly  the  objects  for  which  they  are  contributed,  since  the 
income  therefrom  must  be  devoted  to  the  specified  purposes  and 
no  other.  Such  contributions  may  be  in  the  form  of  property, 
mortgages,  securities,  or  cash.  Trust  donations  paid  in  cash  must 
be  so  invested  as  to  produce  the  greatest  return  and  yet  be  safe 
beyond  question.  The  entries  required  for  recording  the  invest- 
ment of  trust  funds  and  the  handling  of  the  income  therefrom 
are  discussed  in  later  chapters.' 

»  See  Chs.  XXII,  XXIII.  .1 


Part  III — Special  Cases  in  Capital  Stock 
Transactions 


CHAPTER   XIII 
MISCELLANEOUS   STOCK  TRANSACTIONS 

§  107.    Organization  Expenses 

Three  courses  are  open  for  handling  the  costs  of  organizing 
a  new  company.  They  may  be  (i)  carried  permanently  on  the 
balance  sheet  as  an  asset,  (2)  written  off  gradually  over  a  period 
of  years,  or  (3)  charged  off  in  the  period  in  which  incurred. 
The  past  practice  has  been  to  charge  them  off  as  rapidly  as 
possible,  because  if  carried  as  an  asset  they  add  nothing  to  the 
strength  of  a  financial  statement.  1 

Federal  income  tax  regulations,  however,  do  not  allow  the 
deduction  in  determining  the  amount  of  taxable  net  income  of 
certain  expenses  of  organization,  including  attorneys'  and 
accountants'  charges,  incorporating  expenses  and  fees,  pro- 
moters' services,  underwriting  expenses,  etc.  For  this  reason, 
while  invested  capital  was  a  factor  in  determining  the  amount  of 
profits  taxes  it  was  wise  to  carry  the  organization  expenses 
permanently  on  the  books  as  an  intangible  asset.  Now  that 
there  is  no  longer  any  reason  for  showing  in  the  balance  sheet  an 
item  which  adds  nothing  to  the  ntiancial  standing  of  the  corpora- 
tion, it  is  probable  that  accounting  practice  will  swing  back  to 
the  former  plan  of  charging  such  expenses  off. 

At  the  same  time,  if  the  expenses  of  organization  amount  to 
more  than,  say,  $500,  it  is  hardly  just  to  charge  the  entire 

1  See  Book  II,  Ch.  XIII,  "Capitalization." 

"33 


1 134  CORPORATE  ACCOUNTING  [Bk.  III- 

amount  to  Profit  and  Loss  at  any  one  time.  Such  expenditures 
are  essential  to  the  creation  of  a  corporate  business,  and  the 
first  year  receives  no  more  benefit  from  them  than  the  fifth, 
sixth,  or  any  other.  It  would  therefore  seem  more  equitable, 
so  far  as  the  statistical  feature  of  bookkeeping  is  concerned,  to 
write  such  costs  off  over  a  period  of  years. 

Theoretically  this  period  should  be  the  entire  life  of  the 
company,  but  in  order  to  get  rid  of  an  undesirable  asset  and  at 
the  same  time  not  overburden  the  Profit  and  Loss  account  of 
any  one  year,  the  management  usually  elects  to  charge  the 
organization  expenses  off  over  a  comparatively  short  period  of 
time.  Five  years  is  often  considered  a  suitable  period  for  this 
purpose,  in  which  case  one-fifth  of  the  total  amount  should  be 
charged  off  each  year. 

Expenditures  of  this  nature  may  be  carried  in  an  account 
styled  "Organization  Expenses,"  the  analysis  of  which  follows: 

Organization  Expenses 


Debit: 

With  the  cost  of  all  organization 
expenses,  such  as  attorneys'  and  ac- 
countants' fees,  incorporating  expenses, 
promoters'  services,  underwriting  ex- 
penses, etc. 


Credit: 

At  the  close  of  each  month  or  fiscal 

period,  as  the  case  may  be  (depending 

on  whether  or  not  a  monthly  operating 

statement  is  made),   with  the  proper 

proportion  of  the  debits  to  this  account 

b  ased  upon  the  length  of  time  over  which 

the   organization   expenses   are   to   be 

Jn.MO/r!  spread 

The  balance  of  this  account  when  so  handled  is  a  deferred 

expense  and  represents  that  part  of  the  organization  expenses 

which  have  not  yet  been  charged  off. 

§  1 08.     Commission  on  Sale  of  Capital  Stock 

Commissions  paid  on  the  sale  of  its  capital  stock  are  of 
common  occurrence  in  the  promotion  and  organization  of 
a  corporation.  They  are  usually  debited  to  Commissions  on 
Sale  of  Capital  Stock  account,2  which  is  good  practice  as  it  is 

'  Separate  account  for  each  class  of  stock. 


Ch.  13]  MISCELLANEOUS  STOCK  TRANSACTIONS  113  5 

frequently  desired  to  know  quickly  the  amounts  of  commission 
which  have  been  paid. 

Such  commissions  are  often  charged  directly  into  Organiza- 
tion Expenses  account,  but  whether  they  are  carried  in  that 
account  or  in  an  account  by  themselves,  the  same  procedure  is 
applicable  to  them  as  is  suggested  above  for  the  handling  of 
organization  expenses. 

The  payment  of  such  commissions  with  capital  sto(^  creates 
no  unusual  bookkeeping  entries.  If  they  are  paid  by  the 
issue  of  original  stock,  Commission  account  (or  such  other 
account  as  commissions  may  be  charged  to)  is  debited  and 
Capital  Stock  or  Capital  Stock  Unissued  is  credited.  Just  as 
the  entry  for  commissions  paid  in  cash  would  be ; 

Commissions  (or  Organization  Expenses) 
To  Cash 

SO  the  entry  for  commissions  paid  in  stock  would  be^ 

Commissions  (or  Organization  Expenses) 

To  Capital  Stock  Unissued  (or  Capital  Stock) 

Payments  of  these  items  made  from  treasury  stock  are 
credited  to  Treasury  Stock  or  Donated  Stock,  as  the  case  may  be. 

§  109.    Payment  of  Salaries  in  Stock 

Not  infrequently  the  salaries  of  managers  and  officers  of 
corporations  are  paid  wholly  or  partly  in  stock.  The  procedure 
is  not  improper  under  suitable  conditions,  and  the  entries  are 
simple.  It  is  in  effect  a  payment  of  salaries  in  cash  which  is 
returned  as  payment  for  stock.  Such  stock  salaries  might  be 
paid  monthly  if  so  agreed,  but  even  when  based  on  monthly 
instalments,  they  are  usually  allowed  to  accumulate  till  the 
end  of  the  year  or  longer  before  the  stock  is  issued. 

If  the  stock  is  not  issued  immediately  and  it  is  desired 
to  set  up  the  expense  and  the  liability  on  the  books,  a  debit 
at  each  pay-roll  date  will  be  made  to  the  proper  salary  account 
and  a  credit  will  be  made  to  the  account  of  the  individual  or  to 


1136  CORPORATE  ACCOUNTING  [Bk.  IH- 

Subscriptions  to  Stock  account,  depending  on  how  the  trans- 
ations  have  originally  been  handled.  When  the  stock  is  issued 
the  account  of  the  individual  or  Capital  Stock  Subscribed  will  be 
debited,  and  Capital  Stock,  Capital  Stock  Unissued,  or  Treasury 
Stock  will  be  credited,  again  depending  on  the  manner  in  which 
such  transactions  are  being  treated  on  the  books. 

If  the  stock  is  not  taken  at  its  par  value,  the  salary  account 
is  debited  at  the  agreed  amount,  and  any  excess  over  par  is 
credited  to  Premium  or  to  Surplus,  or  any  deficiency  below  par 
is  debited  to  Discount  on  Stock  or  to  Surplus. 

§  no.    Payment  of  Other  Debts  in  Stock 

There  is  no  objection  to  the  liquidation  of  any  debts  by  stock, 
so  long  as  the  capital  is  not  impaired,  by  so  doing,  i.e.,  so  long  as  a 
fair  equivalent  is  received  for  the  issued  stock.  An  existing 
mortgage  or  even  a  loan  or  current  debt  may  be  canceled 
by  means  of  a  stock  issue,  provided  the  creditor  is  willing  to 
accept  it  as  a  substitute  for  cash.  Dividends  are  frequently 
paid  in  stock,  such  dividends  being  known  as  "stock  dividends." 

§  III.    Payment  of  Debts  in  No-Par  Stock 

When  any  debts  are  paid  in  no-par-value  stock  of  the  debtor 
corporation,  whether  these  are  for  organization  expenses,  com- 
missions, salaries,  mortgages,  or  any  other  item  whatsoever, 
the  amount  of  the  debt  which  is  canceled  by  the  issuance  of  the 
stock  is  the  amount  which  is  received  for  the  stock  and  is  con- 
sequently the  amount  which  should  be  credited  to  Capital  Stock 
account. 4  If  this  rule  is  kept  in  mind,  such  transactions  handled 
with  no-par  stock  will  offer  no  difl&culties  whatsoever. 

§  112.    Purchase  and  Sale  of  Stock  of  Other  Corporations 

When  stock  of  another  corporation  is  purchased,  it  is  not 
treasury  stock  of  the  corporation  which  acquires  it.  Stocks  and 
bonds  of  one  corporation  held  by  another  constitute  an  asset  of 

'  See  S127;  also  Book  I,  {  490;  and  Book  II,  Ch.  XXXI,  "Payment  of  Dividends." 
«  See  S  86. 


Ch.  13I  MISCELLANEOUS  STOCK  TRANSACTIONS  113  7 

the  second  corporation,  on  whose  books  they  should  be  carried 
at  cost  if  they  are  made  for  the  purpose  of  investing  surplus  funds. 
If  the  business  of  the  purchasing  corporation  is,  however,  the 
purchase  and  sale  of  securities,  it  may  choose  to  value  such 
assets  on  the  inventory  basis  of  cost  or  market,  whichever  is 
lower.  If  the  purchase  is  made  with  the  object  of  securing  a 
controlling  interest  in  some  competing  concern  and  the  effort  is 
successful,  we  have  a  holding  company  which  may  carry  the 
investment  at  cost  or  may  bring  to  its  own  books  its  share  of  the 
net  worth  of  the  subsidiary. 

It  would  be  beyond  the  scope  of  this  work  to  discuss  the 
handling  of  such  assets  by  an  investment  house,  but  it  may  be 
said  that  the  underlying  principle  is  the  same  as  that  of  any 
Merchandise  Purchases  account.  Other  companies,  however, 
enter  stocks  and  bonds  purchased  for  investment  in  an  account 
headed  "Investments,"  or  "Stocks  of  Other  Companies,"  or 
some  other  distinguishing  caption.  If  bonds  are  included  in  the 
purchase,  the  account  may  be  headed  "Securities  of  Other 
Companies,"  or  "Stocks  and  Bonds  of  Other  Companies."  If 
both  stocks  and  bonds  are  owned,  it  is  often  advisable  to  open 
two  separate  accounts,  or  even  to  open  an  account  for  each  kind, 
stating  the  name  of  the  company  in  connection  therewith,  as 
"Stock  of  American  Bridge  Co.,"  "U.  S.  Steel  Bonds,"  etc. 

Purchase  of  the  asset  described  by  the  title  of  such  an  ac- 
count would  be  debited  to  it  at  cost.  When  the  asset  is  sold, 
this  account  would  be  credited  with  that  original  cost,  any  profit 
being  credited,  or  loss  being  debited,  to  Profit  and  Loss,  or 
preferably  to  an  account  known  as  "Profit  and  Loss  on  Sale  of 
Capital  Assets."  This  account  would  be  closed  into  the  general 
Profit  and  Loss  account  at  the  end  of  the  fiscal  period. 

§  113.    Entries  for  Purchase  and  Sale  of  Stock  of  Other  Corpora- 
tions 

To  illustrate  the  entries  involved,  assume  that  the  American 
Trading  Company  has  purchased  $300,000  par  value  of  stock 


1 138  CORPORATE  ACCOUNTING  [Bk.  III- 

of  the  Baldwin  Mercantile  Company  for  $270,000,  or  at  $90  per 
share.  It  now  disposes  of  $40,000  face  value  of  this  stock  for 
$50,000.  Since  the  400  shares  so  sold  cost,  at  $90  per  share, 
only  $36,000,  the  American  Trading  Company  has  netted  a 
profit  of  $14,000  on  the  sale.     The  following  entries  are  required : 

Stocks  of  Other  Companies  (or  Stock  of  Baldwin  Mercantile 

Company) $270,000 

To  Cash $270,000 

For  purchase  of  $300,000  par  value  of  stock  of  the  Baldwin 
Mercantile  Company.  ;    ; 

Cash $50,000 

To  Stocks  of  Other  Companies '. . .  $36,000 

Profit  and  Loss  on  Sale  of  Capital  Assets 14,000 

For  sale  of  $40,000  par  value  of  stock  of  the  Baldwin 
Mercantile  Company. 

§  114.     Exchange  of  a  Corporation's  Own  Capital  Stock  for  Stock 
of  Other  Corporations 

In  cases  where  the  purchase  of  securities  in  other  corporations 
is  sanctioned  by  statute  or  by  charter,  the  manner  of  making 
payment  is  usually  left  to  the  contracting  parties.  The  stock 
of  another  Company,  instead  of  being  purchased  for  cash,  might 
therefore,  if  the  state  laws  permit,  be  obtained  in  exchange  for 
the  stock  of  the  acquiring  company. 

To  illustrate  the  entries  when  this  is  done,  assume  that  the 
Delaware  Manufacturing  Company  has  been  organized  with  a 
capital  stock  of  $1,000,000,  comprising  10,000  shares  of  the 
par  value  of  $100  each,  of  which  1,000  shares  have  been  sub- 
scribed and  paid  for  in  cash.  Additional  stock  of  the  company 
has  been  disposed  of  as  follows: 

1.  3,000  shares  in  exchange  for  2,500  shares  of  stock,  $100 

each,  of  the  Hudson  Manufacturing  Company. 

2.  1,000  shares  in  exchange  for  1,200  shares  in  the  Superior 

Textile  Company. 

3.  1,000  shares  in  exchange  for  1,000  shares  in  the  Ellis 

Cloth  Company. 


Ch.  13]  MISCELLANEOUS  STOCK  TRANSACTIONS  1139 

4.  1,000  shares  in  exchange  for  500  shares  of  the  Southern 
Cotton  Company. 

Unissued  Stock $1,000,000 

To  Capital  Stock  Authorized $1,000,000 

The  Delaware  Manufacturing  Company  is  incorporated 
with  an  authorized  capital  stock  of  $1,000,000. 

Cash $100,000 

To  Unissued  Stock $100,000 

For  1,000  shares  of  stock  sold  for  cash  to  the  following 
persons: 

{Names  staled) 

Stocks  of  Other  Companies $300,000 

To  Unissued  Stock $300,000 

For  purchase  of  2,500  shares  of  the  Hudson  Manufacturing 
Company  in  exchange  for  3,000  shares  of  this  Com- 
pany. 

Stocks  of  Other  Companies $100,000 

To  Unissued  Stock $100,000 

In  exchange  for  1,200  shares  of  the  Superior  Textile 
Company.  .^^^  ^^^  ^j^^^^^  looi««-jril   tii 

Stocks  of  Other  Companies IC'.'l . .  .-J      $100,000 

To  Unissued  Stock .' .  .t. .'/. .  $100,000 

In  exchange  for  1,000  shares  of  the  Ellis  Cloth  Company.  n i'  (1 

Stocks  of  Other  Companies tVi;^7r.lD.  mii  ^.'X<      $100,000 

To  Unissued  Stock ...■;.;:..  $100,000 

In  exchange  for  500  shares  of  the  Southern   Cotton 
Company. 

'iao  arfJ  ,  jboJrf  hsnot'Jiq  lo  imuav 

The  last  four  entries  might  easily  be  consolidated.  It 
will  be  seen  that  the  stock  has  been  issued  at  par  and  that 
each  lot  of  stock  in  other  companies  has  been  valued  at  the 
par  value  of  the  stock  given  for  it.  The  unsold  stock,  numbering 
3,000  shares,  the  par  value  of  which  is  $300,000,  will  stand  as  a 
debit  balance  of  Unissued  Stock  account  until  such  time  as  it 
may  be  issued. 

If  the  stock  of  the  purchasing  corporation  is  of  no  par  value, 
the  rule  that  no-par  stock  issued  for  tangibles  is  considered  as 


II40  CORPORATE  ACCOUNTING  [Bk.  Ill- 

being  paid  for  at  the  value  of  the  tangibles,  would  apply,  s. 
In  the  above  examples  of  par- value  stock,  the  issuing  corporation 
usually  considers  its  stock  worth  par.  The  stock  purchased  is 
consequently  bought  at  the  par  value  of  the  stock  issued  therefor. 
When  no-par  stock  is  issued  for  stocks  of  other  corporations, 
the  value  of  the  stocks  bought  is  determined  and  the  following 
entry  made  for  the  value  thus  determined : 

Stocks  of  Other  Companies 
To  Capital  Stock 

§  115.    Bonuses  Paid  in  Stock 

Stock  given  as  bonuses  is  issued  without  any  direct  con- 
sideration, and  as  an  extra  inducement  to  purchasers  or  as  a  re- 
ward for  faithful  services,  etc.  Such  issues  are  not  necessarily 
improper  as  they  directly  benefit  tfie  corporation  by  promoting 
the  sale  of  bonds,  preferred  stock,  or  other  securities.  Bonuses 
given  to  employees  as  a  reward  are  usually  considered  as  addi- 
tional compensation  for  services,  but  stock  given  as  a  bonus 
in  the  sale  of  bonds  or  other  stock,  apparently  goes  without 
direct  consideration.  For  this  reason  such  bonuses  are  usually 
given  out  of  stock  which  has  once  been  issued  for  value  and  has 
been  donated  back  to  the  company. 

The  stock  bonuses  are  charged  to  a  Bonus  account  at  their 
par  value.6  Thus,  if  $10,000  face  value  of  common  stock  is 
given  from  treasury  stock  as  a  bonus  to  the  purchasers  of  a  like 
amount  of  preferred  stock,  the  entry  would  be  as  follows: 

Bonus $io,cxx) 

To  Donated  Stock $10,000 

For  100  shares  of  donated  common  stock  given  as  a  bonus 
with  100  shares  of  preferred  stock  sold  at  par. 

Bonus  account  may  thereafter  be  treated  as  part  of  the 
organization  expenses  which,  as  stated  earlier  in  this  chapter, 
are  generally  written  off  over  a  period  of  years,  or  may  be  closed 

'  See  iS  9it  92. 
•See  I  77. 


Ch.  13I  MISCELLANEOUS  STOCK  TRANSACTIONS  1141 

into  Donated  Surplus'  on  the  theory  that  the  surplus  so  accumu- 
lated has  furnished  the  bonuses. 

Original  stock  might  be  issued  as  bonus  stock  so  long  as  no 
one  offers  objection,  but  since,  if  given  purely  as  a  bonus,  it  would 
not  be  full-paid  stock,  the  holders  would  remain  liable  to  cor- 
porate creditors  for  the  unpaid  value  in  case  of  insolvency.  In 
any  such  case  the  outgoing  stock  would  be  debited  to  Bonus  and 
credited  to  Capital  Stock  or  Capital  Stock  Unissued,  as  the 
case  may  be. 

In  the  above  statement  is  found  one  of  the  pronounced 
advantages  of  no-par- value  stock  over  stock  with  an  established 
par.  The  no-par-value  stock  does  not  have  to  be  issued  for  any 
fixed  consideration,  or  indeed  for  any  determinable  consideration 
whatsoever,  and  no-par  stock  of  original  issue  may  be  used  for 
bonuses  without  liability  on  the  part  of  the  holders.  When  such 
stock  is  issued  as  a  bonus  the  only  entry  needed  on  the  general 
books  is  one  to  record  the  number  of  shares  so  given.  This 
entry  would  be  in  the  following  formis 

Bonus $  none  ; 

To  Capital  Stock $  none 

For  100  shares  of  common  stock,  certificate  No ,  given 

as  a  bonus  with  100  shares  of  preferred  stock  sold  at  par 
to 


'  See  I  79. 
•  C/.  »  99. 


CHAPTER  XIV 

DIVIDENDS! 

§  ii6.    Ownership  of  Dividends 

When  a  dividend  from  the  net  profits  of  a  corporation  has 
once  been  legally  and  publicly  declared,  it  cannot  thereafter  be 
rescinded  or  annulled,  but  its  amount  is  immediately  transferred 
from  the  corporate  ownership  to  the  ownership  of  the  stockhold- 
ers. This  principle  holds  even  though  at  the  time  it  was  declared 
no  definite  date  was  fixed  for  its  payment.  Accordingly,  divi- 
dends should  be  entered  on  the  books  of  account  as  soon  as  they 
are  declared,  but  even  dividends  on  cumulative  preferred  stock 
should  not  be  "accrued"  on  the  books,  i.e.,  shown  as  a  HabUity 
before  they  are  declared.^ 

§  117.    Dividends  Payable  Account  ^^ 

The  Dividends  Payable,  or  simply  Dividends  account  is  a 
liability  account  whose  balance  shows  the  amount  of  dividends 

•^  .1-.  .ij   j;  .^.1. 

declared  but  not  paid.     Its  analysis  is  as  follows :     o) 

DivroENDS  Payable 


Debit: 

With  dividends  paid,  whether  by  cash 
or  by  an  issue  of  stock  or  otherwise. 


Credit: 

With  the  amount  of  dividends  de- 
clared by  the  board  of  directors,  the 
corresponding  debit  being  made  to  Sur- 
plus account  or  to  Undivided  Profits 
account. 


It  is  advisable,  when  crediting  this  account,  to  number  con- 
secutively the  dividends  declared,  as  "Dividend  No.  20,"  or 
"Dividend  No.  20,  payable  August  i,  1922."    A  new  account 


1  SeeBookI,Chs.LII.LIII,"Dividends";alsoBookIII.  Chs.  XXX.   XXXI.  "Dividends." 
<  See  i  126. 

I142 


Ch.  14]  DIVIDENDS  1 143 

need  not  be  opened  each  time  a  dividend  is  declared,  though  this 
is  frequently  done. 

If  the  stockholders  are  few  and  the  dividend  is  paid  immedi- 
ately after  being  declared,  it  is  not  necessary  to  open  a  Dividend 
account.^ 

§  118.    Payment  of  Dividends  a  -jol  a--. 

When  a  dividend  is  declared,  its  amount  is  credited  to  Divi- 
dend account  and  debited  to  Surplus.  In  the  smaller  corporations 
dividends  are  usually  paid  by  check  on  the  general  bank  account, 
just  as  in  the  case  of  any  other  company  payment.  Cash  account 
is  credited  and  Dividend  account  debited  as  the  dividend  checks 
are  drawn. 

■ '  In  the  larger  corporations  it  is  usual  to  draw  one  check  pay- 
able to  the  bank  for  the  total  amount  of  the  dividend,  and  this 
check  is  entered  in  the  cash  book  and  posted  to  Dividend  account 
in  the  ledger.  This  closes  the  account,  and  the  general  books  of 
the  company  are  no  longer  concerned  with  that  particular  divi- 
dend, no  matter  how  long  some  of  the  stockholders  may  hold 
their  dividend  checks  before  getting  them  cashed. 

The  check  for  the  total  dividend  is  deposited  in  the  bank  to 
the  credit  of  a  special  account,  as  for  instance,  "Kingston  Steel 
Works — Dividends"  or  "William  Kingston,  Treasurer,"  or  even 
in  another  bank  than  that  in  which  the  corporation  keeps  its 
main  deposit,  and  the  individual  dividend  checks  are  drawn  on 
this  account,  using  a  special  check  book.  These  are  mailed  or 
otherwise  delivered  to  their  owners,  and  from  the  bank's  state- 
ment of  the  dividend  account  it  can  be  seen  at  any  time  which 
stockholders  have  not,  up  to  that  time,  drawn  their  money.  This 
need  not  concern  the  general  books  of  the  corporation,  however, 
because  the  entire  matter  is  now  outside  the  usual  course  of 
business'.'   i"'-^  ^'''  '"'   '  -ijuioi-. 

The  largef '(Corporations  with  many  stockhblders  usually  have 
specially  printed  dividend  checks,  giving  the  date  and  number 

*  See  f  130. 


1 144  CORPORATE  ACCOUNTING  [Bk.  III- 

of  the  dividend.  By  means  of  an  addressing  machine,  the  name 
and  address  of  the  stockholder  are  stamped  on  the  face  of  the 
check  in  the  lower  left-hand  comer,  after  which  the  amount  is 
filled  in  on  the  typewriter  or  other  printing  machine.  After  the 
checks  and  amounts  are  verified,  proved  on  the  adding  machine, 
and  signed  by  the  proper  officials,  they  are  placed  in  window 
envelopes  for  mailing. 

§  119.    Dividend  Sheet  or  Book 

The  practice  of  setting  aside  each  quarter  or  half-year  in  a 
separate  bank  account  the  exact  amount  required  for  the  pay- 
ment of  dividends,  and  drawing  special  checks  against  this  fund, 
keeps  dividend  cash  entirely  separate  from  the  general  cash  of 
the  company,  A  dividend  sheet  or  book*  should  be  prepared, 
showing  the  names  of  stockholders,  date  of  dividend,  amount  and 
number  of  each  check,  etc.  As  the  checks  are  paid  a  record  may 
be  made  in  this  book,  if  desired,  but  where  the  names  are  numer- 
ous this  is  hardly  worth  while. 

The  dividend  sheet  or  book,  as  intimated,  contains  a  list  of 
the  stockholders  entitled  to  receive  dividends.  This  list  is  usually 
made  up  from  the  stock  ledger  each  time  a  dividend  is  declared, 
after  the  transfer  books  are  closed,  or  if  the  transfer  books  are 
not  closed,  on  the  date  specified  in  the  resolution  declaring  the 
dividend.  When  the  stockholders  are  many  and  the  stock  active, 
it  is  very  necessary  that  these  lists  be  compiled,  and  that  care 
be  taken  in  checking  up  and  proving  the  amounts  which  are  to 
be  paid. 

The  bound  dividend  book  is  used  only  by  small  companies 
whose  stock  is  not  active ;  the  larger  corporations  use  loose  sheets 
and  place  them  in  binders  for  convenience.  These  sheets,  if 
bound  together,  would  constitute  the  ordinary  dividend  book. 

Where  stockholders  come  to  the  office  of  the  corporation  or 
to  the  bank  for  their  dividends,  a  space  is  allowed  on  the  dividend 
sheet  for  their  signatures.    Some  companies  prefer  this  plan  as 

*  See  Book  IV,  Forms  257,  258. 


Ch.  14]  DIVIDENDS  1 145 

it  keeps  the  stockholders  in  touch  with  the  corporation  and  its 
business.  Most  companies,  however,  have  adopted  the  plan  of 
mailing  dividend  checks,  and  these  are  always  made  payable  to 
order.  The  indorsement  of  the  check  is  then  considered  a  suflBi- 
dent  receipt,  and  the  receipt  column  is  unnecessary.  :^:>:>fi-j 

§  120.    Entries  for  Cash  Dividends 

To  illustrate  a  simple  form  of  entering  cash  dividends,  suppose 
the  net  profits  of  the  Kingston  Steel  Works  for  the  year  192 1 
amounted  to  $38,690.40.  The  directors  have  declared  dividend 
No.  7  of  5%  on  $500,000  of  outstanding  stock,  payable  in  10  days. 

The  entries  affecting  Surplus,  the  one  necessary  in  closing  the 
books  and  the  other  entering  the  dividend,  are  as  follows: 

December  31,  192 1 

Profit  and  Loss $38,690.40 

To  Surplus $38,690.40 

Closing  Profit  and  Loss  account  on  transactions  of  192 1. 

January  7,  1922 

Surplus $25,000.00 

To  Dividend  No.  7 $25,000.00 

Seventh  annual  dividend  of  5%  on  the  outstanding 
capital  stock  of  the  Company,  declared  this  day  by 
the  Board  of  Directors  and  payable  January  17,  1922. 

January  17,  1922 

Dividend  No.  7 $25,000.00 

To  Cash $25,000.00 

For  pajnnent  of  dividend  No.  7,  as  per  order  of  the 
Directors. 

In  many  cases  no  Dividend  account  is  opened,  in  which  case 
the  dividends  paid  are  charged  direct  to  Surplus  account,  the 
entry  for  the  dividend  being  as  follows: 

January  17,  1922 

Surplus $25,000.00 

To  Cash $25,000.00 

Payment  of  the  seventh  annual  dividend  of  5%  on  the 
outstanding  stock  of  the  Company,  declared  January 
7,  1922,  and  payable  January  17,  1922. 


1 146  CORPORATE  ACCOUNTING  )BL  m- 

If  a  special  bank  account  is  set  apart  for  dividend  checks, 
the  transfer  of  dividend  cash  is  made  as  explained  in  §  118,  by- 
drawing  one  check  for  the  required  amount,  Dividend  or  Surplus 
account  being  debited  and  Cash  credited.  The  individual 
checks  are  then  issued  by  the  officers  in  charge  of  the  dividend 

disbursements. 

iCi  dasO  lot  z^hiaiL     .osi  5? 

§  121.    Dividends  on  No-Par  Stock 

Dividends  declared  on  stock  of  no  par  value  cannot  be,  of 
course,  in  terms  of  any  per  cent  per  share,  but  must  be  a  specified 
amount  of  money  per  share.  There  is  no  other  difference  be- 
tween dividends  on  par- value  and  on  no-par  stock  than  this: 
that  the  dividend  is  declared  at  so  much  per  share,  and  not  so 
much  per  cent.  Holders  of  no-par  stock  share  equally  in 
dividends  and  have  proportionate  interests  in  capital  and  profits 
regardless  of  the  prices  paid  for  their  shares.  The  book  entries 
of  the  dividends  are  the  same  for  either  kind  of  stock. 

§  122.    Dividends  Paid  with  Borrowed  Money 

It  is  not  unusual  for  even  the  most  prosperous  company  to 
be  temporarily  short  of  ready  cash  to  meet  dividend  payments. 
The  current  assets  may  be  three  times  as  much  as  the  current 
liabilities,  and  yet  consist  largely  of  notes  and  accounts  receiv- 
able which  cannot  be  used  to  pay  dividends.  In  such  a  case  it 
is  perfectly  proper  for  the  directors  to  borrow  money  to  pay  a 
dividend.  In  that  event  the  following  entries  might  be  made, 
the  first  a  journal  entry,  all  the  others  cash  book  entries : 

January  4,  1922 

Surplus $10,000 

To  Dividends  Payable $10,000 

Dividend  of  5%  declared  this  day  on  capital  stock  of  the 
Company.    Payable  in  cash  January  15,  1922. 

January  13,  1922 

Cash $10,000 

To  Notes  Payable $10,000 

Three  months'  note  discounted  at  First  National  Bank  to 
secure  funds  for  payment  of  dividend  due  January  15.  ,^ 


Ch.  14]  DIVIDENDS  1 147 

Discount $150 

To  Cash $150 

Discount  at  6%  on  Company's  three  months'  note  of 
$10,000. 

January  15,  1922 

Dividends  Payable $10,000 

To  Cash $10,000 

Payment  of  dividend  of  5%  on  capital  stock  of  the  Company. 

§  123.     Entries  for  Scrip  Dividend 

Another  way  to  pay  a  dividend  when  temporarily  short  of 
cash  is  by  an  issue  of  scrip.  Scrip  is  a  promissory  note  of  a 
corporation,  usually  bearing  interest,  and  falling  due  upon  a 
specified  date,  or  after  a  specified  occurrence,  as  for  instance 
when  a  proposed  bond  issue  shall  have  been  sold.  The  scrip  is 
in  the  form  of  certificates,  on  which  appear  the  company's 
promise  to  pay  the  money  and  the  various  terms  of  the  contract. 
These  certificates  sometimes  call  for  or  are  convertible  into  stock 
of  the  company,  and  such  scrip  sometimes  participates  in  divi- 
dends. The  scrip  certificates  are  frequently  transferable,  and 
pass  by  assignment  from  hand  to  hand  in  the  open  market. 

The  Novelty  Manufacturing  Company  with  a  capital  stock 
of  $1,500,000,  $1,000,000  being  common  stock  and  $500,000  pre- 
ferred stock,  declares  its  regular  annual  dividend  of  3%  on  both 
issues,  payable  in  scrip.  Dividend  declared  May  15,  192 1, 
payable  June  15,  1921;  scrip,  payable  in  cash  June  15,  1922,  and 
bearing  interest  at  the  rate  of  5%. 

The  journal  entries  for  the  declaration  and  payment  of  this 
annual  3%  scrip  dividend  on  the  common  and  preferred  stock 
are  as  follows: 

May  15,   1921 

Surplus $45,000 

To  Dividend— Common $30,000 

Dividend — Preferred 15,000 

Annual  dividend  of  3%  on  both  common  and  preferred  stock 
declared  this  day,  payable  June  15,  1921,  in  scrip  of  the 
Company,  maturing  June  15,  1922,  and  bearing  interest 
at  5%. 


1 148  CORPORATE  ACCOUNTING  [Bk.  Ill- 

June  15,  1921 

Dividend — Common $30,000 

Dividend — Preferred 15,000 

To  Dividend  Scrip  (or  Scrip  Payable) $45,000 

Dividends  paid  this  day  in  scrip  maturing  June  15, 1922,  and 
bearing  interest  at  5%. 

When  the  scrip  matures,  an  entry  similar  to  the  following  is 
necessary: 

June  15,  1922 

Dividend  Scrip $45,000 

Interest 2,250 

To  Cash $47,250 

For  payment  of  dividend  scrip  maturing  today,  with  interest 
from  June  15,  1921,  at  5%. 

§  124.    Entries  for  Special  and  Interim  Dividends 

Occasionally,  after  a  very  prosperous  year  or  a  longer  period 
of  prosperity,  during  which  a  large  surplus  has  been  accumu- 
lated, the  directors  declare  a  "special  dividend"  or  "bonus"  in 
addition  to  the  regular  dividend.  This  is  commonly  called 
"cutting  a  melon."  Sometimes  the  employees  of  the  company 
also  participate,  and  this  is  known  as  "profit-sharing." 

To  illustrate  the  entry  of  such  dividends,  assume  that  a 
corporation  with  $1,000,000  capital  stock,  and  profits  for  the 
year  of  $125,400,  declares  its  regular  annual  dividend  of  7%  and 
at  the  same  time  declares  a  "special  dividend"  of  2%,  and  awards 
to  its  employees  a  bonus  of  10%  of  the  net  earnings  of  the  year 
just  ended.     The  entries  are  as  follows : 

January  4,  1922 

Surplus $102,540 

To  Dividend  No.  17 $70,000 

Special  Dividend  No.  i 20,000 

Bonus  to  Employees 12,540 

As  per  resolution  passed  this  day  by  the  Board  of  Directors 
declaring  the  regular  annual  dividend  of  7%  on  the 
capital  stock  of  the  Company;  an  additional  dividend  of 
2%;  and  awarding  to  the  employees  a  bonus  of  10%  of 
the  net  earnings  of  the  year  just  ended;  all  payable  in 
cash  on  the  15th  day  of  January,  1922. 


Ch.  14]  DIVIDENDS  II49 

January  15,  1922 

Dividend  No.  17 $70,000 

Special  Dividend  No.  i 20,000 

Bonus  to  Employees 1 2,540 

To  Cash $102,540 

For  payment  of  dividends  and  bonus  provided  for  in 
resolution  of  the  Board  of  Directors  passed  January  4. 

Dividends  declared  between  the  regular  dividend  dates  are 
called  "interim  dividends,"  and  are  declared  when  unusual 
profits  exist  to  justify  a  special  dividend,  or  when  for  some  reason 
it  is  desired  to  anticipate  the  regular  dividend  in  whole  or  in 
part.  When  dividends  are  paid  quarterly,  as  is  the  case  with 
most  of  the  larger  corporations,  an  interim  dividend  is  seldom 
declared.  The  entries  in  case  of  interim  dividends  would  of 
course  be  exactly  the  same  as  the  entries  required  for  any  regular 
dividend. 

§  125.    Entries  for  Dividends  Applied  to  Stock  Subscriptions  ^ 

As  a  declared  dividend  is  a  debt  due  from  the  corporation  to 
the  stockholder,  any  indebtedness  of  a  stockholder  to  the  cor- 
poration may  be  set  off  against  his  dividend  and  be  deducted 
from  it,  provided  the  debt  is  actually  due  at  the  time  the  dividend 
is  payable. 

To  illustrate  the  entries  when  dividends  are  to  be  applied  on 
a  stock  subscription,  let  us  suppose  that  $200,000  par  value  of 
new  stock  of  the  Kanawha  Iron  Works  (shares  $50  each)  has 
been  offered  for  sale  to  provide  funds  for  the  erection  of  additional 
buildings;  that  all  this  has  been  subscribed,  and  a  first  instal- 
ment of  50%  has  been  paid  upon  it.  John  Smith  is  a  subscriber 
for  10  shares.  On  January  5,  1922,  the  board  of  directors  passes 
a  resolution  calling  for  the  final  instalment  of  50%  on  the  entire 
subscribed  stock,  payable  February  i.  On  February  3,  at  which 
time  John  Smith  has  not  paid  the  final  instalment  on  his  stock, 
the  directors  declare  an  annual  dividend  of  5%  on  the  entire 


>  See  Book  I,  |  485. 


II50  CORPORATE  ACCOUNTING  [Bk.  III- 

outstanding  stock  ($500,000)  as  of  January  i,  payable  February 
15.    The  entries  for  these  transactions  are  as  follows: 

First  Entry: 

January  5,  1922 

Final  Instalment  on  Stock  (or  Instalment  No.  2) $100,000 

To  Subscriptions $100,000 

As  per  resolution  passed  this  day  by  the  Board  of  Direc- 
tors, calling  for  the  final  instalment  of  $100,000  on 
$200,000  of  capital  stock  of  the  Company. 

This  entry  will  close  the  Subscriptions  account,  substituting 
for  it  the  Final  Instalment  account.  Assuming  that  all  the  stock- 
holders have  paid  the  first  instalment  in  full,  the  First  Instalment 
account  is  already  closed.  .f  -y^-^n,-^ 

Second  Entry: 

February  i,  1922 

Cash $99i7SO 

To  Final  Instalment  on  Stock $99,750 

Payment  of  final  instalment  on  capital  stock. 

This,  of  course,  would  be  comprised  in  cash  book  entries 
showing  the  names  of  the  stockholders  and  amount  paid  by  each. 
To  simplify  the  illustration,  it  is  assumed  that  all  except  John 
Smith  had  paid  at  the  time  of  declaring  the  dividend. 

Third  Entry: 

February  3,  1922 

Surplus $25,000 

To  Dixadend  No.  5 $25,000 

The  Board  of  Directors  have  this  day  declared  the  regular 
annual  dividend  of  5%  on  the  capital  stock  of  the  Com- 
pany, payable  in  cash  on  the  15  th  day  of  February. 

Fourth  Entry: 

February  15,  1922 

Dividend  No.  5 $24,975 

To  Cash $24,975 

Dividend  paid  this  day  as  per  resolution  of  the  Board  of 
Directors,  February  3. 


Ch.  i4l  DIVIDENDS  1151 

Fifth  Entry: 

February  15,  1922 

Dividend  No.  5 $25 

To  Final  Instalment  on  Stock $25 

To  apply  dividend  of  John  Smith  as  part  payment  of  final 
instalment  of  $250  due  on  10  shares  of  capital  stock  of 
the  Company. 

§  126.     Cumulative  Dividends  Passed 

Although  preferred  stock  dividends  may  be  payable  before  the 
common  stock  can  receive  any  share  of  the  profits  of  the  cor- 
poration, these  dividends  do  not  become  an  obligation  of  the 
company  until  they  are  formally  declared  by  the  board  of  direc- 
tors. It  is  therefore  improper  to  enter  "passed"  dividends  on 
the  books  as  an  obligation  at  the  time,  although  this  is  sometimes 
done.  Nor  should  they  appear  among  the  liabilities  on  the 
balance  sheet,  though  it  is  necessary  to  show  by  means  of  a  foot- 
note the  contingent  liability  for  the  dividends  which  have  been 
"passed." 

Where  a  preferred  dividend  is  passed  but  it  is  desired  that  it 
be  shown  on  the  books,  it  might  be  done  by  an  entry  similar  to 
the  following: 

Surplus $30,000 

To  Unpaid  Preferred  Dividend $30,000 

For  1921  preferred  dividend  of  6%  not  declared  by  the 
Board  of  Directors  but  ordered  to  be  shown  upon  the 
books. 

This  might  make  the  Surplus  account  show  a  debit  balance, 
and  in  any  event  it  would  be  reducing  surplus  for  the  sake  of  a 
liability  which  was  only  contingent  and  which,  since  the  dividend 
had  not  been  declared,  would  not  hold  as  against  outside 
creditors.  i/h  'jdt 

§  127.    Entries  for  Stock  Dividends 

Sometimes  the  directors  declare  instead  of  a  cash  dividend, 
what  is  known  as  a  "stock  dividend."  There  may  be  stock  in  the 
company's  treasury,  donated  or  purchased,  that  may  properly 


II52  CORPORATE  ACCOUNTING  [Bk.  Ill- 

be  divided  among  the  stockholders  in  the  form  of  a  dividend. 
Or  unissued  stock  may  be  issued  for  the  purpose,  or  new  stock 
may  even  be  created.  The  directors  are  perfectly  justified  in 
using  such  stock  for  dividends,  provided  there  are  undivided 
profits  of  an  amount  equal  to  the  face  value  of  the  stock  issued 
as  dividends.  To  illustrate  the  entries,  suppose  that  the  Michi- 
gan Furniture  Company,  with  an  authorized  capital  stock  of 
$1,000,000,  has  had  a  very  prosperous  year,  its  profits  amounting 
to  over  $100,000,  but  the  directors  desire  to  invest  most  of  their 
available  funds  in  additional  shops  and  machinery.  Their  regu- 
lar annual  dividend  is  10%.  Only  one-half  of  the  authorized 
capital  stock  has  been  issued,  so  they  declare  the  regular  10% 
dividend  but  make  it  payable  in  stock  of  the  company. 

Surplus $50,000 

To  Dividend  No.  4 $50,000 

A  dividend  of  10%  on  the  $500,000  outstanding  capital 
stock  of  the  Company  has  this  day  been  declared  by  the 
Directors,  payable  in  stock  of  the  Company. 

Dividend  No.  4 $50,000 

To  Capital  Stock $50,000 

Stock  issued  to  pay  stock  dividend  of  10%. 

If  the  unissued  stock  is  being  carried  on  the  books  in  Unissued 
Stock  account,  the  second  entry  would  be  a  credit  to  that  ac- 
count. If  the  dividend  were  paid  out  of  treasury  stock,  Treasury 
Stock  account  would  of  course  be  credited. 

§  128.    Dividends  Payable  in  No-Par  Stock 

When  a  stock  dividend  is  payable  in  stock  without  par  value, 
the  only  entry  required  on  the  general  books  is  one  indicating 
the  number  of  shares  thus  disposed  of.^  No  value,  not  even  an 
arbitrary  one,  is  being  disposed  of,  the  stockholders'  proportion- 
ate interest  remains  the  same,  but  is  merely  cut  up  into  more 
pieces  by  having  more  shares  outstanding.    The  amount  of  sur- 

•c/.  SiiS. 


Ch.  14]  DIVIDENDS  1 1 53 

plus  available  for  other  dividends,  whether  stock  or  cash,  is  not 
affected  in  the  least. 

If  in  the  case  presented  in  the  previous  section  the  stock  of 
the  Michigan  Furniture  Company  was  of  no  par  value,  the 
entries  on  the  journal  would  be  as  follows: 

Surplus $  none 

To  Dividend  No.  4 $  none 

A  dividend  of  10%  on  the  outstanding  capital  stock  has  this 
day  been  declared  by  the  Board  of  Directors,  said  dividend 
being  payable  in  the  capital  stock  of  the  company. 

Dividend  No.  4 $  none 

To  Capital  Stock $  none 

....  shares  of  stock  issued  to  pay  stock  dividend  of  10%. 

§  129.    Dividends  Paid  in  Bonds  or  Property 

If  there  are  profits  from  which  dividends  may  be  legally  paid, 
the  directors  may  pay  them  in  any  property'  owned  by  the  cor- 
poration as  well  as  in  cash  or  stock,  or  they  may  pay  them  in 
bonds  of  the  corporation  as  well  as  in  short  notes  (scrip).  The 
only  stipulation  is  that  they  shall  be  issued  against  actual  profits. 

If  in  the  preceding  example  the  directors,  with  the  consent  of 
the  stockholders,  had  paid  the  dividends  in  bonds,  the  entries 
would  be  as  follows: 

Surplus $50,000 

To  Dividend  No.  4 $50,000 

A  dividend  of  10%  on  the  capital  stock  of  the  Company  has 
this  day  been  declared  by  the  Directors,  payable  in  the 
first  mortgage  bonds  of  the  Company. 

Dividend  No.  4 $50,000 

To  First  Mortgage  Bonds $50,000 

First  mortgage  4%  bonds  given  to  stockholders  in  payment 
of  io%  dividend  on  the  stock  of  the  corporation. 

If  the  dividend  had  been  paid  in  property  of  the  corporation, 
such  as  merchandise  produced  by  it,  the  credit  would  have  been 
passed  to  the  proper  asset  account  instead  of  to  First  Mortgage 
Bonds. 

'  See  Book  I,  |  493. 


■ti54  CORPORATE  ACCOUNTING  [Bk.  Ill- 

§  130.    Bank  Dividends  ^ 

Banks  pay  dividends  on  their  stock  with  checks  drawn  on 
themselves  (cashiers'  checks),  and  this  makes  the  bookkeeping 
entries  slightly  different  from  those  of  other  companies.  The 
first  entry  is: 

Undivided  Profits $50,000 

To  Dividend  No.  34 $50,000 

For  dividend  of  5%  declared  this  day  by  the  Directors  on  the 
capital  stock  of  the  bank. 

The  charges  to  Dividend  account  come  from  the  cash  book  • 
as  the  dividend  checks  are  presented  for  payment  at  the  paying 
teller's  window  or  through  the  clearing  house.  The  balance  of 
Dividend  account,  therefore,  shows  the  amount  of  dividend 
checks  outstanding,  and  appears  on  the  balance  sheet  as  "Unpaid 
Dividends." 

§  131.    Unearned  Dividends  ^ 

Although  the  laws  of  all  of  the  states  forbid  the  payment  of 
dividends  if  such  payment  results  in  the  impairment  of  capital, 
there  are  more  or  less  frequent  evasions  of  this  rule.  The  fact 
that  a  dividend  has  been  paid  out  of  capital  may  not  be  known  to 
anyone  except  the  directors;  in  fact,  the  directors  themselves  are 
sometimes  ignorant  of  such  an  occurrence,  owing  to  errors  as  to 
profits  or  due  perhaps  to  the  fact  that  they  will  not  take  the 
trouble,  or  have  not  sufficient  knowledge  of  accounting,  to  inform 
themselves  of  the  true  condition  of  the  company.  Yet  they  may 
be  held  liable  by  the  courts  for  any  loss  to  creditors  occasioned 
by  the  payment  of  dividends  out  of  capital. 

Errors  as  to  profits  may  arise  from  many  causes.  The  books 
of  the  company  may  perhaps  show  a  surplus  of  earnings  which 
in  reality  does  not  exist,  because  no  provision  has  been  made  for 
bad  debts  or  depreciation;  or  materials  have  been  included  in 
the  inventories  which  have  not  yet  been  credited  to  Accounts 
Payable;  or  materials  have  been  valued  at  the  selling  price;  or 

8  See  Book  I,  i  498. 


Ch.  14]  DIVIDENDS  X15S 

orders  for  future  delivery  may  have  been  booked  as  sales;  the 
book  value  of  real  estate  may  have  been  written  up;  assets  with 
no  value,  such  as  patents  and  copyrights  which  have  expired, 
may  still  be  carried  upon  the  books;  judgments  against  the 
company  may  have  been  omitted  from  the  accounts.  These  and 
other  errors  may  have  been  made  which  hide  the  fictitious  char- 
acter of  the  apparent  profits,  so  that  the  payment  of  dividends 
under  such  conditions  results  in  an  impairment  of  capital.  An 
exammation  by  a  competent  auditor,  however,  would  disclose 
any  such  errors  and  prevent  the  declaration  of  illegal  dividends. 

In  case  accounting  errors  are  discovered  which  have  resulted 
in  a  fictitious  surplus,  the  proper  charges  must  be  made  to  show 
the  true  condition.  This  may,  if  dividends  have  been  declared 
or  other  expenditures  have  been  made  on  the  strength  of  the 
supposed  surplus,  result  in  a  debit  balance  in  Surplus  account. 
It  is  perfectly  proper  to  allow  this  debit  balance  to  remain  on  the 
ledger  until  wiped  out  by  the  accumulating  profits,  but  in  the 
balance  sheet  it  should  be  placed  on  the  asset  side  and  called 
"Deficit,"  or  be  shown  on  the  liability  side  as  a  deduction  from 
the  capital  stock. 

§  132.    Income  from  Dividends 

A  corporation  owning  stock  in  another  company  will  ordin- 
arily have  income  in  the  form  of  dividends  paid  by  the  Under- 
lying corporation.  Were  a  6%  dividend  declared  by  the  Baldwin 
Mercantile  Company,  in  which  we  have  an  investment  to  the 
extent  of  $260,000  par  value,  an  entry  similar  to  the  following 
would  be  required  on  our  books  upon  receipt  of  the  money ' 

Cash ■ $15,600 

To  Dividends  on  Investments $15,600 

For  dividend  of  6%  on  $260,000  par  of  stock  of  the  Baldwin 
Mercantile  Company, 

Dividends  on  Investments  account  would  close  into  Profit 
and  Loss  at  the  end  of  the  fiscal  period. 


CHAPTER  XV 
TYPICAL  CORPORATE  ORGANIZATIONS 

§  133.    Organization  Procedure 

The  organization  details  outlined  in  this  and  the  following 
chapters  are  in  accordance  with  the  laws  of  the  states  in  which 
the  corporations  are  respectively  incorporated.  Of  course,  an 
attorney  will  be  retained  when  an  incorporation  is  to  be  made, 
and  on  him  rests  the  direct  responsibility  for  the  technical 
details;  but  the  accountant  should  have  at  least  a  sufficient 
knowledge  of  the  required  procedure  to  make  his  record  intelli- 
gent. 

A  Manufacturing  Corporation 

§  134.    Details  of  Incorporation 

The  preliminary  organization  of  the  Rockwell  Manufactur- 
ing Company,  of  Philadelphia,  was  effected  on  March  2,  1922. 
The  company  was  incorporated  for  the  manufacture  and  sale 
of  household  furniture,  with  a  capital  stock  of  $100,000,  con- 
sisting of  1,000  shares  of  the  par  value  of  $100  each.  The  in- 
corporators and  the  number  of  shares  subscribed  for  by  each 
are  as  follows: 


Name 

Address 

Shares 

Amount 

George  Rockwell 

657  Broad  St.,  Philadelphia 

400 

$40,000 

Jane  Rockwell 

657  Broad  St.,  Philadelphia 

200 

20,000 

Henry  Lindon 

1415  Market  St.,  Philadelphia 

300 

30,000 

Thomas  J.  Peterson 

Harrisburg,  Pa. 

100 

10,000 

The  first  instalment  of  10%,  as  required  by  the  Pennsylvania 
law,  has  been  paid  in  cash.  Immediately  after  the  date  of  final 
organization,  another  payment  of  50%  will  be  due,  and  the 
balance  will  be  payable  one  month  thereafter, 

1156 


ch.  is]  typical  corporate  organizations  1 157 

§  135.    Books  of  Account 

After  the  organization  has  been  completed  and  all  require- 
ments complied  with,  it  is  in  order  to  make  the  necessary  records 
in  the  books  of  the  corporation.  The  particular  books  of  account 
to  be  used  are  not  prescribed  by  statute,  except  that  either  the 
treasurer  or  secretary  is  required  to  keep  at  the  office  of  the 
principal  place  of  business  a  book  containing  the  names  of  all 
persons  who  are,  or  who  within  one  year  shall  have  been,  stock- 
holders of  such  company,  showing  the  number  of  shares  held, 
when  they  became  owners  thereof,  the  amount  paid  in,  etc.i 

Regardless  of  the  absence  of  specific  stipulations  in  the  law, 
a  complete  set  of  accounting  books  should  be  provided,  and  they 
must  of  course  be  properly  kept.  The  opening  entries  for  jour- 
nal and  cash  book  are  shown  on  the  following  pages,  including 
payment  of  the  first  and  second  subscription  instalments  and  the 
customary  expenses  at  the  time  of  incorporation.  Accounts 
with  stockholders  must  be  opened  in  the  stock  ledger,  instal- 
ment receipts  issued,  and  the  stock  certificate  book  made  ready 
for  use  as  soon  as  the  instalments  are  completed.^ 

§  136.     Journal  Entries 

For  opening  entries,  the  plan  that  will  best  suit  the  case  of 
the  particular  corporation  should  be  adopted.  Since  there  are 
only  a  few  subscribers  to  stock,  separate  subscription  and  instal- 
ment registers  are  not  necessary,  as  their  names  can  be  entered 
in  the  subscription  and  instalment  accounts. 

It  will  be  noted  that  the  first  cash  was  received  March  2, 
1922,  the  date  of  application  for  charter.  Since,  however,  the 
corporation  does  not  come  into  legal  existence  until  the  charter 
is  granted,  it  would  seem  desirable  to  make  the  opening  entries 
on  March  23,  the  actual  date  of  organization.  Entries  should 
state  all  details  fully,  however,  and  give  the  dates  of  any  pay- 
ments already  made. 

'The  stock  ledger  shown  in  Book  IV,  Ch.  VII,  "Stock  Books,"  will  satisfy  the  require- 
ments of  Pennsylvania  and  of  most  other  states. 

'  See  Book  IV,  Ch.  V,  "Subscription  Receipts  and  Records,"  also  Ch.  VI,  "Stock  Certifi- 
cates." 


1 1 58  CORPORATE  ACCOUNTING  [Bk.  IH- 

Because  all  the  capital  stock  is  subscribed  at  the  outset  and 
is  to  be  paid  for  within  a  short  period,  a  single  Capital  Stock 
account  is  used  instead  of  the  Capital  Stock  Authorized  and 
Capital  Stock  Unissued  accounts.^ 

First  Entry: 

March  23,  1922 

Subscriptions $ioo,cxx) 

To  Capital  Stock $100,000 

Incorporation  of  the  Rockwell  Manufacturing  Company 
with  a  capital  stock  of  $100,000,  shares  $100.  Sub- 
scriptions as  below  (under  date  of  March  2,  1922)  on 
terms  of  10%  down,  50%  on  date  of  organization,  and 
the  balance  in  one  month: 

George  Rockwell 400  shares 

Jane  Rockwell 200       " 

Henry  Lindon 300      " 

Thomas  J.  Peterson ,...,.....   100      " 

ni '•  ij '.IV-  J ■-■.{ hi ri  nil 

The  first  instalment  of  10%  having  been  paid  at  the  time  of 
incorporation,  is  entered  directly  in  the  cash  book,  as  shown 
on  the  next  page.  Next,  under  the  same  date,  an  entry  is  made 
for  the  second  instalment.  The  first  instalment  might  of  course 
be  put  through  the  journal  as  is  the  second,  but,  as  it  has  already 
been  paid,  the  cash  book  entry  would  seem  to  be  all  that  is 
necessary.  We  might  also  omit  the  entry  for  Instalment  No.  2 
and  let  that  likewise  be  credited  to  Subscriptions  through  the 
cash  book. 

Second  Entry: 

March  23,  1922 

Instalment  No.  2 $50,000 

To  Subscriptions $50,000 

For  second  instalment,  being  50%  of  the  amount  sub- 
scribed : 

George  Rockwell „. .  j  t .,.    $20,000 

Jane  Rockwell i  .t,.fs .  {      10,000 

Henry  Lindon 15,000 

Thomas  J.  Peterson 5, 000 

If  an  instalment  register*  is  used,  the    journal   entries  for 

»  See  {  36. 

*  See  §  58. 


Ch.  15] 


TYPICAL  CORPORATE  ORGANIZATIONS 


"59 


instalments  would  usually  be  omitted,  and  payments  credited 
directly  to  Subscriptions  account  through  the  cash  book.  When 
Instalment  No.  3  becomes  due  in  one  month,  it  will  be  treated 
in  the  same  manner  as  Instalment  No.  2. 

Stock  certificates  should  not  be  issued  .until  the  final  instal- 
ment is  paid,  and  upon  their  issuance  it  would  in  most  states  be 
necessary  to  open  accounts  with  the  individual  stockholders  in 
a  stock  ledger. 


§  137.    Cash  Book  Entries 


Cash  Book 


Receipts  ,       . 

1922 

Mar.  23  Subscriptions     10% 
paid  in,  by: 
George  Rockwell .  .  .   $4,000.00 

Jane  Rockwell 2,000.00 

1  Henry  Lindon 3,000.00 

Thomas  J.  Peterson .     i  ,000.00 
Instalment    No.    2, 
50%: 
'' '  George  Rockwell .  .  .   20,000.00 

••  Jane  Rockwell 10,000.00 

Henry  Lindon 15,000.00 

Thomas  J.  Peterson .     5,000.00 


Payments 

1922 

Mar.  23  Incorporation  Expen- 
ses: 

Charter  Fee $  30.00 

Bonus  on  Capital. .  .  .      200.00 

Recording  Fees 2.50 

Counsel 100.00 

Accountant 100.00 

Equipment 100.00 

Expenses 3S-oo 


§  138.    The  Ledger  Accounts 

Capital  Stock 


1922 

Mar.  23  Subscriptions. 


5100,000 


Subscriptions 


1922 

Mar.  23  Capital  Stock: 

George  Rockwell ....  $40,000 

Jane  Rockwell 20,000 

Henry  Lindon 30,000 

Thomas  J.  Peterson. .  10,000 


1922 


Mar.  23  Cash,  10% $10,000 

Instalment  No.  2,  50%  50,000 


ii6o 


CORPORATE  ACCOUNTING 
Instalment  No.  2 — 50% 


[Bk.  III- 


1922 

Mar.  23  Subscriptions,  50%: 

George  Rockwell .  .  $20,000.00 
Jane  Rockwell.  .  .".  10,000.00 
Henry  Lindon.  .  .  .  15,000.00 
Thomas  J,  Peterson      5,000.00 


$50,000.00 


1922 

Mar.  23  Cash 

(Payment   may   be 
credited    separ- 
ately if  desired.) 


$50,000.00 


Instalment  No.  '3 — 40% 
{Same  form  of  account  as  for  Instalment  No.  2) 

A  Mining  Corporation 

§  139.    Details  of  Incorporation 

To  illustrate  the  opening  entries  for  a  mining  company, 
assume  that  the  Copper  County  Mining  Company  is  to  be 
incorporated  under  the  laws  of  Michigan  with  an  authorized 
capital  stock  of  $50,000,  consisting  of  2,000  shares  of  $25  each. 
The  company  is  to  take  over  from  James  R.  Cooke  and  Frank 
Patterson,  a  partially  developed  copper  mine  located  in  Copper 
County,  Michigan,  and  carrying  with  it  200  acres  of  mineral' 
land.  The  incorporators  and  the  amount  of  stock  subscribed 
for  by  each  as  of  April  3,  1922,  are  as  follows: 

Name                             Address  Shares  Amount 

James  R.  Cooke  Detroit,  Michigan  900  $22,500 

Frank  Patterson  Calumet,        "  900  22,500 

John  H.  Jerome  Detroit,           "  100  2,500 

John  H.  Wilson                         "                "  100  2,500 

The  entire  mine  property  is  conveyed  to  the  company  by 
Cooke  and  Patterson  in  full  payment  for  their  subscriptions,  and 
Jerome  pays  cash  in  full  for  his  100  shares.  Wilson  pays  $100, 
but,  failing  to  pay  the  balance,  his  stock  is  declared  forfeited. 
Cooke  and  Patterson  each  donate  200  shares  of  stock  to  the  com- 
pany, this  stock  to  be  sold  for  the  purpose  of  providing  working 
capital.     Of  the  donated  stock,  200  shares  are  sold  at  $15  per 


Ch.  isl  TYPICAL  CORPORATE  ORGANIZATIONS  Ii6l 

share  and  loo  shares  at  $20  a  share.  All  this  stock  is  paid  for  in 
cash.  The  sum  of  $2,000  has  been  paid  out  for  development 
expenses,  and  $1,000  is  paid  on  account  of  new  buildings  and 
construction.  The  various  organization  expenses  have  been 
paid  by  the  incorporators,  who  are  reimbursed  after  incorpora- 
tion. 

§  140.    Opening  Entries 

The  books  of  account  must  contain  a  complete  record  of  the 
business  operations  of  the  company.  The  official  books  and 
records  to  be  kept  by  the  secretary  must  be  purchased  and  duly 
entered  up.  Opening  entries  for  the  corporation  are  made, 
under  a  slightly  different  plan  from  the  preceding  illustrations, 
as  on  April  3,  1922,  the  date  of  organization: 

April  3,   1922 

Unissued  Stock $50,000 

To  Capital  Stock  Authorized $50,000 

The  Copper  County  Mining  Company  has  this  day  been  in- 
corporated with  a  capital  stock  of  $50,000,  par  value  of 
shares  $25  each.     (See  minute  book,  page  4.) 

James  R.  Cooke $22,500 

Frank  Patterson 22,500 

John  H.  Jerome 2,500 

John  H.  Wilson 2iSoo 

To  Capital  Stock  Subscribed $50,000 

Subscriptions  have  been  received  as  follows: 

James  R.  Cooke 900  shares 

Frank  Patterson 900      " 

John  H.  Jerome 100      " 

John  H.  Wilson 100      " 

Cash $2,600 

To  John  H.  Jerome $  2,500 

John  H.  Wilson 100 

For  full  payment  of  Jerome's  subscription  to  100  shares  of 
stock,  as  per  agreement;  payment  of  $100  on  Wilson's 
stock,  balance  to  be  paid  in  10  days. 


1 162  CORPORATE  ACCOUNTING  [Bk.  HI- 

Copper  County  Mine  Property $45,000 

To  James  R.  Cooke $22,500 

Frank  Patterson 22,500 

The  Copper  County  Mine  property  and  all  improvements 
have  this  day  been  conveyed  to  the  Company  by  Cooke 
and  Patterson  in  full  payment  for  their  subscriptions  to 
stock  of  the  Company,  1,800  shares.  By  order  of  the 
Directors.     (See  minute  book,  page  5.) 

Capital  Stock  Subscribed $47,500 

To  Unissued  Stock '...  ..V  $47,500 

To  record  the  issuance  of  certificates,  as  follows:  >    "( 

John  H.  Jerome  (No.  i) 100  shares 

James  R.  Cooke  (No.  2) 900      " 

Frank  Patterson  (No.  3) 900      " 

Organization  Expenses $     325 

To  Cash $     325 

To  cover  various  incorporating  fees  and  expenses  advanced 
by  incorporators,  $35;  charges  of  attorney,  $150;  charges 
of  accountant,  $75;  other  preliminary  expenses,  $65. 

§  141.    Entries  for  Donated  Stock 

When  stock  is  donated  to  the  treasury  of  a  company,  an 
entry  is  required  debiting  Donated  Stock  or  Treasury  Stock,  s 
and  crediting  Working  Capital  Donated,  Donation,  or  Donated 
Surplus  account,  as  follows: 

Treasury  Stock $10,000 

To  Working  Capital  Donated $10,000 

For  400  shares  of  the  Company's  stock  donated  by  James  R. 
Cooke  and  Frank  Patterson,  200  shares  each,  to  be  sold  to 
provide  working  capital. 

The  donated  stock  is  placed  in  the  hands  of  a  trustee,  usually 
one  of  the  officers,  appointed  either  by  the  donors  or  by  the 
company.  An  account  with  this  trustee  is  opened  in  the  stock 
book  and  credited  with  the  400  shares  donated.  The  stock 
book  accounts  of  the  donors  are  of  course  debited.  The  donated 
certificates  are  attached  to  their  respective  stubs  in  the  stock 
certificate  book  and  canceled,  but  stock  certificates  need  not  be 


»  See  Ch.  X,  "Par-YftlHe  Ponated  Stock." 


Ch.  15]  TYPICAL  CORPORATE  ORGANIZATIONS  1163 

made  out  in  the  trustee's  favor,  as  that  necessitates  the  making 
of  transfers  each  time  a  sale  is  made.  As  the  stock  is  sold 
certificates  are  made  out  direct  to  the  purchasers,  but  the  record 
of  issue,  both  in  the  stock  certificate  book  and  in  the  stock  ledger, 
will  show  that  the  stock  has  been  transferred  from  "Trustee" 
account.  The  following  entries,  most  of  them  in  the  cash  book, 
are  necessary: 

Cash $3,000 

Working  Capital  Donated 2,000 

To  Treasury  Stock $5,000 

For  sale  of  200  shares  of  treasury  stock  at  $15  per  share  to  the 
following  persons: 

{Names  entered  here) 

Cash $2,000 

Working  Capital  Donated 500 

■i.        To  Treasury  Stock .' . .  .  $2,500 

For  sale  of  100  shares  of  treasury  stock  at  $20  per  share  to  the 
following  persons: 

{Names  here) 

Cost  bf  Development $2,000 

To  Cash $2,000 

Expenditures  for  developing  the  surface  and  entrance  to  the 
mine. 

Mine  Construction  (or  Building  and  Improvements) $1,000 

To  Cash $1,000 

Exp>enditures  for  construction  purposes  at  the  mine. 

§  142.    Entries  for  Forfeited  Subscription 

The  subscription  of  John  H.  Wilson  was  not  completed,  and 
after  calling  on  Wilson  for  payment  of  the  amount  still  due  on 
his  stock,  $2,400,  without  result,  it  was  declared  forfeited.  It  is 
debited  back  to  Capital  Stock  Subscribed  as  follows: 

Capital  Stock  Subscribed $2,500 

To  John  H.  Wilson $2,400 

Profit  on  Forfeited  Stock 100 

For  100  shares  of  stock  subscribed  for  by  John  H.  Wilson,  on 
which  but  $100  was  paid  and  the  stock  was  therefore  de- 
clared forfeited. 


Il64  CORPORATE  ACCOUNTING  [Bk.  III- 

The  entry  to  be  made  for  forfeited  stock  must  obviously 
depend  on  the  manner  of  making  the  opening  entries. 

The  $ioo  paid  by  Wilson  is  retained  by  the  corporation  and 
is  credited  to  Profit  on  Forfeited  Stock,  to  Premium,  or  directly 
to  Paid-in  Surplus.^  Before  forfeiting  stock  for  unpaid  sub- 
scriptions, the  statutes  of  the  state  should  be  consulted  for  the 
procedure  required.  In  the  absence  of  any  such  provision,  the 
stock  may  be  forfeited  when  the  subscriber,  after  demand  there- 
for, refuses  or  fails  to  pay  the  amount  due.  Sometimes  the  for- 
feited shares  are  advertised  for  sale  and  sold  to  the  highest 
bidder  who  in  this  ease  must  offer  at  least  $2,400. 

There  are  still  on  hand  100  shares  of  treasury  stock  which 
may  be  sold  at  an  early  date  or  held  until  it  will  sell  for  a  higher 
rate  or  even  a  premium.  In  case  the  mine  proves  to  be  success- 
ful, there  should  be  no  difficulty  in  disposing  of  this  stock  at  a 
higher  price.  The  profit  reaUzed  from  the  donation  of  stock 
may  be  transferred  from  Working  Capital  Donated  account  to 
Surplus,  if  so  desired. 

The  foregoing  entries  are  for  a  mine  with  a  small  capitaliza- 
tion,but  the  general  requirements  are  the  same  for  any  mining 
company. 

•See84&  -'^- 


CHAPTER  XVI 


INCORPORATION  OF  SOLE  PROPRIETORSHIP 


I  143.    Financial  Details  of  the  Incorporation 

Charles  W.  Hampton  has  been  conducting  a  wholesale  and 
retail  mercantile  business  for  the  past  ten  years  in  the  City  of 
New  York.  He  wishes  to  bring  other  parties  into  the  business, 
and  with  this  in  view  has  decided  to  incorporate  as  of  May  9, 
1922,  under  the  name  of  the  ''Hampton  Trading  Corporation," 
with  a  capital  stock  of  $250,000,  consisting  of  2,500  shares  of  the 
par  value  of  $100  each.  The  balance  sheet  of  Charles  W. 
Hampton  is  as  follows: 


Charles  W.   Hampton 
Balance  Sheet,  as  of  May  i,  1922 


Assets 

Land $  30,000 

Store  and  Warehouse 

Store  Equipment 

Delivery  Equipment 

Office  Equipment 

Merchandise 

Accounts  Receivable 

Notes  Receivable 

Cash 


50,000 
8,500 
9,000 
4,400 
46,300 
16,400 
9,350 
6,740 

$i8o,6qo 


Liabilities 
Mortgage  on  Warehouse . 

Loans  from  Bank 

Notes  Payable 

Accounts  Payable 


Total  Liabilities 

Charles  W.  Hampton,  Capital 
Account 


I  25,000 
10,000 
17.750 
22,800 

$  75.550 
105,140 

$180,690 


The  shares  have  been  subscribed  for  as  follows: 


Name 

Address 

Shares 

Amount 

Charles  W.  Hampton 

New  York  City 

1,250 

$125,000 

Samuel  Johnson 

" 

500 

50,000 

James  J.  Miller 

It 

500 

50,000 

Lincoln  Webster 

Albany,  JNew  York 

100 

10,000 

Robert  W.  Kester 

M. 

100 

10,000 

116^ 


Il66  CORPORATE  ACCOUNTING  [Bk.  III- 

Hampton  is  to  receive  1,250  shares  of  full-paid  stock  in 
exchange  for  his  business,  buildings,  stock,  and  equipment, 
including  the  various  assets  and  liabilities  as  per  the  accompany- 
ing balance  sheet.  The  business  of  Hampton  is  to  be  taken  over 
as  soon  as  possible  after  the  first  meeting  of  the  directors,  at 
which  time  the  other  subscribers  to  the  stock  of  the  company  will 
pa^y  50%  of  their  subscriptions,  the  remainder  to  be  paid  August 
9,  1922. 

§  144.    Good-Will  1 

The  net  worth  of  this  business,  which  the  corporation  is  to 
purchase  for  $125,000  of  its  capital  stock,  is  seen  by  the  above 
balance  sheet  to  be  $105,140.  If  this  is  the  real  value  of  these 
net  assets,  and  the  capital  stock  is  considered  as  being  worth  its 
face  value,  then  there  must  be  another  asset  of  a  value  of  $19,860 
which  is  being  purchased.  This  asset  is  the  good-will  of  Charles 
W.  Hampton,  the  proprietor  of  the  individually  owned  business. 

Good-will  is  not  an  item  entering  solely  into  corporation 
practice,  therefore  a  full  consideration  of  it  would  be  beyond  the 
purposes  of  this  work.  It  does,  however,  enter  into  transfers 
of  going  businesses  with  such  uniformity  that  it  cannot  be 
altogether  ignored. 

"Good-will  is  the  monetary  value  placed  upon  the  connection 
and  reputation  of  a  mercantile  or  manufacturing  concern,  and 
discounts  the  value  of  the  turnover  of  a  business  in  consequence 
of  the  probabilities  of  the  old  customers  continuing.  "2  An 
eminent  English  jurist*  defines  good-will  as  "every  advantage 
.  .  .  that  has  been  acquired  by  the  old  firm  in  carrying  on 
its  business,  whether  connected  with  the  premises  in  which  the 
business  was  previously  carried  on,  or  with  the  name  of  the 
late  firm,  or  with  any  matter  carrying  with  it  the  benefit  of  the 
business." 


1  See  also  Book  I,  5  91;  and  Book  II,  §5  127-132. 
'  Lisle  on  Accounting  in  Theory  and  Practice. 
'  Vice-Chancellor,  Sir  W.  Page  Wood. 


Ch.  i6]  INCORPORATION— SOLE  PROPRIETORSHIP  1167 

Lisle  in  his  "Accounting  in  Theory  and  Practice,"  gives  as 
the  basis  of  the  value  of  good-will,  the  place,  the  name,  and  the 
chance  that  no  one  connected  with  the  old  firm  will  step  in  to 
compete.  There  are  other  elements  which  enter  in,  however; 
such  as  the  personnel  of  the  concern,  its  trade-marks,  etc.  Al- 
though complex,  good-will  may  be  dej&ned  in  general  terms  as  the 
value  of  any  benefits  a  business  may  enjoy  or  advantages  it  may 
possess,  apart  from  its  actual  property  or  other  tangible  holdings. 

§  145.    Practical  Aspects  of  Good-Will 

^,  In  another  part  of  the  present  volume  an  accepted  method  of 
determining  the  value  of  good-will  has  been  given.*  The  purchase 
and  sale  of  a  going  business,  however,  is  a  matter  of  barter,  and 
barter  is  a  problem  of  give-and-take.  The  price  agreed  upon 
between  a  buyer  and  a  seller  may  not  be,  in  the  opinion  of  ex- 
perts, the  value  of  the  article.  Usually  it  is  based  on  a  compro- 
mise between  the  buyer  and  seller  rather  than  upon  any  theoreti- 
cal or  appraised  valuation.  The  purchase  price  of  the  good-will, 
therefore,  becomes  the  difference  between  the  amount  paid  for 
the  other  assets  and  the  total  amount  paid,  irrespective  of  any 
calculation  as  to  what  its  value  should  be.  It  is,  then,  the 
difference  between  the  actual  value  of  the  property  for  which 
stock  of  a  corporation  is  issued  and  the  par  value  of  that  stock. 
Good-will  is  a  thing  to  be  acquired,  arid  not  created  arbi- 
trarily by  a  book  entry,  and  if  it  is  legitimately  acquired  for 
value  there  is  no  reason  why  it  should  not  be  allowed  to  remain 
on  the  books  as  a  permanent  asset.  But  because  of  the  wide- 
spread practice  of  overcapitalizing  which  has  grown  up  in  cor- 
porate organizations,  the  Good-Will  account  is  almost  invariably 
the  difference  between  the  true  value  of  the  tangible  assets  taken 
over  and  the  value  acquiesced  in  or  placed  upon  the  business  as 
a  whole  by  the  board  of  directors.  In  other  words,  a  Good- Will 
account  is  commonly  used  in  the  books  as  an  offset  to  overcapi- 
talization of  the  tangible  assets. 

*  Book  II,  Ch.  XIII,  "Capitalization — Good- Will,  Surplus  and  Initial  Expense." 


ii68 


CORPORATE  ACCOUNTING 


IBk.  111- 


§  146.    Accounting  Treatment  of  Good- Will 

Because  of  this  fact,  good-will  is  looked  at  with  suspicion, 
and  there  has  been  a  tendency  in  modem  business  to  dispense 
with  good-will  altogether,  it  being  written  off  the  books  grad- 
ually. The  General  Electric  Company  and  the  Victor  Talking 
Machine  Company  have  each  written  their  good-will  down,  the 
one  to  $1  and  the  other  to  $2.  at  which  amounts  it  is  now  being 
carried  on  their  respective  books;  and  many  other  prominent 
corporations  have  pursued  the  same  policy.  The  tax  laws 
enacted  during  the  period  of  the  Great  War  checked  this  trend; 
but  now  that  invested  capital  no  longer  enters  into  federal  in- 
come tax  computations,  we  may  see  a  return  to  the  former 
practice  of  writing  down  good- will,  even  when  it  has  been  pur- 
chased for  cash,  by  charges  against  Profit  and  Loss  or  Surplus. 
If  the  good-will  is  on  the  books  because  of  an  excessive  over- 
capitalization, it  may  well  be  written  down  as  a  surplus  is 
acquired. 

The  analysis  of  the  Good- Will  account  is  then : 

Good-Will 


Debit: 

With  the  cost  of  good-will  acquired . 


Credit: 

With  any  portion  of^ood-will  sub- 
sequently written  off. 


§  147.     Opening  Entry 

We  may  assume  that  the  business  of  Hampton  has  been  taken 
over  in  payment  for  stock,  the  first  instalment  on  stock  subscrip- 
tions has  been  received,  and  the  various  organization  expenses 
have  been  paid.  It  is  now  necessary  to  complete  the  official 
records  and  make  the  opening  entries  in  the  books  of  account. 
.  The  opening  entries  in  the  books  of  account  should  now  be 
made,  according  to  the  plan  adopted  by  the  accountant.  A 
matter  of  prime  importance  here  is  the  inclusion  of  adequate  and 
complete  explanations.  Vague  or  incomplete  records  should  not 
be  tolerated. 


Ch.  i6]  INCORPORATION— SOLE  PROPRIETORSHIP  1169 

In  the  opening  entries  which  follow,  the  accounts  of  incor- 
porators are  entered  in  the  general  ledger.  This  would  not  be 
advisable  if  the  number  of  incorporators  or  subscribers  to  be  en- 
tered were  large. ^ 

May  9,  1922 

Charles  W.  Hampton $125,000 

Samuel  Johnson 50,000 

James  J.  Miller 50,000 

Lincoln  Webster 10,000 

Robert  W.  Kester 10,000 

Unissued  Stock SiOoo 

To  Capital  Stock $250,000 

Hampton  Trading  Corporation,  incorporated  with  an 
authorized  capital  of  $250,000,  divided  into  2,500 
shares  of  $100  each,  subscribed  for  as  follows: 

Charles  W.  Hampton 1.250  shares 

Samuel  Johnson 500 

James  J.  Miller 500 

Lincoln  Webster 100 

Robert  W.  Kester 100 

Unissued  Stock 50 

Subscriptions  payable  50%  in  cash  and 
balance  August  9,  1922.  ■     j 

§  148.    Transfer  of  Business  >9htn3  tIaoH  il^nl    .o|.t  >; 

At  the  time  of  incorporation,  certain  necessary  expenses  must 
be  advanced  by  the  incorporators  or  by  the  attorney  in  charge. 
These  are  reimbursed  after  organization.  All  cash  entries  are 
given  in  the  cash  book  shown  below.  The  only  remaining  journal 
entry  required  is  that  recording  the  transfer  of  assets  and  liabili- 
ties from  Hampton  to  the  corporation. 

As  will  be  seen,  the  cash  turned  over  by  Hampton  is  included 
in  the  journal  entry,  in  order  to  show  all  of  the  assets  and  liabili- 
ties together.  This  plan,  which  obviates  the  necessity  of  splitting 
entries,  is  to  be  favored  for  it  sets  forth  the  entire  transaction. 
The  cash  account  is  ticked  in  the  journal,  and  the  general  ledger 
account  in  the  cash  book,  to  indicate  that  they  are  not  to  be 

'  For  other  entries  to  accomplish  this  result,  see  Ch.  VI,  "Par- Value  Stock  of  Original 
Issue — Not  Full-Paid  at  Once." 


it7o 


CORPORATE  ACCOUNTING 


rBk.  Ill- 


posted.     If  this  were  not  done,  the  items  might  be  posted  from 
both  books. 

Land $30,000 

Store  and  Warehouse 56,000 

Store  Equipment 8,500 

Delivery  Equipment 9,000 

Office  Equipment 4,400 

Merchandise 46,300 

Accounts  Receivable 16,400 

Notes  Receivable 9>35o 

Cash , 6,740 

Good-Will 19,860 

To  Mortgages  Payable $  25,000 

Bank  Loans , 10,000 

Notes  Payable i7»7SO 

Accounts  Payable 22,800 

Charles  W.  Hampton 125,000 

For  the  entire  assets  and  liabilities  of  Charles  W.  Hampton, 
taken  over  this  day  in  full  payment  of  his  subscription. 
A  good-will  of  $19,860  is  allowed  over  and  above  the 
net  worth  indicated  by  his  balance  sheet.  (See  minutes 
of  stockholders  and  of  directors  for  authority  and  for 
further  details.) 

§  149.    Cash  Book  Entries  zs&nizuS.  10  lalsimiT    .8^.1  ; 

Cash  Book 


1922 

May  9  Samuel  Johnson  (Paid 

on  May  2) $      500 

Charles  W.   Hampton 
(Balance  transferred)        6,740 

Samuel  Johnson 24,500 

James  J.  Miller 25,000 

Lincoln  Webster 5,000 

Robert  W.  Kester.  . . .        5,000 
(Payment  of  first  in- 
stalment of  50%  on 
subscriptions    to 
stock.) 

$66,740 


1922 

May  9  Organizing  Expenses: 

Organization  Tax 

$     125 

Filing  Certificate 

10 

Recording  Fees 

20 

Counsel's  Fee 

250 

Accountant's  Fee 

250 

Other  Outlays 

200 

Balance 

65,885 

$66,740 


Ch.  i6]  INCORPORATION— SOLE  PROPRIETORSHIP  1171 

§  150.     Other  Entries 

The  necessary  entries  have  now  been  made  in  the  journal  and 
cash  book,  and  the  accounts  called  for  by  these  entries  must  be 
opened  in  the  general  ledger.  An  account  should  also  be  opened 
for  unissued  stock.  The  subscribers'  accounts  will  be  credited 
and  cash  debited,  through  the  cash  book,  when  the  final  pay- 
ments are  made  August  9,  1922. 

There  is  nothing  unusual  in  the  form  of  any  of  these  ledger 
accounts  and  they  are  not  shown  here  in  account  form. 

In  the  stock  ledger,  records  of  the  stockholdings  of  each  sub- 
scriber must  appear.  Instalment  receipts  must  be  issued  as  pay- 
ments are  received,  and  stock  certificates  made  out  when  the 
final  payments  are  made.  It  is  the  duty  of  both  the  attorney  and 
accountant  to  see  that  the  general  procedure  is  in  accordance 
with  legal  and  business  requirements. 


io 


CHAPTER  XVII  <ub3at>qi> 

INCORPORATION  OF  PARTNERSHIP 

§  151.    Conditions  of  the  Incorporation! ^lioij  ^;  yvjii'l 

The  entries  of  the  present  chapter  are  those  required  tor  the 
amalgamation  and  incorporation  of  two  Chicago  partnerships 
which  for  a  number  of  years  have  been  successfully  engaged  in 
manufacturing.  The  entire  business — plant,  good- will,  current 
assets,  and  liabilities — of  each  concern  is  to  be  transferred  to  the 
new  company  in  exchange  for  capital  stock. 

In  Illinois  the  entire  capital  stock  must  be  subscribed  and 
one-half  paid  up  before  the  company  is  permitted  to  begin  opera- 
tions, and  therefore  the  partnership  agreements  to  take  stock 
appear  in  the  application  for  a  charter.  The  actual  transfer  of 
the  partnership  assets  and  liabilities  to  the  corporation  is  not,  of 
course,  made  until  the  latter  is  completely  organized  and  ready 
to  enter  into  contracts.  The  transfer  acts  practically  as  a  dis- 
solution of  the  partnerships. 

The  change  of  ownership  incident  to  the  transfer  of  a  partner- 
ship business  to  a  corporation  does  not  necessarily  produce  any 
change  in  the  business  or  in  the  established  policy  of  manage- 
ment; or  even  in  the  manner  of  keeping  the  books  of  account, 
except  such  changes  as  are  necessary  to  adjust  the  capital  ac- 
count to  the  altered  conditions.  During  the  process  of  the  incor- 
poration now  to  be  considered,  the  partnerships  go  on  with  their 
operations  as  before,  all  profits  after  the  agreed  date  belonging 
to  the  corporation. 

§  152.    Agreement  for  Incorporation 

Certain  preliminary  agreements  have  been  entered  into  by 
the  owners  of  the  two  concerns  now  being  consolidated.    The 

1172 


Ch.  17]  INCORPORATION  OF  PARTNERSHIP  11 73 

details  necessary  for  the  accountant's  purpose  are  given  in  the 
following  extracts  from  the  preliminary  agreement  for  incor- 
poration : 

This  Agreement  for  Incorporation  made  this  28th  day  of  April, 
1922,  by  and  between  Robert  Lowell,  Walter  F.  Mason,  and 
Norman  Lowell,  copartners  in  the  manufacture  and  sale  of  chemicals 
and  chemical  supplies  in  the  city  of  Chicago,  under  the  firm  name 
of  LoweU,  Mason  &  Company,  and  Nelson  G.  Oliver  and  George 
Dickson,  copartners  in  the  manufacture  of  chemicals,  also  in  the 
city  of  Chicago,  under  the  firm  name  of  Oliver  &  Dickson. 
Witnesseth: 
.•j9f>rTf '  ^'  That  the  business  heretofore  conducted  by  each  of  the  above- 
named  firms  shall  be  amalgamated  and  incorporated  under  the  laws 
of  the  State  of  Illinois  as  the  LoweU-Mason  Chemical  Company.        , 

2.  That  the  capital  stock  of  said  corporation  shall  be  Five 
Million  Dollars  ($5,000,000),  consisting  of  Three  Million  Dollars 
($3,000,000)  of  common  stock,  being  30,000  shares  of  the  par  value 
of  One  Hundred  Dollars  ($100)  each,  and  Two  Million  Dollars 
($2,000,000)  of  seven  per  cent  (7%)  cumulative  preferred  stock, 
being  20,000  shares  of  the  par  value  of  One  Hundred  Dollars  ($100) 
each.  Three  Million  Dollars  ($3,000,000)  of  the  common  stock, 
being  the  entire  issue  thereof,  and  One  Million  Dollars  ($1,000,000) 
of  the  preferred  stock,  is  to  be  issued  full-paid  in  exchange  for  the 

'.]!    said  businesses  as  going  concerns  as  hereinafter  stated,  including 

all  of  their  assets,  credits,  trade-names,  formulae,  and  good-will,     ,>^j 
and  said  incorporated  company  shall  assume  all  of  the  outstanding 
liabilities  of  the  said  firms  as  existing  at  the  time  of  transfer  on  the 
date  of  final  organization. 

3.  That  the  stock  of  the  said  corporation  shall  be  issued  full- 
paid  as  follows:  To  the  aforesaid  firm  of  Lowell,  Mason  &  Com- 
pany, One  Million,  Five  Hundred  Thousand  Dollars  ($1,500,000) 
of  common  stock  and  Five  Hundred  Thousand  Dollars  ($500,000) 
of  preferred  stock,  distributed  to  the  partners  as  follows: 

I  -      Robert  Lowell,  7»Soo  shares  common  and  2,500  shares  preferred 

■     Walter  F.  Mason,     6,000      "  "  "    2,000      " 

Norman  Lowell,        1,500      "  "  "       500      "  " 

To  the  aforesaid  firm  of  Oliver  &  Dickson,  One  Million,  Five 
Hundred  Thousand  Dollars  ($1,500,000)  of  common  stock  and        • 
•II    Five  Hundred  Thousand  Dollars  ($500,000)  of  preferred  stock, 
j^j  divided  equally  between  the  partners. 


1 1 74  CORPORATE  ACCOUNTING  [B  k.  ni- 

The  remaining  stock,  being  One  Million  Dollars  ($1,000,000)  of 
preferred  stock,  is  to  be  underwritten  by  Baker,  Wilson  &  Shaw, 
bankers,  at  95  (5%  commission),  a  contract  to  that  effect  having    ,,;. 
already  been  executed. 

4.  And  it  is  covenanted  and  agreed  that  Two  Hundred  Thousand 
Dollars  ($200,000)  of  common  stock  shall  be  returned  by  the  afore- 
said contracting  parties  to  the  corporation.  One  Hundred  Thousand 
Dollars  ($100,000)  from  each  firm,  to  be  treasury  stock  and  to  be 
given  to  the  said  bankers  free  of  charge  as  a  bonus  with  the  One 
Million  Dollars  ($1,000,000)  of  preferred  stock  subscribed  by  them. 

§  153.    Underwriting  Expenses 

In  the  present  instance  the  amount  of  preferred  stock  under- 
written is  $1,000,000,  the  bankers  agreeing  to  take  this  entire 
block  at  95,  or  rather  on  a  5%  commission  basis.  They  then 
sell  the  stock  to  their  customers  at  such  higher  price  as  may  have 
been  agreed  upon  or  as  the  conditions  permit,  the  difference 
between  the  cost  and  selling  prices  representing  their  profit.  It 
is  probable  that  in  a  case  like  this  the  preferred  stock  would  be 
sold  at  par  and  the  $200,000  of  common  stock  be  included  there- 
with as  a  bonus,  the  transaction  bringing  the  bankers  a  profit  of 
$50,000,  the  amount  of  their  commission. 

To  the  newly  organized  company  the  $50,000  realized  by  the 
bankers  is  regarded  as  a  selling  commission,  exactly  as  if  the  ex- 
pense of  selling  the  stock  had  been  incurred  by  the  company 
itself.  The  bonus  of  treasury  stock  given  the  bankers  might  be 
entered  on  the  books,  as  shown  later;  or  be  transferred  directly 
from  the  stockholders  to  the  banking  firm,  or  to  the  new  pur- 
chasers, without  being  entered  on  the  books  at  all.  As  the  incor- 
porators have  donated  the  stock,  it  matters  little  how  the  trans- 
action is  handled  so  long  as  the  desired  end  is  reached,  and  such 
receipts  or  other  evidences  of  it  are  preserved  as  will  establish 
the  facts  should  the  necessity  arise. 

When  stock  is  underwritten  it  is  not  unusual  for  the  bankers 
to  turn  over  to  the  company  full  payment  for  the  underwritten 
stock;  a  check  for  the  difference  between  this  amount  and  the 
underwritten  price  being,  in  turn,  given  to  them.    Such  amount 


Ch.  17] 


INCORPORATION  OF  PARTNERSHIP 


1175 


is  then  charged  to  Commission  account  or  to  Underwriting  Ex- 
pense or  some  other  suitable  account.  This  has  the  merit  of 
bringing  the  transaction  on  the  books  in  a  very  clear  and  simple 
manner,  and  of  eliminating  from  record  the  appearance  of  selling 
stock  at  a  discount.  In  the  present  case,  however,  but  50%  of 
the  par  value  of  the  underwritten  stock  ($500,000)  is  paid  by  the 
imderwriters  at  the  time,  and  a  check  for  $25,000  (5%  commis- 
sion on  50%  of  the  underwritten  stock)  is  given  to  them.  The 
remainder  of  the  underwriters'  subscription  ($500,000)  will  be 
paid  later  as  per  agreement. 

§  154.    Balance  Sheet  of  Lowell,  Mason  &  Company 

The  balance  sheets  of  the  two  partnerships,  Lowell,  Mason 

&  Company  and  Oliver  &  Dickson,  as  of  May  i,  1922,  before  the 

incorporation,  are  given  below.    These  statements  and  the  data 

from  the  agreement  for  incorporation  already  given,  form  the 

'basis  for  opening  the  books  of  the  new  company. 

Lowell,  Mason  &  Company  .dgi  i 

Balance  Sheet,  May  i,  1922 


Assets 

Land $   icx),ooo 

Buildings 150,000 

Machinery  and  Tools 115,000 

Patents  and  Patterns 72,800 

Trucks  and  Motors 25,000 

Fuel  and  Supplies 12,400 

Raw  Material 52,800 

Work  in  Process 5  7,300 

Finished  Stock 44i9oo 

Deferred  Charges  to  Operat- 
ing   9.250 

Investments  in  Stocks  and 

Bonds 143,700 

Notes  Receivable 142,000 

Accounts  Receivable 174,800 

Cash *i-"fti<n»^ii1        9S.OOO 

'"  $1,194,950 


Liabilities 

Mortgage  Payable $    100,006 

Interest  Accrued 2,500 

Notes  Payable 40,000 

Interest  Accrued i.Soo 

Accounts  Payable 30,250 

Accrued  Taxes 6,500 

Reserve  Accounts: 

For  Depreciation 12,000 

"    Bad  Debts 2,200 

Capital  Accounts : 

Robert  Lowell . .  $500,000 

Walter  F.  Mason  400,000 

Norman  Lowell .    100,000     1,000,000 


$1,194,950 


1 1 76 
§155- 


CORPOIL\TE  ACCOUNTING 

Balance  Sheet  of  Oliver  &  Dickson 

Oliver  &  Dickson 
Balance  Sheet,  May  i,  1922 


[Bk.  in- 


Assets 

Liabilities 

Leasehold 

$  156,000 

Notes  Payable  (Secured)     .  $    126,000 

Machinery  and  Tools 

85,000 

Accounts  Payable 136,300 

Delivery  Equipment 

Fuel  and  Supplies 

30,000 
9,400 

Interest  Accrued 1,600 

Accrued  Operating  Charges         10,700 

Patents  and  Patterns 

122,000 

Capital  Accounts : 

Raw  Material 

75.100 
80,900 

Nelson  G.  Oliver  $500,000 

Work  in  Process 

George  Dickson .    500,000     1,000,000 

198,000 
12,300 

Deferred  Charges.  :?f^fl?. 

Bonds  and  Securities 

150,000 

Accounts  Receivable,  Net 

(book  value  $223,000) .  .  . 

221,500 

Cash....,..v 

134,400 

ut  ,n--i 

$1,274,600 

$1,274,600 

§  156.    opening  Entries 

The  opening  entries  for  the  new  corporation  must  be  such  as 
will  record  correctly  and  in  proper  sequence  the  various  transac- 
tions involved  in  the  incorporation  of  the  company,  and  in 
transferring  to  it,  in  exchange  for  its  capital  stock,  the  entire 
plant,  business,  and  net  assets  of  each  firm.  Those  shown  below 
do  not  differ  materially  from  the  entries  given  in  previous  chap- 
ters, except  in  the  manner  of  making  charges  for  stock.  Instead 
of  opening  accounts  for  the  various  subscribers  or  even  for  sub- 
scriptions, accounts  are  opened  separately  for  the  three  different 
concerns  which  have  subscribed  for  stock,  each  firm  being 
charged  with  the  amount  of  stock  to  be  turned  over  to  its  mem- 
bers, or  to  whomsoever  it  directs.  A  separate  entry  and  expla- 
nation might  be  made,  if  desired,  for  each  firm,  or  even  for  each 
subscriber,  but  in  either  case  each  entry  should  clearly  state  the 
amount  of  common  and  preferred  stock  taken.  The  entry  for 
stock  given  to  the  banking  firm  might  with  possible  advantage 
be  separated  from  the  others. 


Ch.  17]  INCORPORATION  OF  PARTNERSHIP  11 77 

May  I,  1922 
First  Entry: 

Lowell,  Mason  &  Company $2,000,000 

Oliver  &  Dickson 2,000,000 

Baker,  Wilson  &  Shaw 1,000,000 

To   Common  Stock $3,000,000 

Preferred  Stock 2,000,000 

The  Lowell-Mason  Chemical  Company  is  incorporated  this 
day  under  the  laws  of  Illinois,  \vith  a  capital  stock  of 
$5,000,000,  divided  into  30,000  shares  of  common  stock 
of  the  par  value  of  $100  each,  and  20,000  shares  of  ^'% 
cumulative  preferred  stock  of  the  par  value  of  $100  each. 
From  the  firms  above  debited  subscriptions  have  been 
received  for  the  entire  common  and  preferred  stock  of 
the  Company,  the  distribution  of  this  stock,  as  per 
agreement  for  incorporation,  the  subscription  list,  and 
the  certificate  of  incorporation,  being  as  follows : 

Shares 
Name  Common     Preferred 

Robert  Lowell 7,Soo  2,500 

Walter  F.  Mason 6,000  2,000  v/miv^  sVu'CV 

Norman  Lowell 1,500  560 

Nelson  G.  Oliver 7,5°°  2,500 

George  Dickson 7i5oo  2,500 

Baker,  Wilson  &  Shaw 10,000 

Total 30,000         20,000 

Second  Entry:  fV 

Land $100,000                       ! 

Buildings . 150,000 

Machinery  and  Tools 1 15,000 

Patents  and  Patterns 72,800                    ,/ 

'Trucks  and  Motors 25,000                     .  ) 

Fuel  and  SuppUes 1 2,400                     „") 

Raw  Material 52,800 

Work  in  Process 57>300 

Finished  Stock 44i900    ' 

Deferred  Charges  to  Operating 9,250'^ 

Investments  in  Stocks  and  Bonds 143,700  ' 

Notes  Receivable 142,000 

Accounts  Receivable 1 74,800 

Cash 95,000 

Good-Will 1,000,000 

To  Mortgage  Payable $100,000 

Interest  Accrued 4,000 


1178 


CORPORATE  ACCOUNTING 


[Bk.  Ill- 


Notes  Payable 

Accounts  Payable 

Accrued  Taxes '. 

Reserve  for  Depreciation 

Reserve  for  Bad  Debts 

Lowell,  Mason  &  Company 

To  record  in  the  ledger  the  various  specific  assets  and 
liabilities  turned  over  by  Lowell,  Mason  &  Company, 
as  a  going  concern,  in  full  payment  of  stock  sub- 
scriptions to  15,000  shares  of  common  and  5,000 
shares  of  preferred  stock  of  the  Company,  as  per 
agreement  for  incorporation.  (See  minute  book, 
page  5.)  All  right,  title,  and  interest  in  the  assets  of 
Lowell,  Mason  &  Company  are  conveyed  to  the 
Lowell-Mason  Chemical  Company,  and  all  liabilities 
of  that  firm  are  assumed  by  the  Lowell-Mason 
Chemical  Company,  as  per  agreement  for  incor- 
poration. 


40,000 

30.250 

6,500 

12,000 

2,200 

2,000,000 


Third  Entry: 

Leasehold $156,000 

Machinery  and  Tools 85,000 

Delivery  Equipment 30,000 

Fuel  and  Supplies 9,400 

Patents  and  Patterns 122,000 

Raw  Material 75»ioo 

Work  in  Process 80,900 

Finished  Stock 198,000 

Deferred  Charges .  .  » 12,300 

Bonds  and  Securities 150,000 

Accounts  Receivable 223,000 

Cash 134,400 

Good-Will '. 1,000,000 

To  Notes  Payable  (Secured) 

Accounts  Payable 

Interest  Accrued 

Reserve  for  Bad  Debts 

Accrued  Operating  Charges 

Oliver  &  Dickson 

To  record  the  specific  assets  and  liabilities  turned  over 
by  Oliver  &  Dickson,  taken  by  this  company  as  a 
going  concern,  as  per  agreement  for  incorporation. 
(See  minute  book  page  5.) 


$126,000 

136,300 

1,600 

1,500 

10,700 

2,000,000 


Ch.  17]  INCORPORATION  OF  PARTNERSHIP  11 79 

§  157.    Entries  for  Commission  and  Stock  Bonus   ligolD 

It  then  remains  to  make  the  entries  for  the  payments  by  the 
underwriters,  showing  their  commission  and  the  turning  over  of 
the  donated  stock     These  will  be  as  follows : 

Fourth  Entry: 

Cash $500,030 

To  Baker,  Wilson  &  Shaw $500,000 

Payment  of  50%  of  subscription  of  Baker,  Wilson  & 
Shaw,  underwriters,  to  $1,000,000  of  preferred  stock. 

Fifth  Entry: 

Organization  Expense • $31,000 

To  Cash $31,000 

By  order  of  the  Directors  for  payment  of  various 
expenses  incurred  during  the  incorporation  of  the 
Company,  including  5%  commission  to  Baker, 
Wilson  &  Shaw  on  $500,000  of  stock  subscription. 
(Give  items  in  detail.) 

Sixth  Entry: 

Treasury  Stock — Common $200,000 

To  Stock  Donation  Account $200,000 

2,000  shares  of  common  stock  donated  to  the  Com- 
pany in  accordance  with  the  agreement  for  incor- 
poration, as  follows: 

Lowell,  Mason  &  Company 1,000  shares 

Oliver  &  Dickson 1,000      " 

'\  T.(irn< 
Seventh  Entry: 

Stock  Donation  Account $200,000 

To  Treasury  Stock — Common $200,000 

For  the  bonus  of  2,000  shares  of  common  stock  trans- 
ferred to  Baker,  Wilson  &  Shaw  as  per  underwriting 
contract,  being  one  share  of  common  stock  for  every 
five  of  preferred  stock  underwritten.  This  stock  has 
been  donated  by  the  incorporators  and  is  full-paid 
and  non-assessable. 

An  amount  of  $500,000  of  the  underwriters'  stock  subscrip- 
tion still  remains  to  be  settled  for  as  per  agreement,  at  which 
time  Cash  and  Organization  Expense  will  be  increased  and  the 
account  with  Baker,  Wilson  &  Shaw  closed  out. 


ii8o  CORPORATE  ACCOUNTING  [Bk.  III- 

§  158.    Closing  the  Partnership  Books  '^aoO  10^  aar  ,;i-^ 

The  manner  of  closing  the  partnership  books  will  be  illus- 
trated in  detail  by  the  closing  entries  for  Lowell,  Mason  &  Com- 
pany. A  somewhat  different  procedure  is  shown  in  condensed 
form  in  closing  the  books  of  Oliver  &  Dickson.  nsu  \ 

It  is  not  unusual,  when  a  partnership  is  incorporated,  for  the 
bookkeeping  system,  if  well-arranged,  to  be  retained  and  be  used 
by  the  new  company,  rather  than  to  open  new  books.  When 
that  is  the  case,  only  such  entiies  are  required  as  are  necessary 
to  open  the  accounts  peculiar  to  the  corporation  and  record  the 
transactions  incident  to  incorporation.  However,  in  the  case  now 
under  consideration  new  books  are  presumed  to  have  been 
opened,  and  of  course  all  asset  and  liability  accounts  must  neces- 
sarily be  closed  on  the  partnership  books  and  the  balances  be 
transferred  to  the  corporation's  accounts. 

It  will  be  noticed  that  each  firm  has  been  allowed  $1,000,000 
for  its  good-will  in  addition  to  payment  in  full  for  its  net  worth. 
The  amount  may  be  too  much,  but  that  is  a  matter  with  which 
the  accountant  is  not  particularly  concerned  since  this  has 
already  been  determined  and  he  must  accept  conditions  as  he 
finds  them.  The  two  firms  receive  stock  of  the  new  company  in 
exchange  for  their  respective  plants  and  net  assets;  and  this 
stock  in  turn  is  apportioned  to  the  former  partners  in  proportion 
to  their  holdings  as  set  forth  in  the  agreement.  The  successive 
entries  shown  below  exhibit  in  proper  sequence  the  procedure 
and  book  entries  required. 

§  159.    Closing  Entries  on  Books  of  Lowell,  Mason  &  Company 

The  following  entries  will  properly  adjust  and  close  the  ac- 
counts of  Lowell,  Mason  &  Company.  The  same  end  could  be 
reached  by  different  series  of  adjusting  entries. 

May  I,  1922 

Good- Will $1,000,000 

To  Robert  Lowell $500,000 

Walter  F.  Mason »»••« i-^«*'       1    rr  s^'         400,000 

Norman  LoweU...^/!^?.:^'.«4r'..^.?.0^?]?/"»»^fi^'^»'        100,000 


Ch.  17]  INCORPORATION  OF  PARTNERSHIP  Il8t 

To  place  upon  the  books  good-will  of  $1,000,000  in 
accordance  with  agreement  for  incorporation  of  the 
Lowell-Mason     Chemical    Company  entered   into  . 

April  28,  1922.     Good-will  apportioned  according 
to  the  partners'  holdings.  .'foikn  SG 


Lowell-Mason  Chemical  Company $2,194,950 

To  Land $100,000 

Buildmgs    ...I. 150,000 

Machinery  and  Tools'.  .'.....'..'.'..' .  115,000 

Patents  and  Patterns '        72,800 

Trucks  and  Motors '.". . . .'. 25,000 

Fuel  and  Supplies ''.f?t\  /. 12,400 

Raw  Material 52,800 

Work  in  Process 57,30o 

Finished  Stock 44i9oo 

Deferred  Charges  to  Operating 9,250 

Investments  in  Stocks  and  Bonds '    '"*'"  "143,700 

Notes  Receivable 142,000 

Accounts  Receivable.  .  .  .  .?^.'f. .  ?^^'.' : .  .....  174,800 

Cash 9S,ooo 

Cood-Will 1,000,000 

Plant,  good-will,  and  sundry  assets  turned  over  to  the 

Ix)well-Mason  Chemical  Company  in  exchange  for 

$2,000,000  par  value  of  stock  of  that  Company,  as 

per  agreement  for  incorporation. 

Mortgage  Payable $100,000 

Notes  Payable nORJIsrCI-  A't^vilO  -to  a^looU  ^     40,ooo 

Interest  Accrued ^<l. 4,000 

Accounts  Payable .O.CUilq  .I.QfJ^f'flS.y )*>;'. 30,250 

Accrued  Taxes.  ..... . ;  .,.^.y,wjj,fi 6,500 

Reserve  for  Depreciationr. 12,000 

Reserve  for  Bad  Debts 2,200 

To  Lowell-Mason  Chemical  Compan^.  .•"'.'/'. '.".''.  i'P'  ''■^'  $194,950' 

To   close   accounts   and    transfer   to   Lowell-Mason  JliW-hool) 

Chemical  Company  all  of  the  liabilities  of  this  firm,    ,.  ,   , ,  riO>WA  oT 
as  per  agreement  for  incorporation.  itosibKI  saio'jD 

§  160.    Distribution  of  Partnership  Assets 

All  assets  and  liabilities  have  now  been  closed  off  and  tran.>- 
ferred  to  the  new  corporation;  and  the  only  accounts  remaining 
open  are  the  capital  accounts  of  partners  and  the  debit  balance 
of  the  Lowell-Mason  Chemical  Company.    The  required  amount 


Il82  CORPORATE  ACCOUNTING  [Bk.  III- 

of  stock  has  been  received  from  the  new  company  to  pay  for  the 
$2,000,000  of  net  assets  turned  over.  This  stock  is  distributed  to 
the  former  partners  as  originally  agreed,  and  entered  on  the  books 
as  follows: 

Stock  of  Lowell-Mason  Chemical  Company $2,000,000 

To  Lowell-Mason  Chemical  Company $2,000,000 

For  20,000  shares  of  stock  of  Lowell-Mason  Chemical 
Company  received  today  in  full  payment  for  net 
assets  shown  in  the  previous  entries.    The  stock  is 
issued  in  the  partners'  names  as  follows: 
Shares 
Com-      Pre-  Par 

Names  mon      ferred       Value 

Robert  Lowell 7,500      2,500  $1,000,000 

Walter  F.  Mason 6,000      2,000       800,000 

Norman  Lowell 1,500        500       200,000 

Total 15,000      5,000  $2,000,000 

Robert  Lowell $1,000,000 

Walter  F.  Mason 800,000 

Norman  Lowell 200,000 

To  Stock  of  Lowell-Mason  Chemical  Company. .  .  $2,000,000 

For  distribution  of  the  above-mentioned  stock  to  the 
partners,  and  to  close  the  capital  accounts  of  the 
firm. 

§  161.    Closing  the  Books  of  Oliver  &  Dickson 

The  entries  below  illustrate  another  plan  of  closing  the  part- 
nership accounts.  These  entries  are  condensed  as  much  as  pos- 
sible so  as  to  show  merely  the  procedure  rather  than  the  record 
of  details  such  as  was  shown  in  the  previous  closing  entries. 

Good-Will $1,000,000 

To  Nelson  G.  Oliver $500,000 

George  Dickson 500,000 

{Full  explanation  here.) 

Lowell-Mason  Chemical  Company $2,000,000 

Sundry  Liabilities  {listed  separately) 276,100 

To   Good-Will  and   Sundry  Other  Assets   (listed 

separately) $2,276,100 

(Full  explanation  here  for  transfer  of  all  assets  and 
liabilities.) 


Ch.  17] 


INCORPORATION  OF  PARTNERSHIP 


1 183 


Nelson  G.  Oliver $i,cxx),ooo 


George  Dickson 

To  Lowell-Mason  Chemical  Company 

To  close  capital  accounts  of  the  partners  upon  dis- 
tribution to  them  of  stock  of  the  Lowell-Mason 
Chemical  Company: 

Shares 
Name  Common      Preferred 

Nelson  G.  Oliver .- .     7,500  2,500 

George  Dickson 7,5oo  2,500 


1,000,000 


Total 15,000 


5,000 


$2,000,000 


§  162.    Balance  Sheet  of  New  Company 

Lowell-Mason  Chemical  Company 
Balance  Sheet  as  on  May  i,  1922 


Assets 

Land $    100,000 

Buildings 150,000 

Machinery  and  Tools 200,000 

Patents  and  Patterns 194,800 

Leasehold 156,000 

Trucks  and  Motors 25,000 

Delivery  Equipment 30,000 

Fuel  and  Supplies 21,800 

Raw  Material 127,900 

Work  in  Process 138,200 

Finished  Stock 242,900 

Deferred  Charges  to  Operat- 
ing   21,550 

Investments 293,700 

Notes  Receivable 142,000 

Accounts  Receivable 397. 800 

Cash 698,400 

Subscriptions  to  Stock 500,000 

Organization  Expenses    . . .  31.000 

Good-Will 2,000,000 

$5,471,050 


Liabilities 

Mortgage  Payable $    100,000 

Notes  Payable 166,000 

Accounts  Payable 166,550 

Interest  Accrued 5, 600 

Accrued  Taxes  and  Charges  17,200 
Reserve  Accounts: 

For  Depreciation 12,000 

"   Bad  Debts 3,700 

Capital  Stock: 

Common 3,000,000 

Preferred,  7%  Cumulative  2,000,000 


$5,471,050 


1 184  CORPORATE  ACCOUNTING   ,,       [Bk.  III- 

The  accompanying  condensed  balance  sheet  of  the  new  cor- 
poration shows  the  combined  assets  and  liabilities  and  capital 
stock  resulting  from  the  merger.  The  balance  sheet  of  each 
firm  as  already  given  shows  its  condition  at  the  time  of  the 
incorporation.  To  the  value  shown,  add  $i,ooo,cxxd  for  good- 
will to  the  net  capital  of  each  firm  to  get  the  value  placed  upon 
its  business.  On  the  books  of  the  new  company  the  assets 
and  liabilities  taken  over  from  the  two  firms  are,  of  course,  to  be 
combined  in  the  respective  accounts,  as  shown  in  the  balance 
sheet  herewith. 


o  'iTzyt)n>:)/.  :iTA^o'iih.» 


Part  rv — Bonds  and  Funds 


CHAPTER  XVIII 
BOND  RECORDS  AND  ACCOUNTSi 

§  163.    Treasury  Bonds 

Bond  issues  are  usually  authorized  for  a  stated  amount,  and 
the  bonds  are  then  sold  at  such  times  and  in  such  amounts  as  the 
conditions  permit.  All  bonds  of  the  same  issue  usually  bear  the 
same  date  regardless  of  the  date  of  sale,  and  any  coupons  which 
have  matured  before  the  particular  bonds  are  sold,  are  clipped 
off,  canceled,  and  pasted  in  the  coupon  register.  The  authorized 
bonds  which  have  not  been  sold  are  sometimes  called  "treasury 
bonds,"  which  designation  ordinarily  includes  the  entire  amount 
of  authorized  bonds  not  disposed  of  by  the  issuing  company. 
Some  accountants,  however,  prefer  to  give  the  term  the  same 
meaning  as  when  employed  in  connection  with  stock,  designat- 
ing as  treasury  bonds  only  such  bonds  of  the  company  as  have 
come  back  into  its  possession  by  purchase  or  otherwise,  for  in- 
vestment or  for  sinking  fund  purposes. 

§  164.    Issued  and  Outstanding  Bonds 

.J  The  following  paragraph,  taken  from  the  accounting  classifi- 
cation of  the  Interstate  Commerce  Commission,  indicates  its 
designations  of  bonds  before  and  after  the  issue  thereof : 

^y|r»<»    For  the  purposes  of  the  balance  sheet  statement,  funded  debt 
,,i     securities  are  considered  to  be  nominally  issued  when  certified  by     .ij 
trustees  and  placed  with  the  proper  officer  for  sale  and  delivery,  or 
pledged,  or  otherwise  placed  in  some  special  fund  of  the  accounting 

i  For  general  discussi«n  of  bonfls,  sec  Book  I,  Chs.  LIV,  LV;  and  Book  II,  Part  II,  "Cor- 
porate Securities." 

1185 


Ii86  CORPORATE  ACCOUNTING  [Bk.  Ill- 

company.  They  are  considered  to  be  actually  issued  when  they 
have  been  sold  to  a  bona  fide  purchaser  for  a  valuable  consideration, 
and  such  purchaser  holds  them  free  from  all  control  by  the  account- 
ing company.  All  funded  debt  securities  actually  issued  and  not 
reacquired  and  held  by  or  for  the  accounting  company  are  con- 
sidered to  be  actually  outstanding.  If  reacquired  by  or  for  the 
accounting  company  under  such  circumstances  as  require  them  to 
be  considered  as  held  alive  and  not  cancelled  or  retired,  they  are 
considered  to  be  nominally  outstanding. 

The  term  "treasury  bond"  is  not  used  in  the  Commission's 
classification.  It  is  understood  by  the  Commission,  however,  to 
cover  either  nominally  issued  or  nominally  outstanding  bonds 
which  are  held  by  the  corporation  in  its  treasury  upon  its  own 
behalf.  It  may  be  said  that  this  is  the  stand  taken  by  public 
utility  commissions  also,  but  the  accountant  or  corporation 
official  may  freely  use  whatever  caption  for  accounts  he  may  de- 
sire, so  long  as  it  is  one  that  is  clearly  understood  by  all  concerned 
and  the  corporation  is  not  subject  to  commission  regulations. 

§  165.    Accounting  Records  for  Bonds 

Under  some  conditions  transactions  in  bonds  require  no  de- 
tailed record  to  be  kept  by  the  issuing  corporation.  If  the  bonds 
are  sold  through  an  underwriting  syndicate,  or  through  a  bank 
or  trust  company  which  acts  as  transfer  agent  and  registrar,  this 
is  always  true.  If,  however,  registered  bonds  are  sold  by  the 
corporation  direct,  the  treasurer  or  the  accounting  department 
must  keep  a  full  record,  and  for  this  purpose  a  bond  register  is 
necessary. 

Registered  bonds  are  of  two  classes:  (i)  bonds  which  are 
registered  both  as  to  principal  and  interest,  interest  checks  being 
issued  on  the  specified  interest  dates  direct  to  the  holders  of 
record;  and  (2)  bonds  which  are  registered  as  to  principal  only, 
the  interest  being  represented  by  coupons  and  therefore  payable 
to  the  holders  of  these  coupons  upon  their  surrender.2 

As  explained  later  in  the  chapter,  if  coupon  bonds  are  issued, 

»  See  Book  I,  {  500.  . 


Ch.  i8]  BOND  RECORDS  AND  ACCOUNTS  I187 

a  coupon  register  should  also  be  kept.  An  index  of  bondholders 
is  also  usually  maintained.  This  is  merely  a  card  list  on  which 
is  entered  the  name  and  address  of  each  bondholder,  together 
with  the  number  of  his  bond,  its  amount,  and  such  other  data  as 
may  be  desirable.  The  card  also  provides  for  a  record  of  the  per- 
son from  whom  the  bond  was  transferred,  in  case  it  is  not  an 
original  issue,  and  blanks  for  the  name  of  the  person  to  whom  it 
may  be  transferred. 

§  166.    The  Bond  Register  ^      I  no  iastd^nl  \o  ziasmxB^ 

The  bond  register  provides  space  for  the  name  and  address  of 
the  holder,  the  number  of  his  bond,  the  date  it  was  acquired,  the 
name  of  the  transferee,  and  20  colimins  for  20  interest  payments. 
Thus  a  complete  record  is  provided  for  a  lo-year  bond  on  which 
interest  is  payable  semiannually. 

When  a  registered  bond  is  transferred,  a  new  one  is  issued  on 
surrender  of  the  old,  just  as  a  new  stock  certificate  is  issued  when 
stock  is  transferred.  The  surrendered  bond  is  canceled  and  filed, 
and  in  the  bond  register  a  red-ink  line  is  ruled  through  the  name 
and  address  of  the  former  owner,  and  through  the  number  and 
amount  of  the  canceled  bond  itself.  Also  the  number  of  the  new 
bond  is  written  directly  after  the  last  entry  of  interest  payment 
on  the  old  bond,  as  indicated  on  the  form  shown.  A  line  ruled 
through  the  remaining  interest  columns  then  completely  cancels 
the  line  devoted  to  the  canceled  bond,  though  the  original  entry 
still  shows  the  transfer  of  the  old  bond  and  the  number  of  the 
new  bond  by  which  it  was  replaced.  The  name  and  address  of 
the  owner  of  the  new  bond  is  then  recorded  on  the  first  vacant 
line  of  the  bond  register  in  the  column  headed  "To  Whom  Is- 
sued," and  the  record  of  the  transfer  is  complete. 

As  will  be  noted,  the  bonds  are  entered  in  numerical  order, 
and  any  special  bond  may  be  readily  located  if  its  number  is 
known.  If  the  number  is  not  known  but  the  name  of  the  owner 
is,  the  bond  may  be  traced  through  the  index  of  bondholders.    If 

«  See  Book  IV,  Forms  2S9a,  2  sob. 


Ii88  CORPORATE  ACCOUNTING  [Bk.  111- 

desired,  the  number  of  the  page  of  the  bond  register  on  which  the 
individual's  name  appears  can  be  entered  on  the  index  of  bond- 
holders.* 

The  difference  between  the  footings  of  the  "Amount"  columns 
of  the  bond  register  and  the  sum  total  of  all  bonds  canceled — 
which  is  obtained  by  adding  together  all  amounts  through  which 
the  red-ink  line  is  drawn — should  agree  widi  the  balance  of  the 
Bond  account  in  the  general  ledger, 

§  167.    Pajnnents  of  Interest  on  Non-Coupon  Bonds 

If  the  bonds  are  not  coupon  bonds,  interest  is  computed  on 
each  at  the  half-yearly  or  yearly  interest  dates,  and  recorded 
under  the  proper  interest  period  in  the  bond  register.  At  the 
same  time,  interest  checks  are  issued  to  the  registered  holders. 
The  sum  total  of  the  footings  of  the  Interest  columns  should  agree 
with  the  total  amount  of  interest  checks  issued,  and  is  charged 
through  the  cash  book  to  the  Accrued  Interest  on  Bonds  account. 
This  is  on  the  assumption  that  accrued  bond  interest  is  entered 
monthly  or  at  least  prior  to  the  date  of  payment. 
!,,!•  Interest  checks  are  made  out  direct  from  the  bond  register. 
For  the  sake  of  accuracy,  it  is  advisable  to  arrange  these  interest 
checks  alphabetically  and  compare  the  names  of  the  payees  with 
the  names  shown  by  the  cards  of  the  index  of  bondholders.  This 
reduces  to  a  minimum  the  possibiUty  of  checks  being  made  pay- 
able to  the  wrong  person. 

The  register  for  coupon  bonds  does  not  show  interest  pay- 
ments, but  merely  the  ownership  of  the  bonds.  In  such  case  the 
rulings  for  interest  payments  are  omitted.  The  bonds  are  en- 
tered as  presented  for  registry  rather  than  numerically  as  is  the 
case  with  registered  bonds. 

§  168.    Payment  of  Coupons 

Coupons  are  generally  presented  for  payment  at  the  office  of 
the  fiscal  agent  or  trustee,  in  envelopes  specifying  the  title  of  the 

*  See  Book  IV,  Form  260,  "Index  of  Bondholders." 


Ch.  18]  BOND  RECORDS  AND  ACCOUNTS  1 189 

security,  number  and  amount  of  the  coupons,  and  the  name  of 
the  concern  or  individual  presenting  them.  Payment  is  made  by 
check  when  possible,  and  of  course  out  of  funds  supplied  by  the 
issuing  corporation.  The  coupons  arc  canceled  by  having  one  or 
more  holes  punched  in  them;  all  canceled  coupons  are  kept 
together,  and  at  proper  intervals  are  sent  to  the  company  which 
issued  the  security,  with  a  statement  of  the  account  showing  the 
total  coupons  paid  and  the  amount  still  outstanding. 

§  169.    The  Coupon  Register  ^ 

Coupon  bonds  registered  as  to  principal  are  entered  in  the 
bond  register,  and  an  alphabetical  card  index  of  bondholders  is 
provided  for  each  denomination  of  bonds  issued.  A  coupon  regis- 
ter is  also  provided  for  the  proper  record  of  paid  coupons. 

K  coupon  bonds  are  not  registered,  but  are  transferred  by  de- 
livery, the  bond  register  and  the  card  index  of  bondholders  are  of 
course  unnecessary,  the  coupon  register  alone  being  maintained. 

An  entire  page  of  the  coupon  register  is  required  for  the  record 
of  each  bond,  and  all  paid  coupons  belonging  to  that  bond  are 
pasted  on  the  page  allotted  to  it  in  the  space  numbered  to  corre- 
spond with  the  particular  coupon.  The  method  of  using  the  cou- 
pon register  is  simple.  As  will  be  noted,  the  number,  the  amount, 
and  a  brief  description  of  each  bond  are  entered  at  the  top  of  the 
page  devoted  to  that  bond.  As  each  coupon  comes  in  and  is  paid, 
it  is  pasted  over  its  number  on  this  page.  A  glance  at  the  coupon 
register  will  therefore  show  at  any  time  what  coupons  have  been 
paid  and  also  what  coupons  are  due  but  unpaid. 

A  special  bank  account  should  be  kept  for  the  payment  of 
coupons,  and  the  balance  of  this  bank  account  should  agree  with 
the  total  due  and  unpaid  as  shown  by  the  coupon  register. 

§  170.    Accounts  Used 

Bonds  may  sell  at,  or  below,  their  par  value,  or  at  a  premiimi, 
depending  in  part  upon  the  stability  of  the  issuing  company  and 

'Book  IV.  Form  261. 


1 190 


CORPORATE  ACCOUNTING 


[Bk.  III- 


the  rate  of  interest  to  be  paid.  The  bonds  may  be  all  or  partly 
sold  at  the  tune  of  issue,  and  those  that  have  been  disposed  of 
may  be  paid  for  in  monthly  or  periodical  instalments.  In  any 
case  there  are  numerous  expenses  incident  to  a  bond  issue,  and 
these  may  either  be  charged  immediately  to  operating  expenses 
or  spread  over  a  term  of  years. 

The  financing  of  corporations  through  bond  issues  has  already 
been  discussed.^  The  accounts  used  for  recording  sales  of  bonds 
are  analyzed  in  the  following  sections.  It  will  be  seen  that  they 
correspond  rather  closely  with  similar  accounts  for  handling 
capital  stock  transactions, 

§  171.    Bonds  Authorized  Account 


Debit: 
With  the  par  value  of  bonds  retired. 


Credit: 

With   the   par  value  of  bonds  au- 
thorized for  issue. 


The  uses  of  this  account  may  be  considered  as  parallel  to 
those  of  the  Capital  Stock  Authorized  account.^  Just  as  was 
suggested  in  that  connection,  separate  accounts  should  be  opened 
with  each  different  series  of  bonds  authorized,  the  nature  of  each 
issue  being  clearly  set  forth  by  the  title  of  its  account,  as  Author- 
ized First  Mortgage  5%  Bonds  of  1940,  Collateral  Trust  5% 
Bonds  Authorized,  First  Mortgage  30- Year  Sinking  Fund  Gold 
Bonds  Authorized,  etc. 

§  172.    Bonds  Unissued  Account* 


Debit: 

With  the  par  value  of  bonds  au- 
thorized for  issue. 


Credit: 
With  the  par  value  of  bonds  issued. 


The  difference  between  the  balance  of  this  account  and  the 
balance  of  the  Bonds  Authorized  account  represents,  paralleling 
the  equivalent  capital  stock  accounts,  the  par  value  of  the  bonds 
outstanding. 


•  Book  II,  Part  II,  "Corporate  Securities." 

'See  {§33.  34- 

'  Separate  account  for  each  series  of  bonds. 


See  {  171. 


Ch.  i8] 


BOND  RECORDS  AND  ACCOUNTS 


1191 


§  173.    Bonds  Account 

Not  all  authorities  consider  it  necessary  to  show  the  amount 
of  the  authorized  bonds  and  of  those  unissued  on  the  books,  pre- 
ferring to  enter  only  those  issued  as  credits  to  a  Bonds  account  ^ 
whose  functions  are  as  follows: 

Bonds 


Debit: 
With  the  par  value  of  bonds  retired. 


Credit: 

With  the  par  value  of  bonds  issued 
or  assumed. 

The  use  of  this  single  account,  the  balance  of  which  represents 
the  par  value  of  the  bonds  outstanding,  is  more  satisfactory  than 
*s  the  use  of  the  single  Capital  Stock  account.io  When  it  is  used 
it  is  well  to  show  the  amount  of  the  authorized  issue  as  a  paren- 
thetical note  at  the  top  of  the  Bonds  account. 

The  objection  raised  to  the  failure  to  show  the  amount  of  the 
authorized  issue  on  the  books  and  on  financial  reports,  is  that  by 
the  authorization  a  mortgage  liability  of  that  amount  has  been 
placed  on  certain  assets  or  income,  effective  when,  and  to  the 
amount  for  which  the  bonds  are  sold.  The  showing  of  only  the 
amount  of  bonds  issued  would,  when  that  is  less  than  the  author- 
ization, fail  to  indicate  the  true  amount  for  which  the  property 
would  become  mortgaged  without  further  action  than  the  sale 
of  more  bonds,"''"''  "'  "-^"'"^'^-i^  1  »'«"*"•  »» 

§  174.    Bond  Premium 


Debit: 
With  amounts  of  premium  amortized 


received   on    bonds 


Credit: 

With    premium 
sold  above  par. 

This  account  when  it  exists  has  a  credit  balance  and  shows 
the  amount  of  bond  premium  not  yet  written  off.  This  premium 
is  not  a  profit  which  should  be  used  for  the  payment  of  dividends. 
On  the  balance  sheet  the  balance  of  the  account  is  usually  carried 
among  the  deferred  credit  items  on  the  liability  side. 

•  Separate  account  f6r  each  series  of  bonds, 
to  See  I  36. 


II92 


CORPORATE  ACCOUNTING 


[Bk.  III- 


The  amortization  of  bond  premium  presents  a  number  of 
problems  which  are  discussed  in  a  later  chapter." 

§  175.    Bond  Discount 

Debit:  Credit: 

With  the  discount  allowed  to  bankers         With  amounts  of  discount  amortized, 
or  underwriters  on   sale  of   the   com- 
pany's bonds. 

With  other  bond  issue  expenses  in- 
curred at  the  date  of  issue.  • 

This  account  is  a  deferred  expense  which  is  usually  spread 
over  a  term  of  years.  If,  however,  the  profits  will  justify,  it  may 
be  all  charged  off  during  the  first  one  or  two  years.  It  is  the 
practice  to  charge  to  this  account  all  expenses  incident  to  floating 
a  bond  issue.  Such  expenses  are  common  to  nearly  all  cor- 
porate bond  issues,  and  are  usually  written  off  over  the  life  of  the 
bonds.  The  methods  of  handling  this  are  discussed  in  a  later 
chapter.i2 

1 
§  176.    Interest  on  Bonds  '^ 


Debit: 

At  the  close  of  each  month,  or  fiscal 
period  if  monthly  profits  are  not  as- 
certained, with  the  amount  of  interest 
on  bonds  outstanding  applicable  to  the 
month  or  fiscal  period  just  ended,  as 
the  case  may  be.  The  corresponding 
credit  is  to  Accrued  Interest  on  Bonds. 


Credit: 

Balance  of  this  account  constitutes  a 
fixed  revenue  charge,  and  should  be 
transferred  to  Profit  and  Loss  account 
when  the  books  are  closed- 

:n.uiaierfl  haoS.    .^i  ^ 


When  the  cash  receipts  and  disbursements  method  of  ac- 
counting is  used  instead  of  the  accrual  method,  the  debits  to 
this  account  will  consist  of  the  amounts  of  interest  paid,  the 
corresponding  credit  being  to  Cash.  The  account  would  be 
closed  into  Profit  and  Loss  as  by  the  accrual  method. 


"  See  Ch.  XXI,  "Bond  Discount  and  Premium." 

12  Ibid. 

"  See  also  Ch.  XX,  "Bond  Interest." 


Ch.  i8]  BOND  RECORDS  AND  ACCOUNTS  II93 

§  177.    Accrued  Interest  on  Bonds 


Debit: 

With  payments  of  interest  on  bonds 
outstanding. 


Credit: 

At  the  close  of  each  month,  or  fiscal 
period  if  monthly  profits  are  not 
ascertained,  with  the  amount  of  interest 
accrued  on  outstanding  bonds  during 
the  month  or  fiscal  period  just  ended,  as 
the  case  may  be.  The  corresponding 
debit  is  to  Interest  on  Bonds. 

The  balance  of  this  account  is  a  Hability,  and  represents  inter- 
est accrued  and  not  due. 

''  Since  in  most  large  corporations  it  is  the  practice  to  require 
monthly  profit  and  loss  statements  and  balance  sheets,  accruals 
of  interest  on  bonds,  mortgages,  and  other  obligations  must  be 
set  up  in  the  general  ledger  accounts. 

§  178.    Funds  and  Reserves 

There  are  a  number  of  accounts  having  to  do  with  sinking 
and  redemption  funds  and  with  various  reserves,  discussion 
of  which  is  deferred  to  Chapter  XXII,  "Principles  of  Fund 
Accounting." 


CHAPTER  XIX 
BOND   SALES 

§  179.    First  Mortgage  Bonds  Sold  at  Par 

To  illustrate  the  sale  of  bonds  at  par,  we  will  assume  that  the 
directors  and  stockholders  of  the  Lenox  Iron  Works  have  author- 
ized January  i,  1922,  an  issue  of  first  mortgage  gold  bonds  for 
$1,000,000,  having  20  years  to  run,  with  interest  at  5%,  payable 
semiannually  on  the  first  day  of  January  and  July.  The  bonds 
are  coupon  in  form  with  the  privilege  of  registration  as  to 
principal. 

Under  these  circumstances,  it  might  be  permissible  to  ignore 
the  matter  as  far  as  the  books  of  account  are  concerned,  until 
the  bonds  are  sold,  at  which  time  an  entry  would  be  made  only 
for  those  sold,  as  shown  below.  It  seems  prudent,  however,  to 
have  a  transaction  of  such  importance  placed  upon  the  books 
immediately.  For  this  purpose,  at  the  date  of  issue  and  before 
sale  of  the  bonds,  an  entry  is  made  as  follows: 

January  i,  1922 

Unissued  First  Mortgage  Bonds $i,cxx5,ooo 

To  First  Mortgage  Bonds $1,000,000 

Authorized  issue  of  $1,000,000  first  mortgage  5% 
20-year  gold  bonds  as  sanctioned  this  day  by  the 
directors  and  stockholders. 

Instead  of  "Unissued  Bonds,"  some  other  appropriate  title 
for  the  account  may  be  used,  if  desired,  as  "First  Mortgage 
Treasury  Bonds,"  "Unsold  First  Mortgage  Bonds,"  etc.  The 
credit  entry  may,  if  desired,  be  made  to  "First  Mortgage  Bonds 
Payable,"  "Authorized  First  Mortgage  Bonds,"  "Bonds  Pay- 
able," or  any  other  caption  that  will  designate  the  issue  clearly. 
If  there  are  different  issues,  the  caption  may  distinguish  them  by 
indicating  the  interest  rate,  the  life,  or  the  due  date  of  the  bonds, 

1 194 


Ch.  19]  BOND  SALES  1195 

as  "First  Mortgage  5%  Gold     Bonds     of     1950"  or     "First 
Mortgage  6%  20- Year  Bonds,"  etc. 

§  180.    Entry  of  Sale  of  Bonds 

If  the  entire  issue  of  bonds  is  sold  by  the  issuing  company  for 
cash,  the  following  entry  should  be  made : 

Cash ,. $1,000,000 

To  Unissued  First  Mortgage  Bonds $1,000,000 

Sale  at  par  of  the  entire  issue  of  first  mortgage  bonds  as 
■ '         authorized  by  the  directors. 

In  case  the  bonds  are  paid  for  in  property  of  some  kind,  then 
of  course  the  property  received  is  debited  in  place  of  cash. 

If  the  bonds  were  not  recorded  on  the  books  at  the  time  of 
authorization,  the  cash  book  entry  would  be: 

Cash $1,000,000 

r  To  First  Mortgage  Bonds $1,000,000 

Sale  at  par  of  the  entire  issue  of  first  mortgage  5% 
20-year  gold  bonds  as  authorized  by  the  Directors. 

In  case  only  a  part  of  the  bond  issue  has  been  taken  at  the 
date  of  issue,  then  a  cash  book  entry,  to  Unissued  Bonds  account 
must  be  made  for  only  the  sum  taken.  Subsequent  sales  of  bonds 
for  cash  should  be  recorded  in  the  same  manner.  In  the  sale  of 
bonds  after  date  of  issue,  however,  the  element  of  accrued  interest 
is  involved  in  the  sale  price  and  must  be  included. 

§  181.    Bonds  Sold  at  Par  and  Accrued  Interest 

Inasmuch  as  the  entire  bond  issue  bears  the  date  of  authori- 
zation, it  is  apparent  that  interest  will  have  accumulated  on  all 
bonds  sold  on  subsequent  dates.  It  matters  not  whether  the 
bonds  are  sold  at  par  or  otherwise;  interest  will  have  accrued  on 
the  par  value  thereof  to  the  date  of  sale,  and  the  investor  is  ex- 
pected to  add  it  to  the  purchase  price  of  the  bonds.  In  that  case 
the  cash  book  entry  would  be  as  follows,  assuming  that  $500,000 
of  bonds  were  sold  three  months  after  the  bonds  were  issued. 


1 196                                   CORPORATE  ACCOUNTING  [Bk.  Ill- 
April  I,  1922 

Cash $506,250 

To  Unissued  First  Mortgage  Bonds , .  $500,000 

First  Mortgage  Bond  Interest 6,250 

Sale  of  $500,000  of  first  mortage  bonds  and  accrued  'W14      .001  > 

interest  on  same  at  5%  for  three  months.  '    ^t 

The  payment  by  the  purchaser  of  this  accrued  interest  in- 
volves no  loss  to  him  except  the  interest  which  the  $6,250  so  paid 
might  earn  from  April  i  until  the  next  interest  date,  three 
months  later.  His  payment  at  this  time  is  merely  a  refund  (in 
advance)  of  the  interest  which  he  has  not  earned  and  which  will 
be  paid  to  him  when  he  cashes  his  first  coupons  for  six  months' 
interest.  Three  months  after  the  date  of  his  purchase  the  com- 
pany will  pay  the  entire  interest  on  all  outstanding  bonds  for  the 
first  half-year;  at  that  time  the  purchaser  will  receive  back  the 
interest  money  advanced  by  him,  and  in  like  manner  the  com- 
pany will  return  the  interest  thus  received.  If  the  sale  were  de- 
ferred until  the  first  or  some  subsequent  interest  date,  accrued 
interest  would  not  enter  into  consideration  at  all,  for  at  that 
time  the  company  would  clip  all  coupons  from  the  unsold  bonds 
and,  after  cancellation,  paste  them  in  the  coupon  register. 

§  182.    Bond  Subscriptions  Paid  for  in  Instahnents  -  .rn 

t'>  'If  bonds  are  sold  directly  to  the  public  by  the  issuing  com- 
pany, or  even  through  brokers  on  a  commission  basis,  it  is  not 
unusual  to  allow  the  purchasers  a  term  of  months  in  which  to 
make  their  payments,  the  instalments  being  due  at  designated 
intervals.  If  the  present  bond  issue  had  been  sold  to  subscribers 
on  the  instalment  plan,  the  entry  would  be : 

January  i,  1922 

Bond  Subscriptions $1,000,000 

To  Unissued  First  Mortgage  Bonds $1,000,000 

Sale  of  $1,000,000  of  bonds  to  sundry  subscribersat  par, 
payable  one-quarter  down  and  the  balance  in  three 
monthly  payments  of  one-quarter  each  on  the  first 
day  of  each  month.  (Names  of  subscribers  should  be 
entered  on  separate  sheets  or  in  a  subsidiary  sub- 
scription ledger  provided  for  the  purpose.) 


Ch.  19]  BOND  SALES  1197 

Bond  Subscriptions  should  be  credited  as  payment  of  each 
instalment  is  made,  and  official  receipts  be  issued  therefor. 
When  payments  are  completed,  the  instalment  receipts  are  re- 
turned and  the  bonds  issued.  The  deferred  instalments  may  per- 
haps bear  interest  at  a  given  rate,  or  at  the  same  rate  the  bonds 
are  to  draw,  in  which  case  an  additional  credit  to  Bond  Interest 
account  for  the  interest  received  is  necessary,  which  in  turn  will 
offset  an  equivalent  charge  to  the  same  account.  Monthly  bal- 
ance sheets  made  during  the  interval  would  of  course  show  the 
amount  of  bond  subscriptions  deferred. 

Instalment  payments  may  obtain  when  bonds  are  sold  to  the 
company's  bankers.  In  that  event  the  entire  contract  amount, 
after  allowance  for  discount,  if  any,  should  be  charged  up  to  the 
brokers  as  shown  below: 

Barton  &  Day,  Bankers $1,000,000 

To  Unissued  First  Mortgage  Bonds   (or  to  First 

Mortgage  Bonds) $1,000,000 

Entire  issue  of  first  mortgage  bonds  sold  at  100  flat,  pay- 
able $400,000  down  and  the  balance  in  two  instal- 
ments of  $300,000  each,  due  in  one  and  two  months 
respectively. 

Credit  is  of  course  given  Barton  &  Day  as  payments  are  made 
by  them. 

^  183.    Guaranteed  Bonds 

When  bonds  of  one  corporation  are  guaranteed  by  another 
corporation,  it  is  manifest  that  the  guaranteeing  corporation 
must  constantly  hold  itself  In  readiness  to  pay  the  bond  interest 
upon  any  default  on  the  part  of  the  issuing  company;  but 
were  such  payment  made,  it  would  be  considered  only  as  an 
advance  or  loan  to  the  subsidiary  company,  from  whom  repay- 
ment would  be  expected  at  some  future  date.  The  entries  to  be 
made  on  the  issuing  and  guaranteeing  companies'  books 
should  be  in  harmony. 

The  decision  as  to  whether  or  not  a  ledger  entry  is  required 
by  either  company  at  the  time  bonds  are  guaranteed,  as  an  official 


1 1 98  CORPORATE  ACCOUNTING  [Bk.  III- 

record  of  the  conditions,  depends  on  the  wishes  of  the  directors. 
If  a  minute  of  such  guarantee  is  clearly  set  forth  in  the  official 
records  of  each  company,  that  should  suffice,  since  the  fact  of  the 
guaranty  is  conspicuously  stated  in  the  bonds  themselves  as  well 
as  in  the  deed  of  trust.  A  footnote  of  the  guaranty  should  of 
course  be  made  on  the  balance  sheet  of  the  guaranteeing  com- 
pany. 

§  184.    Collateral  Trust  Bonds  ^ 

Collateral  trust  bonds  are  bonds  secured  by  a  deposit  of  stocks 
and  bonds  of  other  corporations.  The  book  entries  for  transac- 
tions in  such  bonds  do  not  differ  materially  from  those  required 
for  recording  regular  mortgage  bonds.  With  the  mortgage  bond, 
however,  though  a  conveyance  under  trust  mortgage  is  made  to 
the  trustee,  the  real  estate  security  remains  in  the  company's 
possession;  while  in  the  case  of  the  collateral  bond,  all  of  the 
security  is  placed  in  the  hands  of  the  trustee.  The  terms  of  the 
trust  indenture  usually  provide  that  the  collateral  may  be 
changed  at  any  time  for  other  collateral  of  equal  value,  either  at 
the  request  of  the  issuing  company  or  of  the  trustee. 

The  collateral  security  must  be  conveyed  to  the  trustee  before 
the  actual  sale  of  bonds  begins,  though  this  conveyance  does  not 
deprive  the  company  of  its  rights  and  privileges  as  owner  of  the 
collateral,  such  as  voting  at  meetings  of  stockholders,  receiving 
the  income  from  its  investment,  etc.  The  question  now  arises: 
What  kind  of  record  should  be  made  for  the  collateral  deposited 
with  the  trustee?  An  adequate  record  of  the  transfer  should  of 
course  be  made  in  the  official  minutes,  and  the  Public  Service 
Commission  of  New  York  requires  that  the  pledged  collateral 
must  be  set  forth  in  an  account  by  itself.  Corporations  not  sub- 
ject to  commission  regulations  may  make  entries  in  any  logical 
manner,  but  in  all  cases  it  seems  desirable  to  set  forth  in  a  sep- 
arate account  all  pledged  securities. 


I  See  Book  II.  {  91. 


Ch.  iq]  bond  sales  1 199 

§  185.    Entries  for  Collateral  Trust  Bonds 

The  stocks  and  bonds  used  as  collateral,  when  first  purchased, 
are  usually  entered  on  the  books  at  the  purchase  price  regardless 
of  par  value,  and  are  charged  to  some  representative  account, 
as  "Investments"  or  "Stocks  and  Bonds  of  Other  Companies," 
or  to  accounts  representing  the  kinds  of  securities  purchased. 

On  the  assumption  that  the  collateral  is  standing  in  an  "In- 
vestments" account  and  has  a  book  valuation  of  $1,340,000,  the 
following  entry  is  required  suitably  to  record  the  conditions: 

Pledged  Investments  (to  secure  collateral  trust  bonds) ....   $1,340,000 

To  investments $1,340,000 

To  record  the  pledge  of  the  following  collateral  with  the 
Hudson  Trust  Company,  as  security  for  the  issue  of 
$1,000,000  collateral  trust  bonds:  {Here  list  details  of 
the  stocks  and  bonds  pledged.) 

The  above  entry  removes  the  collateral  entirely  from  the  In- 
vestments account  and  leaves  therein  only  such  securities  as  are 
still  in  the  company's  possession;  while  the  Pledged  Investments 
account  exhibits  the  book  value  of  securities  in  the  trustee's  pos- 
session. In  a  manufacturing  corporation  an  account  might  be 
opened  with  the  trustee  and  the  collateral  security  stated  therein. 
If  there  are  several  bond  issues,  it  is  desirable  to  have  separate 
accounts  for  the  pledged  collateral  belonging  to  each  issue.  In 
case  the  market  value  of  pledged  collateral  falls  below  a  given 
margin  of  safety,  the  trustee  may  call  for  an  additional  deposit. 

Corporations  which  have  a  considerable  investment  in  stocks 
and  bonds  usually  provide  separate  books  for  recording  the  de- 
tails of  such  investments.  When  this  is  the  case,  a  notation  in 
the  accounts  affected  might  perhaps  be  considered  a  suflficient 
record  of  securities  deposited  as  collateral,  but  the  entry  shown 
above  is  preferable  since  it  provides  a  more  systematic  record. 

§  186.    Entries  for  Short-Term  Notes 

The  opening  entries  for  short-term  notes  do  not  differ  from 
those  required  for  collateral  trust  bonds.  An  entry  should  of 
course  be  made  crediting  the  entire  issue  of  notes  under  whatever 


I200  CORPORATE  ACCOUNTING  [Bk.  III- 

caption  is  necessary,  as  "Three- Year  Notes/'  "Two- Year  Col- 
lateral Trust  Notes,"  etc.,  and  debiting  the  cash  received  and 
selling  expense.  In  case  the  notes  are  secured  by  collateral,  an 
entry  for  the  collateral  is  necessary  as  already  explained. 

§  187.    Entries  for  Equipment  Trust  Serial  Bonds 

To  illustrate  the  entries  required  when  equipment  trust  bonds 
are  sold,  assume  that  the  Green  Valley  Railway  Company  has 
issued  equipment  trust  5%  gold  bonds  dated  July  i,  1921,  for 
$4,000,000,  payable  in  instalments  of  $400,000  each  year  begin- 
ning July  I,  1922;  the  bonds  are  secured  by  new  standard  equip- 
ment costing  $5,000,000,  upon  which  an  initial  payment  of 
$1,000,000  has  been  made  by  the  company.  Since  the  issue  of 
equipment  or  car  trust  certificates  is  subject  to  commission  regu- 
lations, these  regulations  must  be  followed  in  making  the  entries. 
Assuming  that  the  equipment  was  purchased  through,  and  the 
bonds  given  to,  Murray  Brothers  &  Co.,  bankers,  at  95,  that  a 
trust  mortgage  is  made  to  a  trustee  as  security  for  bondholders, 
and  that  expenses  connected  with  the  issue  amount  to  $6,000,  the 
required  entries  are  as  shown  below. 

When  the  trust  is  created  and  the  first  payment  of  20%  is 
made  on  account  of  the  equipment,  the  entries  are : 

July   I,   1921 

Equipment $i,<xx),ooo 

To  Cash $1,000,000 

Initial  payment  of  20%  on  the  following  equipment 
costing  $5,000,000  purchased  through  Murray 
Brothers  &  Co.,  for  which  $1,000,000  is  paid  in 
cash  and  the  balance  is  satisfied  by  equipment 
bonds.  {Here  give  details  of  the  equipment  and  bonds, 
or  else  refer  to  the  agreement  where  they  can  be  found) 

Leased  Equipment $4,000,000 

To  Equipment  Trust  5%  Bonds $4,000,000 

For  issue  of  equipment  trust  bonds  in  denominations  of 
$1,000,  being  balance  of  payment  of  equipment  pur- 
chased through  Murray  Brothers  &  Co.,  Bankers,  as 
per  trust  agreement.     The  bonds  mature  $400,000  on  ■ 
July  I  of  each  year  during  the  next  10  years. 


Ch.  19]  BOND  SALES  1 20 1 

If  thought  preferable,  these  payments  might  be  put  through 
the  account  of  the  bankers,  who  are  holders  of  the  lien;  Equip- 
ment and  Leased  Equipment  being  debited  and  the  bankers 
credited  with  the  entire  purchase  price,  as  shown  below: 

Equipment $1,000,000 

Leased  Equipment 4,000,000 

To  Murray  Brothers  &  Company $5,000,000 

(Full  explanation  here.) 

Murray  Brothers  &  Company $1,000,000 

To  Cash $1,000,000 

Murray  Brothers  &  Company $4,000,000 

To  Equipment  Trust  5%  Bonds $4,000,000 

(Ftill  explanation  here.) 

The  entry  for  the  expense  connected  with  the  issue  would  be : 

Expense  on  Equipment  Trust  Bonds $6,000 

To  Cash $6,000 

As  each  bond  instalment  matures  and  is  paid,  an  entry  is  re- 
quired in  the  bond  account  and  also  in  the  Equipment  account, 
since  the  portion  paid  must  be  transferred  from  "Leased  Equip- 
ment" to  the  "Equipment"  account.  The  equipment  is  required, 
of  course,  to  be  fully  and  adequately  maintained  by  the  operating 
company.  The  entries  for  interest  are  required  to  be  made  semi- 
annually, and  monthly  adjustments  should  be  made  to  distribute 
the  interest  over  its  period.    The  instalment  entries  are : 

July   I,   1922 

Equipment  Trust  5%  Bonds $400,000 

To  Cash $400,000 

First  instalment  on  equipment  trust  bonds  paid  this  day, 
per  trust  agreement. 

At  the  same  time,  and  at  each  instalment  date  thereafter,  the 
following  transfer  entry  is  required : 

Equipment $400,000 

To  Leased  Ikjuipment $400,000 

For  transfer  to  the  Equipment  account,  of  property  covered 
by  current  instalment. 


CHAPTER  XX 
BOND  INTEREST 

§  1 88.    Paying  Bond  Interest 

Bond  interest  is  usually  paid  semiannually  from  the  date  of 
issue,  but  the  deed  of  trust  may  specify  that  it  shall  be  paid 
quarterly  or  annually.  Interest  on  registered  bonds  is  paid  to 
the  registered  holders  by  checks  sent  out  at  interest  periods  by  the 
company  itself  or  by  its  fiscal  agent,  while  interest  on  coupon 
bonds  is  paid  upon  presentation  of  the  coupons  at  the  office  of 
the  company  or  of  its  fiscal  agent.  The  coupons  are  sometimes 
made  payable  at  any  one  of  two  or  three  different  agencies. 
Owners  of  coupons  may  either  send  them  direct  to  the  issuing 
company  or  agency  and  receive  a  cash  remittance  in  exchange,  or 
deposit  them  in  their  local  banks  for  collection.i 

§  189.    Method  of  Handling  Interest  Coupons 

Using  the  bond  issue  of  $1,000,000  5%  gold  bonds  of  the 
Lenox  Iron  Works,  cited  in  the  preceding  chapter,  we  assume 
that  the  first  interest  date,  July  i,  1922,  has  arrived  and  that 
$25,000  has  been  turned  over  to  the  company's  fiscal  agent  for 
payment  of  the  coupons  as  they  are  presented.  On  the  com- 
pany's books  the  only  entry  required  at  the  time  is  the  following, 
which  of  course  should  appear  in  the  cash  book : 

July   I,    1922 

Bond  Interest $2S,coo 

To  Cash $25,000 

For  payment  of  semiannual  bond  interest  on  $1,000,000  5% 
bonds,  due  today  at  the  office  of  the  trustee,  The  Grove 
Street  Trust  Company,  to  whom  the  check  has  been 
issued. 


See  js  167,  168. 


Ch.  20]  BOND  INTEREST  1203 

This  entry  is  made  immediately  on  sending  the  interest  check 
to  the  trust  company  or  bank  where  the  coupons  are  payable. 
This  check  is  usually  sent  the  day  before  the  interest  is  payable 
or  perhaps  sooner,  depending  on  the  distance.  When  the 
coupons  are  paid  and  canceled,  they  are  then  turned  over  to  the 
issuing  company  and  pasted  in  the  coupon  register  or  otherwise 
disposed  of. 

§  190.    Recording  Interest  Liability 

In  case  the  interest  coupons  are  payable  at  the  office  of  the 
company,  it  is  obvious  that,  with  the  simple  accounting  system 
assumed,  no  entry  would  be  necessary  until  the  coupons  were 
presented  and  paid.  Even  when  the  coupons  are  payable  at  the 
company's  office,  a  special  bank  account  is  frequently  opened  for 
their  payment,  a  check  being  drawn  for  the  full  amount  and 
deposited  in  this  account.  If  the  coupons  were  all  paid  on  the 
due  date,  the  entry  would  be  similar  to  that  given  above,  the 
credit  being  to  the  special  account  and  the  explanation  being 
changed  to  show  that  payment  was  made  at  the  office.  It  is 
rarely,  however,  that  this  happens,  and  when  it  is  not  the  case, 
entry  is  gf  course  made  only  for  the  coupons  presented  and  paid. 
The  amount  still  outstanding  can  easily  be  calculated,  but  the 
bond  interest  account  itself  will  not  show  its  correct  debit  until 
all  of  the  coupons  have  been  paid.  It  is  apparent,  therefore,  that 
at  the  end  of  each  year  the  books  must  either  be  kept  open  until 
all  coupons  come  in,  or  present  an  incomplete  record  comprising 
only  such  bond  interest  as  has  been  paid.  Neither  of  these  plans 
meets  the  needs  of  present-day  accounting.  The  most  approved 
plan  is  to  set  up  at  each  interest  date  the  amount  of  interest  due. 
Assuming  that  this  plan  is  adopted,,  the  following  entry  is  nec- 
essary at  the  end  of  the  preceding  month : 

June  30,   1922 

Bond  Interest $25,000 

To  Bond  Interest  Payable $25,000 

For  half-yearly  bond  interest  due  and  payable  tomorrow. 


ia04  CORPORATE  ACCOUNTING  [Bk.  III- 

Instead  of  "Bond  Interest  Payable,"  the  account  might  be 
termed  "Coupons  Payable."  There  is  a  difference  between 
interest  "due  and  payable"  and  interest  "accrued."  For 
instance,  on  Jime  i,  1922,  the  larger  portion  of  the  interest  on 
the  bonds  for  the  period  under  consideration  has  accrued,  but  it 
is  not  due  and  payable  until  July  i,  1922. 

Outstanding  coupons  continue  to  be  obligations  of  the  com- 
pany until  paid.  As  the  coupons  are  redeemed,  charges  are 
made  against  Bond  Interest  Payable  account,  so  that  the  excess 
credit  to  this  account  will  show  at  any  time  the  liability  on  out- 
standing coupons.  If  there  are  several  bond  issues,  an  Interest 
Payable  account  might  be  set  up  for  each. 

Assuming  that  all  of  the  bond  coupons  were  paid  by  the  com- 
pany on  the  due  date,  we  have  the  following  entry : 

July   I,    1922 

Bond  Interest  Payable $25,000 

To  Cash $25,000 

For  interest  coupons  presented  and  paid  this  day. 

At  the  time  of  each  book  closing,  the  Bond  Interest  account 
should  be  closed  into  Profit  and  Loss  or  into  such  other  account 
as  the  system  in  use  may  call  for. 

§  191.    Bond  Interest  Accrued 

Nearly  all  large  corporations  require  monthly  statements  of 
income  and  operating  expenses  and  statements  of  condition,  so 
that  it  becomes  necessary  at  the  end  of  each  month  to  compile 
the  various  expenses  belonging  to  that  period.  These  expenses 
obviously  comprise  not  only  the  current  expenses  and  pay-roll, 
but  a  proportionate  share  of  prepaid  and  accruing  charges,  as 
interest,  discount,  taxes,  insurance,  etc.  Bond  interest  is  gen- 
erally payable  half-yearly,  so  that  each  monthly  statement 
should  include  one-sixth  of  the  half-yearly  fixed  interest  charge. 
As  an  offset  to  each  monthly  interest  apportionment,  a  corre- 
sponding credit  is  set  up  to  "Accrued  Bond  Interest,"  or  "Accrued 
Interest  Coupons,"  or  "Accrued  Bond  Coupons,"  or  some  other 


Ch.  2ol  BOND  INTEREST  1 205 

account  that  will  clearly  designate  the  interest  obligation.  Such 
entries  are  made  through  the  journal.  For  example,  referring 
to  the  previous  illustration,  if  the  half-yearly  bond  interest  of 
$25,000  is  to  be  accrued  in  monthly  proportions,  an  entry  is 
required  at  the  end  of  each  month  as  follows: 

January  31,  1922 

Bond  Interest $4,166.67 

To  Bond  Interest  Accrued $4,166.67 

Accrual  of  interest  on  $1,000,000  of  5%  bonds  for  month 
of  January. 

A  similar  entry  should  be  made  at  the  end  of  each  succeeding 
month.  A  like  entry  is  necessary  for  registered  bond  interest, 
and  for  interest  on  any  other  bond  or  mortgage  obligation,  and 
even  for  interest  accruals  on  current  liabilities.  Monthly  entries 
are  advisable  also  for  interest  accruing  on  investments  and 
receivables,  especially  when  monthly  statements  are  required. 

At  the  end  of  each  six  months  the  bond  interest  is  paid.  Cash 
being  credited,  and  the  Bond  Interest  Accrued  account  closed  by 
the  corresponding  debit;  but  whether  or  not  the  Bond  Interest 
account  is  closed  at  the  same  time  depends  on  the  closing  dates 
adopted  by  the  company.  As  a  rule  it  remains  open  until  the 
end  of  the  fiscal  year,  so  that  at  any  time  during  the  year  it  shows 
the  cumulative  total  for  all  of  the  months  as  well  as  the  interest 
for  each  month.  Sometimes  the  ledger  accounts  are  closed 
monthly,  in  which  case  the  Bond  Interest  account  is  closed  into 
Profit  and  Loss  twelve  times  a  year. 

§  192.    Interest  on  Registered  Bonds 

In  the  case  of  registered  bonds,  interest  checks  are  usually 
sent  by  the  treasurer  of  the  company  direct  to  the  holders,  though 
not  infrequently  the  checks  are  sent  by  the  fiscal  agent.  They 
are  usually  mailed  so  as  to  reach  the  payees  on  the  date  when  the 
interest  is  due  or  as  soon  as  possible  thereafter.  The  book 
entries  for  accruing  and  paying  interest  on  registered  bonds  do 
not  differ  from  those  required  and  illustrated  for  interest  on 


l2o6  CORPORATE  ACCOUNTING  [Bk.  III- 

coupon  bonds.  An  alphabetical  list  of  the  registered  bondhold- 
ers entitled  to  receive  interest  checks  must  be  prepared  for  each 
interest  period. 

§  193.    Interest  on  Two  or  More  Bond  Issues 

Definite  examples  of  entries  to  fit  all  bond  interest  conditions 
cannot  well  be  given.  Those  already  given,  with  those  which 
follow,  illustrate  their  general  character  and  are  in  accordance 
with  the  entries  employed  by  many  of  the  larger  corporations. 
Each  entry  must  indicate  for  what  purpose  it  was  made  and  the 
conditions  involved.  Monthly  entries  are  made  for  accruing 
bond  interest  on  the  various  bond  issues  and  for  the  several  series 
of  any  particular  issue.  An  account  is  opened  for  each  separate 
obligation  as  a  rule,  and  sometimes  for  each  part  issue  thereof. 

As  a  basis  for  the  entries  which  follow,  assume  that  on 
January  i,  1922,  first  mortgage  5%  bonds  are  issued  for  $2,000- 
000,  interest  payable  April  i  and  October  i;  also  first  and  re- 
funding 6%  mortgage  gold  bonds  for  $4,000,000,  interest  payable 
January  i  and  July  i.  At  the  end  of  June,  the  following  entry 
is  necessary  to  record  the  interest  accruals  for  the  month,  similar 
en  cries  having  been  made  for  the  intervening  months. 

June  30,   1922         ' 

Interest  on  Funded  Debt $28,333.34 

To  Accrued  Interest  on  Bonds $28,333.34 

Monthly   interest   accrual   on   outstanding   bonds   as 
follows: 

Bonds  Accrued 

Outstanding  Interest 
First  mortgage  5%  bonds.  $2,ooo,cxx).oo  $8,333.34 
First   and   refunding   6% 

bonds 4,000,000.00     20,000.00 


$6,000,000.00  $28,333.34 

When  several  series  of  bonds  are  outstanding,  it  may  be 
advisable  to  open  an  interest  account  for  each  series,  as  "Accrued 
Interest  on  Bonds — Series  A,"  "Accrued  Interest  on  Bonds — 
Series  B,"  etc.     Of  course,  in  a  bookkeeping  system  where  the 


Ch.  2o]  BOND  INTEREST  1207 

voucher'  is  in  use,  a  journal  voucher  would  be  made  out  for  the 
above  entry,  giving  full  details  respecting  the  interest  applica- 
tions, as  "Accrued  Interest  on  First  Mortgage  5%  Bonds,"  and 
"Accrued  Interest  on  First  and  Refunding  6%  Mortgage  Bonds." 
Since  the  coupons  of  the  first  and  refunding  mortgage  6% 
bonds  are  now  due,  an  entry  is  made  setting  up  the  liability  for 
the  particular  coupon  and  closing  off  the  portion  of  interest 
accrued  to  date,  thus:  ci 

June  30,   1922 

Accrued  Interest  on  Bonds $i20,cxxd 

To  Bond  Coupons  No.  q.  Due  July  i,  1922  (A  Co.  6's)  $120,000 

For  six  months'  interest  due  July  i,  1922,  on  $4,000,000 
of  first  and  refunding  6%  gold  bonds. 

'■■  An  entry  similar  to  the  above  is  required  each  time  the 
cdiipons  on  any  particular  bond  issue  fall  due.  At  the  same 
time  a  check  is  issued  to  the  financial  agent  for  redemption  of 
the  coupons  No.  9  as  they  mature.    The  entry  is: 

The  Globe  Trust  Company,  Trustee $120,000 

To  Audited  Vouchers  (or  Cash) $120,000 

For  payment  of  six  months'  interest  due  July  i,  1922,  on 
$4,000,000,  etc. 

It  will  be  seen  now  that  all  No.  9  coupons  are  standing  on  the 
ledger  as  a  Hability  and  so  remain  until  paid,  no  matter  how  long 
that  may  be;  also  that  there  is  a  corresponding  charge  to  the 
trustee  for  an  equivalent  amount.  The  trustee  renders  a  report 
at  the  end  of  each  month,  setting  forth  the  amount  and  number  of 
coupons  paid  to  date,  all  of  which  are  turned  over  to  the  company 
for  cancellation.  At  that  time  an  entry  is  made  for  as  many 
coupons  as  may  have  been  paid.  For  illustration  we  will  assume 
that  $84,800  of  the  above  amount  has  been  presented  and  paid, 
requiring  this  entry: 

July  31,  1922 

Bond  Coupons  No.  9,  Due  7/1/22  (A  Co.  6's) $84,800 

,. , ,,      To  The  Globe  Trust  Company,  Trustee $84,800 

,  For  interest  coupons  paid  by  The  Globe  Trust  Company, 
Trustee,  during  the  month  of  July,  1922,  per  statement 
rendered.  ^    ''tlni 


l2o8  CORPORATE  ACCOUNTING  [Bk.  III- 

If  more  than  one  class  of  coupons  were  paid,  the  others 
would  be  entered  in  like  manner.  For  the  first  mortgage  5% 
bonds,  similar  entries  are  required  at  the  end  of  September,  At 
the  end  of  the  fiscal  year  or  half-year,  the  account  for  the  interest 
on  bonds  must  of  course  be  closed  into  Profit  and  Loss.  At  that 
time  Bond  Interest  accounts  for  any  and  all  issues  or  series, 
whether  accrued  for  the  full  year,  or  only  for  one  month,  must 
be  closed  off. 

§  194.    Interest  on  Treasury  Bonds 

Treasury  bonds,  for  the  present  consideration,  are  under- 
stood to  comprise  the  issuing  company's  own  bonds  which  have 
been  acquired  by  purchase  or  donation.  This  ownership,  so 
long  as  the  bonds  have  not  been  canceled,  makes  no  difference 
in  the  manner  of  handling  or  accruing  bond  interest  payable. 
The  monthly  accruals  are  set  up  as  usual,  and  the  interest  check 
handed  over  to  the  paying  bank  at  the  proper  date,  while  the 
bank  in  turn  cashes  the  bond  coupons  presented  for  payment, 
regardless  of  ownership  or  of  the  sources  whence  they  come. 
The  issuing  company,  on  the  other  hand,  treats  the  treasury 
bonds  as  investments,  the  same  as  bonds  of  other  companies, 
and  collects  the  income  therefrom  in  like  manner.  In  case 
monthly  accruals  of  $10,000  income  from  treasury  bonds  and 
other  investments  aie  required  to  be  set  up,  an  entry  should  be 
made  at  the  end  of  each  month  about  as  follows : 

■•'"'•''"'■'-'''"  '"  '  January  31,  1921  ""'^ 

A^t^ed  Income  ffoin  Investments $10,000 

To  Income  from  Investments $10,000 

For  accrued  income  on  investments  for  one   month,   as 
follows:  (Recite  the  amount,  rate,  etc.) 

If  it  is  desired  that  the  income  from  treasury  bonds  be  kept 
separate  from  that  of  other  investments,  debit  Accrued  Income 
from  Treasury  Bonds  and  credit  Income  from  Treasury  Bonds. 

As  the  cash  is  received  in  payment  the  following  cash  book 
entry  is  required  on  the  due  date : 


Ch.  20]  BOND  INTEREST  1209 

July  I,  1921        All  no  ; 

Cash ^ . , . .  I . ,    $6o,poo 

To  Accrued  Income  from  Investments $60,000 

For  cash  income  on  investments  due  today  as  follows: 
{Recite  details  of  investments.) 

At  the  end  of  each  fiscal  period  the  Income  from  Investments 
account  is  closed  to  Profit  and  Loss  as  follows : 

December  31,  1921 

Income  from  Investments $120,000 

To  Profit  and  Loss  (or  Income) $1 20,000 

To  close  into  Profit  and  Loss,  being  total  income  for  the 
year  from  investments. 

§  195.    Interest  on  Guaranteed  Bonds 

Interest  payments  on  guaranteed  bonds  are  handled  in  the 
same  manner  as  those  of  any  other  class  of  bonds.  The  issuing 
company  pays  the  interest  in  the  usual  way  if  it  is  able.  In  case 
it  is  unable  to  do  so,  the  guaranteeing  company  must  make  the 
payment,  which  must  obviously  be  considered  an  advance  to 
the  subsidiary  company,  to  be  repaid  at  some  future  date.  At 
the  time  ot  the  advance,  a  cash  book  entry  should  be  made  as 
follows : 

Advances  to  Subsidiary  Company  (giving  name  of  company) .  . .    $25,000 

To  Cash $25,000 

For  payment  of  interest  due  this  day  on  $1,000,000  of  guar- 
anteed 5%  bonds  of  The Company. 

On  the  books  of  the  issuing  company  the  following  entry  is 
required : 

Bond  Interest  (or  Bond  Interest  Accrued) Y-.' !'.'':*?!  \\  !^^.'   $25,000      '  ^ 

To  Advances  from Compahy .' .  ;  .  .  $^5,066 

.  {Full  explanation  here.) 

The  entries  may  of  course  be  very  different  from  those 
shown,  depending  upon  the  agreement  existing  between  the  two 
companies;  but  in  any  case  the  matter  should  be  clearly  set 
forth  in  each  company's  books  so  as  to  show  the  amounts  respec- 
tively payable  and  receivable. 


1 2 10  CORPORATE  ACCOUNTING  [Bk.  IH- 

§  196.    Interest  on  Income  Bonds* 

Since  income  bonds  are  to  all  intents  and  purposes  the  same 
as  preferred  stock,  it  is  manifest  that  the  book  entries  for  the 
interest  thereon  would  be  practically  the  same  as  those  required 
for  dividends  when  declared.  As  in  the  case  of  stock,  interest 
on  income  bonds  can  be  paid  only  when  the  company's  profits  are 
sufficient  to  justify  such  payment;  therefore,  as  a  rule  no  entry 
is  necessary  or  advisable  until  the  directors  decide  whether  or  not 
it  shall  be  paid.  On  the  other  hand,  when  it  is  practically  assured 
that  the  interest  coupons  will  be  paid,  monthly  entries  for 
accruing  interest  are  in  order.  Income  bonds  generally  contain 
half-yearly  coupons,  though  their  payment,  of  course,  is  con- 
tingent upon  the  company's  earnings.  When  declared  at  the 
interest  date  the  following  entry  is  made : 

December    31,     192 1 

Interest  on  Income  Bonds $25,000 

To  Interest  Payable  on  Income  Bonds $25,000 

For  interest  at  5%  on  income  bonds  for  six  months,  declared 
by  the  Directors  and  payable  January  i,  1922. 

The  Interest  account  is  closed  into  Profit  and  Loss.  When 
the  interest  is  paid,  the  cash  entry  should  be  as  follows : 

January  i,  1922 

Interest  Payable  on  Income  Bonds $25,000 

To  Cash $25,000 

For  payment  of  interest  on  income  bonds. 

§  197.    Interest  on  Special  Bond  Issues 

The  principles  already  stated  for  the  entry  of  bond  interest 
apply  in  handling  the  interest  on  all  other  bond  issues  where 
registered  and  coupon  bonds  are  used,  whether  secured  or  other- 
wise. Profit-sharing  or  participating  bonds  require  extra 
entries  for  setting  aside  the  share  of  profits  apportioned  to  them, 
which  in  turn  would  be  paid  by  check  or  otherwise,  as  the  case 
might  be. 

»  See  Book  II,  {  go.  .  JiUi^YI  J 


Ch.  2o]  BOND  INTEREST  12 1 1 

§  198.    Interest  Charged  to  Construction   1  moil  ^raoonl    .qqx 

The  Interstate  Commerce  Commission  and  the  various  state 
public  utility  commissions  permit  the  capitalization  of  various 
charges  during  periods  of  construction.  This  principle  might 
apply  equally  well  to  corporations  not  under  commission  regu- 
lation, so  long  as  the  charges  capitalized  are  actual  and  legi- 
timate and  expended  during  the  construction  of  plant,  or  ex- 
tension of  property  and  equipment.  Real  estate  development 
companies  and  other  similar  enterprises  generally  include  certain 
"loading"  charges  as  part  of  the  development  or  construction 
cost.  Such  charges  may  include  development  expenses,  interest 
on  bonds  and  loans,  legal  and  other  direct  expenditures,  bond 
discount,  etc.  These  items  are  usually  charged  to  the  appro- 
priate accounts;  and  then  at  the  end  of  the  year,  or  upon  com- 
pletion of  the  construction,  a  transfer  entry  is  made  to  place  them 
in  the  Construction  account — or  to  such  other  account  as  may  be 
proper. 

The  following  entry  shows  the  manner  in  which  such  transfers 
should  be  made: 

December  31,  192 1 

Construction  Account $42,000 

To  Construction  Expenses $20,000 

Bond  Interest 10,000 

Loan  Interest .         4,000 

Bond  Discount 8,000 

To  close  above  accounts  into  Construction  account,  being 
all  of  the  construction  expenses  and  interest,  and  the  pro- 
portionate amount  of  the  bond  discount  for  the  period. 

Many  corporation  officials  advocate  the  addition  of  all  bond 
discount  and  expense  to  plant  account  if  the  bond  issue  was 
created  for  the  purpose  of  extending  the  plant;  but  this  practice 
is  objected  to  on  the  ground  that  the  manufacturing  account 
through  depreciation  charges  would  eventually  be  made  to 
bear  a  considerable  portion  of  the  expense  of  financing  the 
company. 


tili  CORPORATE  ACCOUNTING  [Bk.  UI- 

§  199.    Income  from  Investments 

Income  from  investments  other  than  treasury  bonds  is 
handled  in  the  same  manner.  If  income  is  derived  from  several 
disconnected  investments,  it  is  advisable  to  open  separate 
accounts  to  distinguish  the  sources,  as  Income  from  Bonds,  In- 
come from  Real  Estate  Investments,  Income  from  Dividends, 
etc.  Dividends  from  stock  investments,  however,  should  not  be 
entered  as  accrued  monthly  income,  or  entered  in  any  other  way 
until  the  dividend  has  actually  been  declared.^ 

A  plan  of  entering  income  from  investments  that  differs 
slightly  is  given  below.  Assume  that  Company  A  owns  $1,000,- 
000  of  Company  B's  6%  bonds,  payable  January  i  and  July  i. 
At  the  end  of  each  month  the  following  entry  should  be  made 
on  Company  A's  books  for  the  accrued  income:  :^.hiuo:)i£.  'Ar'nii 

January  31,  1922 

Accrued  Interest  on  Bonds  Owned $5,000 

To  Interest  on  Bonds  Owned $S,ooo 

(Full  explanation  here.)  .(ftfWoHol  Uti  ! 

At  the  regular  interest  dates,  July  i  and  January  i,  or  in 
fact  the  day  preceding,  the  following  entry  should  be  made : 

June  30,   1922 

Company  B .''."/V'5l^1 .'. . .    $30,000 

To  Accrued  Interest  on  Bonds  Owned $30,000 

(Full  explanation  here.) 

When  the  bond  coupons  are  presented  to  the  paying  bank 
and  the  cash  received  therefor,  the  following  entry  is  required : 

July   I,    1922 

Cash $30,000 

1 1  m >i    To  Company  B i J,  ui^OtiH  \.u :  i',\Mi)m^  Jfiwl  BHiitflXtH  $30, 000 

^f^'^Full  explanation  here.)  > 

''^It  is  apparent,  of  course,  that  this  could  be  handled  in  other 
ways.  The  precise  method  is  immaterial  so  long  as  it  records 
the  matter  adequately  and  clearly. 

»  See  {  132. 


^^^'^CHAPTER  XXI 
BOND  DISCOUNT  AND  PREMIUM 

§  200.    Adjustment  of  Accrued  Interest  in  Selling  Price 

When  bonds  are  sold  at  other  than  the  regular  interest  dates, 
allowances  must  of  course  be  made  for  accrued  interest  in  deter- 
mining the  price  actually  received  for  the  bonds.  For  instance, 
a  bond  bearing  interest  at  the  rate  of  6%  per  annum,  payable 
semiannually,  January  i  and  July  i,  must  receive  its  3%  on  the 
interest  date  regardless  of  when  it  was  sold.  If,  then,  such  a 
bond  were  sold  March  i,  interest  has  accrued  to  the  amount  of 
1%,  and  this  must  be  deducted  from  the  amount  received  to 
determine  the  real  price  of  the  bond.  If  the  amount  received 
for  the  bond  were  103,  it  is  obvious  that  1%  on  the  face  of  the 
bond  must  be  allowed  for  the  accrued  interest,  and  this  being 
deducted  leaves  102  as  the  price  actually  received  for  the  bond. 

If  the  bond  were  sold  for  100,  there  would  obviously  be  a  dis- 
count of  1%  on  the  transaction,  the  actual  price  being  99. 

§  201.    Expenses  of  Bond  Issue 

Many  authorities  consider  the  expenses  incurred  in  the 
floating  of  a  bond  issue  as  directly  chargeable  to  the  cost  of  the 
issue,  in  the  same  manner  as  discount  on  the  bonds.  The 
Public  Service  Commission  of  the  First  District  of  New  York 
includes  among  such  expenses  the  following: 

All  expenses  connected  with  the  issue  and  sale  of  evidences  of 
debt,  such  as  fees  for  drafting  mortgages  and  trust  deeds,  fees  and 
taxes  for  recording  mortgages  and  trust  deeds,  cost  of  engraving 
and  printing  bonds,  fees  paid  trustees  provided  for  in  the  mortgages 
and  trust  deeds,  fees  and  commissions  paid  underwriters  and 
brokers  for  marketing  such  evidences  of  debt,  and  other  regular 
expenses. 

1213 


1 2 1 4  CORPORATE  ACCOUNTING  [Bk.  III- 

§  202.    Entries  for  Bond  Discount  and  Expense 

To  illustrate  the  disposition  to  be  made  of  discount  on  bonds 
and  the  other  expense  inevitable  in  connection  with  a  bond  issue, 
we  will  assume  that  the  bond  issue  of  $1,000,000  of  the  Lenox 
Iron  Works  was  sold  for  cash  at  90  flat,  and  that  expenses  in- 
curred in  connection  with  the  issue  amounted  to  $5,000.  The 
bond  discount  may  be  charged  under  "Discount  on  Bonds"  or 
some  other  suitable  title,  and  the  expense,  to  "Expense  of  Bond 
Issue";  or  both  the  discount  and  expense  may  be  charged  to  one 
account,  as  "Bond  Discount  and  Expense."  The  entry  for  the 
sale  is: 

January  i,  1922 

Cash $900,000 

Bond  Discount  and  Expense 100,000 

To  Unissued  First  Mortgage  Bonds $i,ooo«coo 

For  entire  issue  of  first  mortgage  5%  bonds  sold  to 
bankers  at  90. 

Bond  Discount  and  Expense [  .v!) .  k\  /VVX^J.  i       $5,000 

To  Cash .••:••• '>"<>fi  9;$S,ooo 

For  bond  issue  expenses  paid  in  cash.  •  :    , 

§  203.    Entries  for  Bond  Premium 

Premium  received  on  the  sale  of  bonds  is  credited  to  a  dis- 
tinguishing account,  as  "Premium  on  Bonds,"  "Bond  Premium," 
or  "Premium  and  Discount  on  Bonds."  Assuming  that  the 
issue  of  $1,000,000  bonds  of  the  Lenox  Iron  Works  sold  at  a 
premium  of  2%,  the  following  entry  would  be  made : 

January  i,  1922 

Cash $1,020,000 

To  Unissued  First  Mortgage  Bonds $1,000,000 

Premium  on  Bonds .......'.  /. .' 20,000 

(Full  explanation  here.) 

§  204.    Nature  of  Bond  Premium  and  Discount 

The  entries  required  to  bring  bond  premium  or  bond  discount 
upon  the  books  are  simple.  After  they  are  brought  upon  the 
books,  their  proper  treatment  is  a  more  difficult  problem. 


Ch.  2i]  BOND  DISCOUNT  AND  PREMIUM  1215 

The  premium  or  discount  which  is  either  received  or  given 
upon  the  sale  of  the  bonds  may  be  said  to  represent  a  deduction 
from,  or  an  addition  to,  the  nominal  rate  of  interest  specified  in 
the  bonds. 

Any  corporation  of  good  standing  and  stability  can  sell  its 
bonds  at  par  if  they  bear  sufficient  interest.  The  rate  which 
they  must  bear  to  sell  exactly  at  par  is  known  as  the  true  or 
effective  rate.  If  the  corporation  chooses  to  sell  the  bonds  at 
any  other  rate,  they  will  be  sold  at  a  premium  or  discount  as  the 
case  may  be.  This  premium  or  discount  is  the  interest  refunded 
in  advance  or  taken  in  advance  on  account  of  the  difference 
between  the  effective  and  nominal  rates. 

§  205.    Treatment  of  Bond  Premium  and  Discount 

Since  bond  premimn  or  discount  is  from  its  very  nature  a 
deduction  from,  or  an  addition  to,  the  amount  of  nominal 
interest  paid  during  the  life  of  the  bonds,  the  premium  or  dis- 
count cannot  be  considered  as  interest  applicable  to  the  year  of 
sale  only,  but  must  be  spread  over  the  life  of  the  bonds. 

In  order  that  each  accounting  period  may  show  accurately  the 
true  cost  of  carrying  the  issue,  the  premium  or  discount  must, 
as  stated,  be  written  off  over  the  life  of  the  bonds,  and  credited 
or  charged  periodically  to  the  Interest  account  and  through  this 
to  Profit  and  Loss,  By  this  procedure  the  interest  expense  of 
each  period  is  so  increased  or  decreased  that  the  charge  against 
income  for  each  instalment  is  for  the  amount  of  the  interest  at 
the  nominal  rate  plus  a  part  of  the  discount  or  minus  a  part  of 
the  premium.  This  procedure  is  known  as  "the  amortization 
of  the  premium  or  discount." 

Some  organizations  with  a  large  surplus  make  a  practice  of 
writing  off  the  Bond  Discount  and  Expense  account  immediately, 
but  this  does  not  show  the  true  cost  of  carrying  the  issue  and  is 
therefore  misleading.  Other  organizations  write  off  the  discount 
in  several  instalments,  but  this  is  not  accurate  and  is  as  objec- 
tionable as  the  practice  of  charging  it  off  immediately. 


12 16  CORPORATE  ACCOUNTING  [Bk.  lU- 

Bond  premium  is,  much  more  frequently  than  discount, 
thrown  immediately  into  Profit  and  Loss  or  Surplus.  This 
practice  is,  of  course,  just  as  misleading  as  the  same  method  oi 
handling  a  discount  would  be. 

The  objections  to  charging  off  the  premium  or  discount  im- 
mediately are  that  by  this  practice  the  true  rate  of  interest  paid 
on  loans  during  their  currency  is  lost  sight  of,  current  fixed 
charges  against  earnings  are  understated,  and  the  portion  repre- 
senting the  discount  or  premium  is  charged  against  or  credited  to 
surplus  arising  out  of  previous  operations,  instead  of  being 
charged  against  or  credited  to  income  from  current  and  future 
operations,  to  which  it  applies.  The  result  is  that  not  only  cur- 
rent but  future  operating  statements  are  distorted  during  the 
life  of  the  bonds.  ;'"-"^  "  '  '".- 

§  206.     Principles  of  Amortization 

When  the  discount  at  which  bonds  have  been  sold  is  to  be 
amortized,  a  certain  part  of  that  discount,  as  well  as  the  periodi- 
cal interest  instalment,  is  debited  to  Interest  account  as  the  inter- 
est is  paid  or  the  accrued  interest  set  up.  The  amount  of  discount 
thus  charged  off  is  credited  to  Bond  Discount,  or  Bond  Discount 
and  Expense,  or  whatever  the  account  into  which  the  discount 
was  charged.  If  the  bonds  were  sold  at  a  premium  which  is  now 
to  be  amortized,  the  amount  of  the  debit  to  Interest  is  reduced 
below  the  amount  actually  to  be  paid,  the  reduction  being  the 
amount  of  the  periodical  amortization  of  premium.  This 
amount  is  charged  to  Bond  Premium  account.    t)Jfii  innLraofl  odi 

The  entries  required  for  the  handling  of  bolid  premium  and 
discount  at  the  dates  of  sale  of  the  bonds  and  of  periodical 
interest  payments  are  summarized  below.  The  difficulty  in  the 
actual  making  of  the  entries  arises  from  problems  connected 
with  the  computation  of  the  amounts  of  the  peiiodical  charges 
to  Bond  Premium  or  credits  to  Bond  Discount  at  the  inteiest 
dates.  In  subsequent  sections  various  methods  of  amortizing 
the  premium  or  discount  are  discussed. 


Ch.  2i]  BOND  DISCOUNT  AND  PREMIUM  1217 

§  207.    Entries  for  Bond  Premium  and  Discount 
Bonds  sold  at  a  discount  and  redeemable  at  par: 

Entry  at  time  of  sale: 
Cash  (amount  received) 
Bond  Discount  (amount  of  discount) 
To  Bonds  (par  value  of  bonds) 

Entry  at  lime  of  periodical  interest  payment: 

Interest  (amount  of  interest  plus  proper  part  of  discount  to  be 
amortized  with  this  payment) 
To  Bond  Discount  (proper  part  of  discount  to  be  amortized 
with  this  payment) 
Cash  (amount  paid) 

Bonds  sold  at  a  premium  and  redeemable  at  par: 

Entry  at  time  of  sale: 
Cash  (amount  received) 

To  Bond  Premiiun  (amount  of  premixmi) 
Bonds  (par  value  of  bonds) 

Entry  at  time  of  periodical  interest  payment: 

Interest  (amount  of  interest  minus  proper  part  of  premium  to  be 

amortized  with  this  payment) 
Bond  Premium  (part  qf  premium  to  be  amortized  at  this  time) 
To  Cash  (amount  paid) 

Bonds  issued  at  par  and  redeemable  at  a  premium: 

Entry  at  tim^  of  sale: 
Cash  (amount  received) 

To  Bonds  (par  value  of  bonds) 

Entry  at  time  of  periodical  interest  payment: 

Interest  (amount  of  interest  plus  proper  part  of  premium  to  be 
amortized  with  this  payment) 
To  Bond  Premium  (proper  part  of  premium  to  be  amortized 
with  this  payment) 
Cash  (amount  paid) 

Bonds  sold  at  a  discount  and  redeemable  at  a  premium : 

Entry  at  time  of  sale: 
Cash  (amount  received) 

Bond  Premium  and  Discount  (amount  of  discount) 
To  Bonds  (par  value  of  bonds) 


I2i8  CORPORATE  ACCOUNTING  [Bk.  III- 

Enlry  at  time  of  periodical  interest  payment: 

Interest  (amount  of  interest  plus  proper  part  of  discount  given  at 
time  of  sale  and  of  premium  to  be  paid  at  time  of 
redemption) 
To  Bond  Premium  and  Discount  (proper  part  of  discount 
given  at  time  of  sale  and  of  premium  to  be  paid  at 
time  of  redemption) 
Cash  (amount  paid) 

This  periodical  credit  to  Bond  Premium  and  Discount  will 
gradually  convert  the  debit  balance  of  that  account  into  a  credit 
which  vdll  eventually  become  sufficient  to  equal  the  amount  of 
all  premiums  payable  on  final  redemption. 

If  it  is  desired  to  accrue  the  interest  and  the  amortization  of 
premium  or  discount  monthly  or  at  any  other  dates  than  those 
of  the  periodical  interest  payments,  the  entries  given  above  as 
being  applicable  at  the  dates  of  the  interest  payments  would  be 
used  with  the  exception  that  instead  of  the  credits  to  Cash  the 
entries  would  show  credits  to  Accrued  Interest  on  Bonds  for  the 
amount  accrued.  The  payments  of  the  interest  would  then  be 
shown  by  the  following  entry : 

Accrued  Interest  on  Bonds 
To  Cash 

The  only  problem  in  making  the  above  entries  arises  in  deter- 
mining the  amount  of  the  proper  part  of  the  premium  or  dis- 
count to  be  amortized  with  each  payment  of  interest,  or,  in  other 
words,  is  found  in  the  computing  of  the  amount  of  the  periodical 
charge  to  Interest  account.  The  various  methods  in  use  for  de- 
termining this  amount  are  discussed  in  the  following  sections. 

§  208.    Effective  Rate  Method 

The  best  modem  practice  for  amortizing  either  bond  premium 
or  discount  is  known  as  the  "effective  rate  method."  Under  this 
plan  there  is  taken  as  a  charge  against  profits  of  each  year  the 
effective  interest  rate  calculated  from  the  known  conditions  of 
issue  upon  the  whole  amount  outstanding  during  the  year.    As- 


Ch.  2i]  BOND  DISCOUNT  AND  PREMIUM  I219 

certaining  the  effective  rate  is,  however,  a  rather  difficult  prob- 
lem in  actuarial  science,  the  discussion  of  which  would  be  far 
beyond  the  scope  of  this  work.i  Because  of  its  complexity  the 
effective  rate  method,  while  undoubtedly  the  most  scientific,  is 
not  so  common  as  are  some  of  the  other  methods  discussed  below. 
The  bonds  outstanding  method,  presented  later  in  the  chapter, 
gives  results  so  close  to  those  achieved  by  the  effective  rate 
method  that  it  is  considered  almost  as  satisfactory,  and  is  much 
more  generally  used  because  of  the  greater  ease  of  computation. 
In  cases,  however,  where  the  highest  accuracy  is  desired  for  any 
reason,  and  it  is  thought  best  to  make  the  calculations  as  exact 
as  possible,  the  effective  rate  method  is  preferable. 

§  209.    Equal  Instalment  Method 

A  method  more  common  than  the  effective  rate  method  and 
easier  of  computation,  is  to  ignore  altogether  the  effective  inter- 
est rate,  charging  against  the  profits  of  each  year  the  interest 
actually  paid  plus  a  proportionate  part,  according  to  the  whole 
term  of  issue,  of  the  discount  on  issue  or  premium  on  redemption, 
or  minus  a  proportionate  part  of  the  premium  received  at  the 
time  of  issue. 

To  illustrate  the  handling  of  premium  or  discount  accounts 
on  the  books  under  this  method,  let  us  assume  that  the  $1,- 
ocxD,ooo  issue  of  the  Lenox  Iron  Works  which  sold  at  90  flat,  and 
the  expenses  of  which  were  $5,000,  runs  for  20  years  and  bears 
interest  at  the  rate  of  5%  per  annum,  payable  annually.  The 
total  of  the  Bond  Discount  and  Expense  account  shows  $105,000 
that  must  be  written  off  over  the  life  of  the  bonds.  In  addition 
to  interest  at  the  rate  of  5%,  or  $50,000,  which  the  issue  carries, 
the  Interest  account  must  be  charged  each  year  with  one- 
twentieth  of  the  discount  and  expense  of  $105,000,  or  $5,250, 
making  the  total  charge  against  income  $55,250.    At  the  end  of 


'  Readers  desiring  to  go  into  this  field  are  referred  to  Sprague  and  Perrine  on  The  Account, 
of  Invest.;  Walton  and  Finney  on  Math,  of  Acctg.  &  Finance. 


I220  CORPORATE  ACCOUNTING  [Bk.  HI- 

the  first  year,  if  monthly  entries  are  not  made,  the  entries  re- 
cording this  would  be : 

Interest  on  Bonds HvVt  .r^i4h\K> $50,000 

To  Accrued  Interest  on  Bonds $50,000 

Interest  accrued  on  the  issue  of  $1,000,000  first  mortgage 
5%  bonds. 

Interest  on  Bonds i,.;.  .r..^.  .■>.->;*•  •  •  •      $5,250 

To  Bond  Discount  and  Expense ....;. $5,250 

Difference  between  the  nominal  and  true  effective  rates  on 
the  $1,000,000  bond  issue. 

Accrued  Interest  on  Bonds $50,000 

To  Cash ' $50,000 

Payment  on  accrued  interest  on  $1,000,000  bond  issue. 

The  interest  is  eventually  closed  into  Profit  and  Loss  by  the 
following  entry : 

Profit  and  Loss $55,250 

To  Interest  on  Bonds $55,250 

Transfer  of  the  interest  on  $1,000,000  bond  issue  to  Profit 
and  Loss. 

The  entries  for  bond  premium  would  of  course  be  of  the  same 
general  nature.  .  -         . 

The  equal  instalment  method  has  a  wide  popularity  because  of 
its  simplicity,  but  there  are  those  who  object  to  it  on  the  ground 
that  it  is  unscientific.  In  view,  however,  of  its  frequent  use, 
the  objection  might  be  considered  a  purely  academic  one.  Yet 
it  is  not  as  satisfacotry  as  the  bonds  outstanding  method. 

§  210.    Bonds  Outstanding  Method 

A  third  method  is  to  distribute  the  discount  or  premium  over 
the  period  in  the  proportion  that  the  bonds  outstanding  for  each 
year  bear  to  the  sum  of  the  bonds  outstanding  for  all  years  of  the 
currency  of  the  loan.  "The  charge  to  Income  account  on  the 
bonds  outstanding  method  is  arrived  at  as  shown  in  the  following 
table.  It  is  so  close  to  that  given  by  the  effective  interest  method 
that  for  all  practical  purposes  it  may  safely  be  adopted." 


Ch.  2i]  BOND  DISCOUNT  AND  PREMIUM  1 221 


Period           Bonds 
Yi  Year  Outstanding 

Proportion 
of  Out- 
standing 
Bonds  to 
Total  Bonds 

Amount 
ot  Discount 
Instalment 

Interest 
Payment 

Profit   on 

Bond 
Purchase 

Annual 
charge  to 

Profit 
and  Loss 

I 

$    1,000,000 

100  /1050 

$  1 1 ,905 

$   25,000 

$  4,000 

$32,905 

3 

950,000 

95  A050 

11,310 

23,750 

4,000 

31,060 

3 

900,000 

90  /lOSO 

10,714 

22,500 

3,500 

29,714 

4 

850,000 

85  /1050 

10,119 

21,250 

3,500 

27,869 

5 

800,000 

80  /1050 

9,524 

20,000 

2,500 

27,024 

6 

750,000 

75  A050 

8,929 

18,750 

2,500 

25,179 

7 

700,000 

70  /loso 

8,333 

17,500 

1,500 

24,333 

8 

650,000 

65  /1050 

7.738 

16,250 

1,500 

22,488 

9 

600,000 

60  /loso 

7,143 

15,000 

1,000 

21,143 

lO 

550,000 

55  /loso 

6,548 

13,750 

1,000 

19,298 

II 

500,000 

50  /1050 

5,952 

12,500 

2,500 

15,952 

12 

450,000 

45  A050 

5,357 

11,250 

2,500 

14,107 

13 

400,000 

40  /1050 

4,762 

10  000 

1,500 

13,262 

14 

350,000 

35  Aoso 

4,167 

8750 

1,500 

11,417 

15 

300,000 

30  Aoso 

3,571 

7,500 

500 

10,571 

i6 

250,000 

25  A050 

2,976 

6,250 

500 

8,726 

17 

200,000 

20  A050 

2,381 

5,000 

7,381 

i8 

150,000 

15A050 

1,786 

3,750 

5,536 

19 

100,000 

10  A050 

1,190 

2,500 

3,690 

20 

50,000 
$10,500,000 

5  A050 

595 

1,250 

1,845 

$125,000 

$262,500 

$34,000 

5353,5002 

§  211.     Complications  Introduced  by  Market  Conditions 

Bonds  for  sinking  fund  purposes  are  often  purchased  in  the 
market  at  prices  varying  from,  and  generally  less  than,  the 
specified  redemption  prices,  and  are  then  transferred  to  the 
trustees  of  the  sinking  fund  at  the  specified  prices.  A  saving  is 
thus  effected  which  must  be  taken  into  account  when  determin- 
ing the  annual  charge  against  income.  This  saving  may  best  be 
dealt  with  by  closing  such  gains  to  Profit  and  Loss  each  year, 
thus  finally  disposing  of  them.  This  method  is  not  theoretically 
accurate,  but  theoretical  accuracy  is  impossible  in  view  of  the 
impossibility  of  determining  what  the  market  price  will  be  in 
the  future. 


*  By  permission,  from  Acctg.  Prac.  &  Proc.,  by  A.  Lowes  Dickinson,  p.  141* 


1222  CORPORATE  ACCOUNTING  [Bk.  III- 

It  will  be  seen  that  the  equal  instalment  method  discussed 
earlier  in  the  chapter  is  inadequate  in  such  cases  as  this. 

§  212.    Anticipation  of  Redemption  Dates  ' 

Further  disturbing  factors  in  accounting  for  bond  redemp- 
tion may  be  introduced  by  anticipating  the  redemption  dates  for 
a  whole  or  part  of  the  issue.  The  treatment  of  such  cases  is  a 
more  difficult  matter,  for,  if  carried  out  on  a  fairly  large  scale 
and  not  accompanied  by  an  equitable  reduction  on  the  redemp- 
tion price,  the  true  interest  rate  will  be  materially  increased. 

Under  such  conditions  the  equal  instalment  method  will  be 
seen  to  be  unsound.  If  the  effective  rate  method  is  used,  it  will 
be  necessary 

...  to  recalculate  the  effective  rate  on  the  basis  of  the  bonds 
still  outstanding  and  the  new  redemption  terms.  If  this  is  not 
done,  there  may  be  a  considerable  shortage  to  make  up  at  the  date 
of  final  redemption.  This  fact  is  frequently  overlooked,  although 
it  should  be  recognized  as  an  important  factor,  particularly  in  any 
refunding  or  redemption  plan.  .  .  . 

For  instance,  if  the  conditions  of  the  issue  provided  that 
$100,000  of  bonds  be  retired  during  the  year  at  105,  and  as  a  matter 
of  fact  they  are  purchased  at  95,  the  true  interest  on  the  bonds 
bearing  interest  during  the  year  would  be  reduced  by  $10,000, 
representing  the  saving  on  bonds  retired  during  the  year  as  com- 
pared with  the  price  therefor  assumed  in  determining  the  efifective 
rate.  The  tendency  of  this  method  would  probably  be  to  increase 
gradually  the  annual  charge  to  Income  for  interest  and  sinking 
fund  until  the  limit  price  of  redemption  was  reached;  for,  as  the 
amount  of  the  bonds  outstanding  diminished,  the  market  price 
might  be  expected  to  rise. 


in  i 


§  213.    Operation  of  the  Various  Methods 

In  order  to  show  the  effect  of  these  various  methods,  it  may  be 
well  to  consider  a  specific  case  as  foUows: 

An  issue  of  $1,000,000  of  bonds  is  made  at  90,  carrying  interest 
at  5%,  and  redeemable  at  the  rate  of  $50,000  each  half  year,  at  100 

•  Quotations  in  this  and  the  following  section  and  the  table  given  at  the  end  of  the  chapter 
are  taken  by  permission  from  Acctg.  Prac.  &  Proc.,  by  A.  Lowes  Dickinson,  pp.  136-140. 


Ch.  2i] 


BOND  DISCOUNT  AND  PREMIUM 


1223 


Charge  to  income 
when  Discount 
charged  to  Profit 
and  Loss  Ac- 
count 


Charge  to  Income 
when  Discount 
written  off  on 
Bonds  outstand- 
ing method 


Charge  to  Income 
on  equal  annual 
Instalment 
Method 


Charge  to  Income 
on  effective  in- 
terest method 


Surplus  on  p  u  r  - 
chase  at  less  than 
redemption 
price 


Discount  provided 
for  (2)  —  (1) 


Effective  Interest 
charge  at  8  3/16% 
p.  a.  (b) 


Payments  for  In- 
terest at  5%  p. 
a.  (a) 


Period  54  Year 


88888888888888888888 

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II 


1224  CORPORATE  ACCOUNTING  [Bk.  Ill 

for  the  first  five  years,  and  thereafter  at  105.  Calculations  made 
on  these  premises  show  that  the  effective  rate  of  interest  is  approxi- 
mately 83/16%.  Bondsare  redeemed  each  as  specified,  but  they  are 
purchased  in  the  market  at  the  following  prices,  viz. : 

ist  year , . . . ...... ..' '.' 92 

2nd  year ', .: .; . : .:..... . . . . .  .^  .V 93 

3rd  year 95 

4th  year : 97 

5th  year , 98 

6th  year 100 

7th  year 102 

8th  year 104 

9th  and  loth  drawn  at 105 

The  table  on  page  1223  gives  all  the  essential  figures. 

In  the  table  on  the  preceding  page,  the  last  four  columns  show 
the  charges  to  Income  account  on  the  basis  (5)  of  the  effective 
interest  method;  (6)  of  the  equal  instalment  method;  (7)  of  the 
bonds  outstanding  method;  and  (8)  of  charging  all  discount  and 
premium  to  surplus;  in  each  case  crediting  to  Income  account  the 
surplus  arising  from  purchasing  bonds  at  less  than  the  fixed  redemp- 
tion price. 

If  the  latter  be  credited  direct  to  surplus,  or  carried  in  the  Bond 
Discount  account  until  all  discount  has  been  written  off  by  the 
operation  of  these  credits  and  the  balance  of  the  effective  rate,  then, 
at  the  end  of  the  nth  half  year  in  the  first  case  and  at  the  end 
of  the  isth  half  year  in  the  second,  the  discount  will  be  extinguished 
and  thereafter  only  the  actual  interest  paid,  less  surplus  on  market 
purchases,  will  be  charged  to  Income. 


CHAPTER   XXII 
PRINCIPLES  OF  FUND  ACCOUNTING 

§  214.    Nature  of  Funds 

A  fund  is  normally  represented  by  a  debit  balance.  It  is  a 
reservation  of  assets  set  aside  periodically  for  a  specified  purpose 
and  usually  placed  in  the  hands  of  a  trustee  for  safe-keeping 
until  the  date  arrives  for  their  expenditure  in  accordance  with 
the  purpose  for  which  the  fund  was  created.  While  funds  are 
usually  composed  originally  of  cash,  this  cash  may  be  invested 
in  order  that  an  income  may  be  produced  therefrom.  In  such 
cases  the  assets  thus  purchased  compose  their  part  of  the  fund. 

Funds  are  resorted  to  as  a  convenient  method  of  accumulating 
money  for  various  purposes,  and  are  established  in  two  broad 
general  classes,  i.e.,  those  from  which  the  income  only  is  to  be 
used,  the  principal  being  maintained  intact,  and  those  which  are 
so  constituted  that  both  principal  and  income  are  to  be  used  for 
the  desired  purpose.  The  best  examples  of  the  first  classification 
are  the  endowment  funds  of  educational  institutions  and  the 
trusts  created  by  will  or  otherwise.  The  use  of  the  income  from 
such  funds  may  be  limited  to  specific  purposes,  but  the  usual  use 
of  the  income  from  endowment  funds  is  for  the  payment  of 
current  expenses. 

Funds  established  with  the  intention  of  using  both  the  prin- 
cipal and  income  are  accumulated  for  many  purposes,  as  for 
example,  the  cancellation  of  a  lease,  the  acquirement  of  addi- 
tional machinery  or  new  buildings,  the  securing  of  a  new  mine  or 
other  wasting  asset  when  that  which  is  now  owned  is  exhausted, 
the  retirement  of  a  bond  issue  or  of  preferred  stock,  or  simply  in 
order  to  be  able  to  meet  promptly  and  without  embarrassment 
any  extraordinary  loss  or  expense  which  certain  businesses  are 

1225 


1226  CORPORATE  ACCOUNTING  [Bk.  III- 

liable  to  suffer  without  notice.  The  names  given  such  funds  are 
usually  descriptive  of  their  purposes,  as,  for  example,  New 
Machinery  Fund,  Factory  Building  Fund,  Bond  Sinking  Fund, 
Bond  Retirement  Fund,  Preferred  Stock  Redemption  Fund, 
Emergency  Fund,  etc.  When  the  fund  is  used  in  connection 
with  the  depletion  of  mines  or  other  wasting  assets,  it  is  fre- 
quently called  an  "Extinguishment  Fund." 

§  215.    Confusion  between  ''Reserve"  and  "Fund" 

There  can  be  little  excuse  for  a  confusion  which  exists  between 
the  uses  of  the  words  "fund"  and  "reserve."  The  fund  is  an 
asset;  the  reserve  is  a  credit  item  representing  either  a  deduction 
from  an  asset  valuation  (as  in  the  case  of  Reserve  for  Deprecia- 
tion and  Reserve  for  Losses  from  Uncollectible  Accounts)  or  an 
appropriation  of  surplus.  The  reserve  account  shows  a  credit 
balance,  while  the  fund  shows  a  debit  balance. 

A  fund  is  created  by  the  reservation  of  cash,  or  by  the  in- 
vestment of  cash  in  securities,  the  cash  or  securities  being 
held  for  a  specific  purpose.  When  this  purpose  is  the  redemption 
of  bonds  or  the  replacement  of  a  wasting  asset,  the  result  is 
a  sinking  fund,  redemption  fund,  or  replacement  fund,  as  the 
case  may  be.  If,  however,  a  reserve  is  created  for  the  redemp- 
tion of  bonds  by  a  charge  against  Surplus,  but  no  actual  reserva- 
tion of  cash  or  other  property  is  made,  the  result  is  a  reserve 
but  there  is  no  corresponding  fund. 

In  the  one  case  the  actual  cash  is  withdrawn  and  held,  and  it, 
or  its  equivalent  if  it  is  invested,  is  there  for  the  redemption  of 
the  bonds  as  they  fall  due.  In  the  other  case,  the  profits  have 
merely  been  withdrawn  from  Surplus,  so  that  they  cannot  be 
declared  in  dividends  or  diverted  to  other  uses.  This  is  all  the 
reserve  does,  and  the  directors  must  take  such  steps  as  may  be 
necessary  to  secure  cash  to  pay  the  bonds  when  they  fall  due. 
Sufficient  cash  may  perhaps  be  in  the  treasury  for  the  purpose, 
but  in  the  case  of  a  large  amount  of  bonds  or  an  entire  issue  falling 
due,  this  is  seldom  the  case;  as  a  result  cash  must  be  borrowed 


Ch.  22]  PRINCIPLES  OF  FUND  ACCOUNTING  1227 

or  be  secured  by  the  sale  of  some  of  the  company's  property  to 
meet  redemptive  needs.  For  this  reason,  to  provide  for  the  re- 
demption of  bonds  or  the  liquidation  of  any  heavy  obligation, 
the  fund,  or  both  fund  and  reserve,  are  customary. 

The  vital  point  is  that  the  appropriation  of  profits  by  estab- 
lishing a  reserve  and  rendering  the  profits  unavailable  for  divi- 
dends is  one  thing;  the  actual  placing  of  cash  or  other  assets  in 
a  fund  is  a  different  thing.  Either  the  fund  or  the  reserve  can 
exist  independent  of  the  other.  The  reserve  has  no  specific 
function  to  perform  beyond  the  mere  safeguarding  of  the  profits.^ 

§  216.    Contract  Requirements  for  Funds  and  Reserves 

Deeds  of  trust  frequently  provide  that  reserves  for  the 
redemption  of  bonds  "shall  be  created  out  of  profits."  Bonds 
may  be  refunded,  but  if  they  are  to  be  paid  off  without  the 
acquirement  of  additional  liability,  it  must  usually  be  out  of 
profits  or  the  proceeds  of  the  sale  of  capital  assets.  While  it 
is  argued  that  there  is  no  more  need  of  reserving  profits  for  the 
redemption  of  bonds  than  for  the  reservation  of  profits  for  the 
payment  of  promissory  notes  or  ordinary  bank  loans,  the  con- 
tract provision  has  merit  as  the  bond  issues  are  usually  much 
larger  in  amount  than  current  borrowings  and  the  reserve  has  a 
tendency  to  prevent  directors  from  paying  dividends  that  might 
so  deplete  the  company's  quick  assets  as  to  make  the  payment 
of  the  bonds,  when  due,  difficult  if  not  impossible. 2  When  a 
reserve  for  redemption  of  bonds  is  established,  there  is  also 
usually  a  setting  aside  of  an  equal  amount  of  actual  cash  in  a 
fund. 

A  reserve  for  redemption  of  a  bond  issue  is  set  aside  out  of 
profits  by  means  of  a  debit  to  Surplus  and  a  credit  to  Sinking 
Fund  Reserve,  or  to  Bond  Extension  Reserve,  or  to  Debt 
Extinguishment  Reserve.  If  the  bonds  are  redeemed  without 
the  issuance  of  new  bonds,  the  reserve  for  redemption  remains 


'  Cf.  Ch.  Ill,  "Reserve  Accounts." 

'See   Book   II,   Ch.    XI,   "Redemption  of   Bonds — Sinking   Funds." 


1228  CORPORATE  ACCOUNTING  [Bk.  ni- 

on  the  books  unaffected  by  the  retirement  of  the  bonds  and  must 
be  closed  into  Surplus.  This  results  in  a  sudden  and  substantial 
increase  of  profits  available  for  dividends,  and  the  directors  may 
then  properly  "cut  a  melon"  if  they  see  fit. 

§  217.    Funds  for  Redemption  Purposes 

j  The  most  common  use  of  the  fund  in  corporation  affairs  is 
for  the  redemption  of  bond  issues  and  the  retirement  of  pre- 
ferred stock.  The  name  "sinking  fund"  is  often  improperly 
applied  to  all  such  funds.     Speaking  accurately, 

A  sinking  fund  consists  of  assets,  usually  in  the  form  of  cash 
or  securities,  set  apart  to  accumulate  at  compound  interest,  and 
dedicated  to  the  purpose  of  paying  at  its  maturity  a  debt  now  owing 
or  certain  to  be  incurred. 

Unless  a  fund  fulfils  all  of  the  conditions  of  this  definition  it  is 
not  a  true  sinking  fund.  The  accumulation  of  compound  interest 
is  indispensable.  While  it  is  true  that  a  liability  due  in  ten  years 
could  be  provided  for  by  putting  one-tenth  of  the  total  amount 
necessary  into  a  fund  each  year,  such  a  financial  arrangement 
would  not  be  a  sinking  fund.  The  interest  under  such  conditions 
would  not  have  to  be  added  to  the  fund  because  the  ten  equal 
annual  contributions  would  provide  for  the  payment  of  the  liability. 
The  proper  name  for  such  a  fund  would  be  Bond  Redemption 
Fund 

A  true  sinking  fund  must  be  established  for  the  payment  of  a 
f>ositive  liability,  certain  to  mature.  If  the  fund  is  to  be  used  to 
acquire  an  asset  it  is  not  a  sinking  fund  from  the  accountant's 
standpoint.  From  the  mathematical  standpoint  any  fund  ac- 
cumulating at  compound  interest  is  a  sinking  fund,  but  as  used  in 
accountancy  it  is  intended  to  pay  a  debt.  Moreover,  this  debt 
must  be  certain  to  mature;  if  the  fund  is  provided  to  meet  a  contin- 
i  gent  liability  it  may  never  be  required.  Hence  it  is  a  contingent 
I  fund  and  not  a  sinking  fund.  If  the  intended  use  is  the  redemption 
of  preferred  stock,  the  term  sinking  fund  cannot  properly  be 
applied  because  stock  has  no  definite  maturity;  the  corporation 
cannot  enter  into  an  unconditional  contract  to  redeem  its  stock  at  a 
definite  date. 

Payment  of  the  liability  at  its  maturity  is  another  essential  to 
the  definition.     If  a  fund  is  established  to  pay  off  a  bond  issue,  the 


Ch.  22] 


PRINCIPLES  OF  FUND  ACCOUNTING 


1229 


bonds  must  be  retired  and  canceled  at  maturity  and  not  before. 

Thus,  if  a  company  provides  a  fund  to  liquidate  its  bonded  debt, 

it  may  cancel  the  entire  indebtedness  at  maturity,  or  cancel  por- 

,    tions  thereof  at  various  times.     But  if  it  chooses  the  latter  pro- 

cJ^^^-'tedure,  the  fund  is  a  redemption  fund  and  not  a  sinking  fund.   This 

f        does  not  mean  that  the  company  accumulating  a  sinking  fund 

i        cannot  buy  up  year  by  year,  the  very  bonds  which  the  fund  is 

intended  to  retire.     But  if  this  is  done,  such  bonds  must  be  held 

alive.     That  is,  they  must  be  included  in  the  liabilities  instead  of 

canceled,  and  they  must  be  carried  as  part  of  the  fund.^ 


§  218.     Sinking  Fund  Account 


Credit: 

With  amounts  of  money  disbursed 
for  the  purpose  for  which  the  special 
fund  was  created. 


Debit: 

With  the  value  of  assets  transferred 
from  the  general  funds  of  the  business 
to  a  special  fund  for  the  specific  purpose 
of  creating  or  increasing  a  sinking 
fund  to  meet  some  fixed  obligation  at 
a  particular  time,  as  a  bond  issue, 
mortgage,  or  other  debt. 

With  the  income  derived  from  the 
investments  of  money  set  aside  as  a 
sinking  fund.  (At  this  time  credit 
Sinking  Fund  Income  account.) 

The  balance  of  this  account  is  an  asset  and  should  at  any- 
time represent  the  accumulated  value  of  the  sinking  fund.  The 
moneys  thus  taken  are  usually  handed  over  to  a  trustee  or 
board  of  trustees  for  safe-keeping  and  investment,  the  duties  of 
such  trustee  in  respect  of  such  funds  being  set  forth  in  the 
document  creating  the  trust. 

The  handling  of  other  funds  on  the  books  of  account  is  the 
same  as  that  of  the  sinking  fund. 

For  the  account  with  the  fund,  as  given  above,  there  are 
frequently  substituted  in  the  case  of  either  sinking  or  other 
kinds  of  funds  several  accounts  descriptive  of  the  form  in  which 
the  assets  are  held,  as  Sinking  Fund  Cash,  Sinking  Fund  Invest- 


•Adv.  Acctg.,  by  Seymour  Walton,  p.  A773. 


123© 


CORPORATE  ACCOUNTING 


[Bk.  III- 


ments,  etc.  The  Sinking  Fund  Cash  account  would  be  debited 
with  money  transferred  to  the  fund,  with  receipts  of  income,  and 
with  the  proceeds  of  the  sale  of  sinking  fund  investments.  It 
would  be  credited  with  cash  spent  or  invested.  The  Sinking 
Fund  Investments  account  would  be  debited  with  the  value  of 
assets  transferred  and  the  cost  of  assets  purchased,  and  would 
be  credited  with  any  sales  of  investments,  the  amount  of  the 
credit  being  the  figure  at  which  the  assets  sold  were  originally 
charged  to  the  account.  The  amount  of  any  loss  would  be 
debited  to  Sinking  Fund  Expense;  that  of  any  profit  would  be 
credited  to  Sinking  Fund  Income. 

§  219.     Sinking  Fund  Income  Account 


Debit: 

At  each  periodical  closing  of  the  books 
this  account  is  debited  with  the  balance 
remaining  in  it,  the  corresponding  credit 
being  to  Profit  and  Loss  or  to  Sinking 
Fund  Reserve  account. 


Credit: 

With  any  income  in  the  shape  of 
interest  or  dividends  received  from  in- 
vestment or  deposit  of  sinking  fund 
moneys,  as  reported  by  the  sinking  fund 
committee  or  trustee  in  charge  of  the 
sinking  fund. 


Income  from  sinking  fund  moneys,  whether  invested  in 
securities  or  on  deposit  in  the  savings  bank,  is  a  profit  to  the 
corporation,  and  is  usually  credited  to  some  representative  ac- 
count, as  Sulking  Fund  Income,  or  Interest  on  Sinking  Fund. 
As  illustrated  in  the  next  chapter,  this  account  is  in  turn  closed 
into  Profit  and  Loss,  or  Reserve  for  Sinking  Fund  in  case  the 
latter  account  is  being  carried. 


§  220.    Sinking  Fund  Expense  Account 


Debit: 

With  the  amount  of  expenses  incurred 
in  operating  the  fund,  such  as  trustees' 
and  brokers'  commissions,  etc.,  and 
with  the  amount  of  loss  on  the  sale  of 
fund  investments. 


Credit: 

At  each  periodical  closing  of  the 
books  this  account  is  credited  with  the 
balance  remaining  in  it,  the  correspond- 
ing debit  being  to  Profit  and  Loss  or  to 
Sinking  Fund  Reserve. 


Ch.  22]  PRINCIPLES  OF  FUND  ACCOUNTING  1231 

The  general  principles  underlying  the  handling  of  the  Sinking 
Fund  Income  account  apply  equally,  but  in  reverse,  in  the  case 
of  the  Sinking  Fund  Expense  account. 

§  221.     Summary  of  Sinking  Fund  Principles 

The  sinking  fund,  as  already  stated,  is  made  up  of  periodical 
cash  payments  to  the  trustee  and  the  interest  accumulations; 
therefore,  definite  book  entries  are  required  at  regular  periods 
to  record  properly  the  instalments  and  interest  accretions. 
An  account  must  be  opened  for  the  sinking  fund,  or  for 
the  sinking  fund  trustee,  to  which  shall  be  debited  the  various 
payments  and  accumulations,  with  corresponding  credits  to 
Cash  and  to  Sinking  Fund  Income.  If  the  trust  agreement 
requires  that  the  sinking  fund  shall  be  created  out  of  profits, 
then  an  annual  reserve  equivalent  to  the  sinking  fund  instalment 
must  be  set  aside.  The  fund  itself,  however,  is  composed  of 
assets  and  recorded  on  the  debit  side  of  the  ledger,  while  the 
Sinking  Fund  Reserve  account  is  a  credit  and  shown  on  the 
credit  side.  Careful  book  records  must  of  course  be  kept  of  all 
details  respecting  the  sinking  fund  and  any  reserves  required  in 
connection  therewith. 

In  the  case  of  small  companies  the  sinking  fund  procedure  is 
often  much  less  formal  than  in  the  case  of  larger  companies,  and 
it  is  not  unusual  for  the  whole  of  the  funds  to  remain  in  the  hands 
of  the  directors  themselves ;  but  in  any  case  the  accounts  should 
be  so  kept  as  to  show  all  information  that  may  be  required  by 
any  of  the  interested  parties  respecting  the  bonds  and  the  sinking 
funds. 

The  regulations  of  the  Interstate  Commerce  Commission 
provide  for  sinking  fund  accounts  of  railroads,  and  quotations 
from  these  may  be  of  interest  to  other  than  railroad  accountants. 
The  first  quotation  prescribes  what  shall  be  included  in  the 
sinking  fund: 

This  account  shall  include  the  amount  of  cash,  the  ledger  value 
of  live  securities  of  other  companies,  and  other  assets  which  are 


1232  CORPORATE  ACCOUNTING  [Bk.  Ill- 

held  by  the  trustees  of  sinking  and  other  funds  for  the  purpose  of 
redeeming  outstanding  obligations,  including  such  assets  so  held 
in  the  hands  of  the  accounting  company's  treasurer  when  the  assets 
are  segregated  under  a  distinct  fund ;  also  amounts  deposited  with 
such  trustees  on  account  of  mortgaged  property  sold,  the  proceeds 
of  which  are  to  be  held  for  the  redemption  of  securities,  and  the  par 
value  of  live  securities  issued  or  assumed  by  the  accounting  com- 
pany and  held  in  such  funds.  A  separate  account  shall  be  kept  for 
each  fund.  The  title  of  each  such  account  shall  designate  the 
obligation  in  support  of  which  the  fund  is  created. 

Railway  companies  not  infrequently  create  sinking  fund 
reserves  also,  which  of  course  must  be  set  aside  out  of  profits. 
The  Commission's  ruling  on  the  subject  of  the  Sinking  Fund 
Reserve  account  is  as  follows: 

This  account  shall  include  the  net  balances  in  accounts  to  which 
are  credited  definite  appropriations  of  income  and  surplus,  whether 
held  in  general  funds  or  specifically  set  aside  in  the  hands  of  a 
trustee  for  sinking  and  redemption  funds.  It  shall  also  include 
income  accretions  to  such  funds  retained  therein. 

Income  from  sinking  fund  assets  is  required  to  be  cared  for 
under  "Income  from  Sinking  and  Other  Reserve  Funds."  To 
this  account  are  to  be  credited  income  accrued  on  cash  securities 
and  other  assets  belonging  to  sinking  and  other  reserve  funds, 
such  income  being  included  under  non-operating  income  in  the 
company's  regular  income  statement.  In  case  a  Sinking  Fund 
Reserve  account  is  maintained,  a  definite  amount  must  be  set 
aside  out  of  income  by  a  debit  to  the  account  "Surplus  Applied 
to  Sinking  and  Other  Reserve  Funds"  and  a  credit  to  "Sinking 
Fund  Reserves."  Such  amounts  are  generally  set  up  monthly, 
but  at  the  end  of  each  year  "Surplus  Applied  to  Sinking  and 
Other  Reserve  Funds"  account  must  necessarily  be  closed  out. 

§  222.    Adequacy  of  the  Sinking  Fund 

It  will  readily  be  seen  that  the  amount  of  the  sinking  fund 
deposits  must  be  calculated  in  advance,  so  that  when  the  bonds 
mature  there  will  be  sufficient  cash  available  for  their  redemption, 


Ch.  22]  PRINCIPLES  OF  FUND  ACCOUNTING  1 233 

In  case  of  shortage  for  any  cause,  additional  funds  must  be  raised 
to  pay  off  the  maturing  bonds.  On  the  other  hand,  if  the 
required  amount  has  been  accumulated  prior  to  the  date  of 
maturity,  further  sinking  fund  payments  may  be  discontinued 
unless  otherwise  provided  in  the  agreement  under  which  the 
sinking  fund  is  created. 

A^Tiere  definite  amounts  are  set  aside  yearly,  such  amounts 
are  generally  governed  by  the  aggregate  debt  outstanding,  and 
by  the  estimated  rate  of  interest  the  fund  is  likely  to  earn.  For 
example,  if  it  is  desired  to  meet  a  debt  of  $800,000  in  20  years, 
an  annual  deposit  of  $26,866  to  the  sinking  fund  would,  at  4% 
interest  compounded  annually,  provide  an  adequate  cash  supply 
for  the  purpose,  but  this  presupposes  that  the  trustee  will  be 
able  to  keep  the  funds  continuously  invested  at  this  rate.  This 
may  not  always  be  possible,  and  on  the  other  hand  it  is  probable 
that  the  trustee  may  be  able  to  secure  a  better  interest  rate, 
particularly  if  he  is  permitted  to  invest  in  the  company's  own 
bonds.  It  will  be  seen,  then,  that  the  exact  earning  capacity 
of  trust  funds  cannot  be  accurately  foretold,  and  that  officials 
should  be  governed  accordingly  in  determining  the  sinking  fund 
instalments. 

§  223.    Annuity  Method  for  Sinking  Funds 

There  is  a  growing  tendency  to  apply  scientific  annuity  cal- 
culations to  bonds  and  sinking  funds,  as  well  as  to  amortizing 
diminishing  balances.  Under  this  plan  it  is  assumed  that  all 
instalments  and  interest  accumulations  to  the  sinking  fund  will 
earn  compound  interest  from  year  to  year,  at  a  given  rate,  say 
3%  or  4%.  The  amount  that  shall  be  in  the  fund  at  any  time 
is  carefully  estimated  when  the  bonds  are  issued,  so  that  at  the 
date  of  maturity  there  may  be  in  the  hands  of  the  trustee  enough 
to  pay  the  debt.  If  at  any  time  this  estimate  falls  short,  because 
of  a  lower  earning  rate  or  for  any  other  reason,  an  adjustment 
must  be  made  by  increasing  the  annuity  or  by  making  a  special 
deposit  equal  to  the  existing  deficit.     When  estimating  the  rate 


1234  CORPORATE  ACCOUNTING  [Bk.  IH- 

of  yield,  care  must  be  taken  not  to  use  a  higher  rate  than  the 
regular  savings  bank  interest.  If,  however,  the  sinking  fund 
trustee  invests  in  the  company's  own  bonds  at  any  time,  the 
income  will  be  materially  increased. 

§  224.    Calculating  Fund  Annuities 

Annuity  calculations  may  be  largely  avoided  by  the  use  of 
annuity  tables,  but,  notwithstanding  this,  it  is  most  desirable 
to  ]jiave  at  least  a  working  knowledge  of  their  principles. 

An  annuity  is  a  definite  sum  of  money  paid  at  regular  inter- 
vals. For  example,  an  investment  of  $1  at  6%  per  annum, 
compounded  annually,  amounts  in  5 "  years  to  approximately 
$1.33822558.  In  other  words,  if  the  original  $1  were  left  on 
deposit  in  some  one  bank  for  5  years,  and  the  annual  interest 
of  6  cents  withdrawn  each  year  and  deposited  in  another  bank 
at  6%  compounded  annually,  at  the  end  of  5  years  there  would 
be  the  original  $1  in  the  first  bank  and  $.33822558  in  the  second 
bank.  This  latter  amount  is  the  result  of  an  annual  deposit 
of  6  cents  for  a  period  of  5  years  "with  the  interest  accumulations; 
therefore,  $.33822558  is  the  value  at  maturity  of  an  annuity  of 
6  cents  for  5  years  at  6%.  From  this  the  final  value  of  any 
annuity  at  6%  for  5  years  may  readily  be  found,  by  dividing 
$.33822558  by  6  to  find  the  value  of  an  annuity  of  i  cent,  and 
multiplying  this  by  the  number  of  cents  in  the  actual  annu- 
ity.   Thus,  an  annuity  of  $1  for  5  years  has  a  final  value  of 

— ^ —  X  100,  which  equals  $5.637093.    This  plan  requires 

6 

the  use  of  only  the  ordinary  compound  interest  tables. 

To  find  the  final  value  of  an  annuity  for  a  given  time  at  a 

given  rate,  first  multiply  the  compound  interest  on  $1  for  the 

given  time  at  the  given  rate  by  100,  and  divide  by  the  given 

rate.     This  gives  the  final  value  of  an  annuity  of  $1.     Then  the 

final  value  of  the  given  annuity  is  found  by  multiplying  the  final 

value  of  an  annuity  of  $1  by  the  number  of  dollars  in  the  given 

annuity. 


Ch.  22]  PRINCIPLES  OF  FUND  ACCOUNTING  1235 

§  225.    Application  of  Method 

The  following  example  will  illustrate  more  fully  the  applica- 
tion of  the  compound  interest  method  to  sinking  fund  accumu- 
lations : 

The  Consumers'  Gas  Company  on  January  i,  1922,  issued 
$2,000,000  of  first  mortgage  5%  sinking  fund  gold  bonds,  pay- 
able in  25  years,  interest  payable  semiannually.  In  order  to 
meet  the  bonds  at  maturity,  such  annual  sum  in  cash  is  to  be 
deposited  with  a  designated  trust  company  as  will  accumulate, 
at  4%  compound  interest  during  the  currency  of  the  obligations, 
to  an  amount  sufficient  to  redeem  the  bonds. 

In  finding  the  amount  of  the  yearly  annuity  payment,  we 
need  not  consider  discount  if  the  bonds  should  be  sold  at  less 
than  par,  nor  the  expenses  of  the  issue,  nor  the  payment  of  inter- 
est coupons.  Bond  discount  and  expense  are  treated  as  expense 
incident  to  the  issue,  and  as  the  coupons  mature  they  are  paid 
out  of  current  funds,  and  the  amount  charged  to  Bond  Interest, 
which  in  turn  is  closed  into  the  Profit  and  Loss  account.  We 
have  therefore  to  provide  only  for  the  payment  of  the  principal 
sum  of  $2,000,000  at  the  end  of  the  25th  year. 

We  find — usually  by  consulting  an  annuity  table — that  $1 
invested  annually  at  4%  compound  interest,  will  amount  to 
$41.64590829  at  the  end  of  25  years.  If  $1  invested  annually  for 
25  years  at  4%  compound  interest  will  amount  to  $41.64590829, 
then  by  dividing  this  value  into  $2,000,000 — the  amount  to  be 
accumulated — the  quotient  is  the  number  of  dollars  which  must 
be  invested  each  year  to  amount  in  25  years,  at  4%  compound 
interest,  to  the  desired  sum.  Carrying  out  this  division  we  find 
the  required  annuity  payment  to  be  $48,023.93. 

In  ascertaining  the  amount  of  a  sinking  fund  annuity,  the 
determining  factors  are  the  principal  to  be  accumulated,  the 
time  to  run,  and  the  rate  of  interest  obtainable. 


CHAPTER  XXIII 
ENTRY  OF  FUND  TRANSACTIONS 

§  226.    The  Trustee  and  the  Fund  Accounts 

Sinking  funds  may  or  may  not  be  placed  in  the  hands  of  a 
trustee,  although  it  is  customary — except  in  the  case  of  munici- 
palities— to  appoint  an  independently  responsible  trustee  to  take 
charge  of  sinking  funds  required  by  contract.  An  officer  of  the 
corporation  is,  however,  sometimes  appointed  in  his  individual 
capacity  to  act  as  trustee. 

If  the  corporation  itself  maintains  the  sinking  fund  without 
an  outside  trustee,  the  transactions  in  connection  with  the 
handling  of  the  fund  will  usually  be  recorded  on  the  corporatioil 
books  as  they  occur,  no  independent  books  of  account  being  kept. 
If  an  officer  of  the  corporation  acts  as  trustee,  the  transactions 
are  usually  recorded  on  the  corporation  books,  although  the 
ofiicer-trustee  also  frequently  keeps  an  independent  set  of  books 
for  the  fund.  If  there  is  an  independent  trustee  he  (or  it,  if  the 
trustee  is  a  corporation,  such  as  a  trust  company)  should  cer- 
tainly keep  a  full  record  of  his  handling  of  the  fund.  Even  in 
this  case  the  corporation  establishing  the  fund  should  show  on 
its  own  books  the  investment  of  the  fund  and  the  profit  there- 
from, although  it  must  rely  on  the  statements  rendered  it  by  the 
trustee.  In  this  case  the  entries  are  made  in  summary  on  the 
corporation  books  as  reports  are  received  from  the  trustee. 

The  principles  laid  down  in  the  present  chapter  for  sinking 
fund  entries,  when  all  the  transactions  are  recorded  on  the  books 
of  the  corporation,  are  equally  applicable  to  any  other  funds 
which  a  corporation  may  establish.  Also  the  method  sug- 
gested for  recording  the  transactions  as  they  occur  serves  equally 
well — except  as  noted  in  connection  with  the  various  entries — 

1236 


Ch.  23I  ENTRY  OF  FUND  TRANSACTIONS  1237 

for  putting  on  the  books  the  transactions  of  a  trustee  as  these 
are  taken  from  his  reports. 

§  227.    Entries  for  Sinking  Fund  Instalments 

The  sinking  fund  instalments  are  paid  in  cash  to  the  trustee, 
either  half-yearly  or  yearly,  or  even  at  greater  intervals,  accord- 
ing to  the  requirements  of  the  deed  of  trust.  For  illustration,  we 
will  assume  that  the  5%  bond  issue  of  the  Lenox  Iron  Works  for 
$1,000,000  required  an  annual  deposit  of  $50,000  to  the  sinking 
fund  beginning  December  31,  192 1.  This  payment  will  be 
recorded : 

December  31,  1921 

Sinking  Fund  Cash $50,000 

To  Cash $50,000 

First  deposit  to  the  sinking  fund  for  redemption  of  $1,- 
000,000  first  mortgage  5%  bonds  due  January  i,  1941, 
as  required  by  trust  agreement. 

If  there  were  several  bond  issues  requiring  sinking  funds, 
each  fund  would  have  a  separate  account.  They  should  be  desig- 
nated according  to  the  kind  and  tenor  of  the  bonds,  as  "Sinking 
Fund  of  First  Mortgage  5%  Bonds  of  1925,"  "Sinking  Fund  of 
$4,000,000  First  Mortgage  5%  Sinking  Fund  Gold  Bonds  of 
1940,"  as  the  case  may  require.  Sometimes  the  name  of  the 
trustee  is  included  in  the  caption,  as  "Security  Trust  Company, 
Trustee  of  Sinking  Fund,"  or  "Trustee  of  Sinking  Fund  of  $1,- 
000,000  5%  Bonds,"  etc.  The  title  should  be  sufficiently  descrip- 
tive to  indicate  clearly  the  fund  and  its  purpose. 

§  228.    Entries  for  Sinking  Fund  Interest 

The  duty  of  the  trustee  being  to  safeguard  the  sinking  fund 
properly  and  to  keep  it  earning,  we  will  assume  in  the  present  in- 
stance that  he  deposited  the  funds  in  the  savings  bank  to  draw 
4%.  At  the  end  of  the  first  year  he  must  make  his  report  to  the 
company,  giving  the  status  of  the  fund  and  stating  the  accumu- 
lated income  thereon,  which  in  this  case  would  be  4%  of  $50,000, 


1238  CORPORATE  ACCOUNTING  [Bk.ni- 

or  $2,000.    Upon  receipt  of  this  report  the  following  entry  should 
be  made  on  the  company's  books : 

'        December  31,  1922 

"■'■''   '!'''! 
Sinking  Fund  Cash '. "......    $2,000 

To  Sinking  Fund  Income .'. $2,000 

,t ,  ,To  record  income  from  sinking  fund  deposit  of  $25,000  for  one 

year  at  4%,  as  per  report  of  the  trustee. 

Sinking  fund  income  should  be  credited  to  some  account  that 
will  clearly  indicate  the  sources  from  which  it  came,  as  shown  in 
the  above  entry.  Sinking  Fund  Income  account  may  be  closed 
at  the  end  of  the  fiscal  period  into  Profit  and  Loss,  or  if  there  is 
a  Sinking  Fund  Reserve  account,  the  Sinking  Fund  Income 
account  may  be  closed  into  that.i  In  the  former  case  the  entry 
wiU  be: 

Sinking  Fund  Income $2,000 

To  Profit  and  Loss $2,000 

To  close  Sinking  Fund  Income  account  into  Profit  and  Loss. 

If  there  is  a  Sinking  Fund  Reserve  account,  and  it  is  consid- 
ered desirable  to  close  the  Sinking  Fund  Income  account  into 
that,  the  entry  will  be : 

Sinking  Fund  Income $2,000 

To  Sinking  Fund  Reserve $2,000 

To  close  the  Sinking  Fund  Income  account  into  the  Sink- 
ing Fund  Reserve. 

Under  the  terms  of  trust  under  which  the  sinking  fund  was 
established,  no  mention  has  been  made  of  the  disposition  of  the 
income  from  the  fund.  It  might  be  handled  in  any  one  of  three 
ways,  i.e.,  (i)  be  turned  over  to  the  company,  (2)  retained  by  the 
trustee  as  an  addition  to  the  sinking  fund,  or  (3)  be  applied  to 
lessening  the  next  sinking  fund  instalment. 

Since  this  is  supposed  to  be  a  true  sinking  fund,  the  income 
must  be  added  to  the  principal  and  draw  compound  interest. 
Under  this  procedure  the  entries  are  more  involved  than  in  the 
first  or  third  methods  of  handling  income  from  funds.    Under  the 

>  C/.  J232. 


Ch.  23]  ENTRY  OF  FUND  TRANSACTIONS  1239 

first  method  the  trustee  would  turn  over  to  the  company  cash  to 
the  amount  of  the  interest  or  income;  and  the  company,  if  the 
entry  of  Sinking  Fund  Cash  to  Sinking  Fund  Income  had  already 
been  made,  would  debit  Cash  and  credit  Sinking  Fund  Cash, 
but  if  otherwise  would  debit  Cash  and  credit  Sinking  Fund 
Income. 

To  illustrate  monthly  entries  showing  the  accrual  of  the  sink- 
ing fund  interest,  the  following  have  been  constructed  upon  the 
facts  of  the  preceding  material : 

Accrued  Sinking  Fund  Income $166.67 

To  Sinking  Fund  Income '. $166.67 

Accrued  income  at  4%  on  $50,000  of  cash  on  deposit  in 
savings  bank  for  one  month,  ^/i2  of  $2,000. 

This  entry  would  be  made  at  the  end  of  each  month,  and  at 
the  end  of  the  year  the  following  entry  would  be  made : 

Sinking  Fund  Cash $2,000 

To  Accrued  Sinking  Fund  Income $2,000 

Cash  collected  by  sinking  fund  trustee  during  the  year,  being 
4%  on  $50,000  on  deposit  at  the  savings  bank. 

§  229.    Entries  for  Sinking  Fund  Investment 

Instead  of  depositing  the  sinking  fund  cash  in  the  savings 
bank,  the  trustee  may  find  it  more  profitable  to  invest  it,  or  a 
portion  of  it,  in  gilt-edged  bonds  paying  a  higher  rate  of  interest. 
In  some  cases  he  is  required  to  invest  the  funds  in  bonds  of  other 
companies,  or  of  the  issuing  company  itself.  We  will  assume, 
therefore,  that  on  January  i,  1923,  the  trustee  purchases  $100,- 
000  of  first  mortgage  5%  bonds  of  the  United  States  Steel  Cor- 
poration at  par,  interest  due  January  i  and  July  i. 

If  the  trustee  of  the  sinking  fund  keeps  his  own  books  and 
makes  such  investments  as  this  independently  of  the  company, 
the  money  paid  to  the  trustee  will,  as  shown  in  the  preceding 
section,  be  debited  to  Sinking  Fund  Cash,  and  no  entry  be  made 
on  the  company's  books  for  the  purchase  of  the  United  States 
Steel  bonds  until  the  trustee's  periodical  report  is  received.    The 


124©  CORPORATE  ACCOUNTING  [Bk.  III- 

asset  value  is  continued  to  be  carried  in  Sinking  Fund  Cash  ac- 
count until  the  details  of  the  investment  and  perhaps  of  the  peri- 
odical profit  therefrom  are  furnished.  In  making  the  investment 
the  trustee  is  simply  replacing  a  certain  amount  of  cash  assets 
with  an  equivalent  amount  of  securities,  and  the  company's 
net  worth  remains  unchanged. 

But  whenever  it  is  possible  to  record  on  the  company's  books 
all  the  transactions  as  they  occur,  so  as  to  show  how  the  sink- 
ing fund  is  invested  and  the  amount  of  this  investment  separ- 
ately from  the  sinking  fund  cash,  even  though  the  securities  are 
in  the  hands  of  the  trustee,  the  following  would  be  the  procedure : 

January  i,  1923 

Sinking  Fund  Investments $ioo,cxx) 

To  Sinking  Fund  Cash $100,000 

For  investment  by  the  trustee  in  5%  bonds  of  the  United 
States  Steel  Corporation  at  par,  as  per  his  report  of 
this  day. 

§  230.    Income  on  Sinking  Fund  Investments 

The  sinking  fund  now  contains  bonds  which  will  pay  interest 
twice  during  the  year,  $2,500  in  cash  each  six  months.  If  the 
bonds  had  been  purchased  at  a  premium  or  discount,  another  ele- 
ment would  have  been  introduced — that  of  properly  recording 
such  diflference.2  At  the  end  of  the  first  half-year  an  entry  for 
income  would  be  required  as  follows: 

July  I,  1923 

Sinking  Fund  Cash $2,500 

To  Sinking  Fund  Income $2,500 

For  coupons  collected  on  $100,000  5%  bonds  of  United 
States  Steel  Corporation  held  in  the  sinking  fund  as  per 
report  of  the  trustee.  {Full  details  necessary.) 

If  desired  this  could  be  handled  by  monthly  entries  accruing 
the  income. 

At  the  end  of  the  year,  interest  will  have  accumulated  on  both 


>n  k 


See  Ch.  XXI,  "Bond  Discount  and  Premium.' 


Ch.  23]  ENTRY  OF  FUND  TRANSACTIONS  124I 

interest  and  bonds,  requiring  the  following  entry  on  the  com- 
pany's books: 

December  31,  1923  ' 

Sinking  Fund  Cash $2,630 

To  Sinking  Fund  Income $2,630 

For  interest  accumulations  to  the  fund,  as  per  report  of  the 
trustee,  as  follows: 

Interest  at  4%  on  $2,000  in  bank,  one  year $     80 

Interest  at  5%  on  $100,000  bonds,  one  half-year.  .  2,500 
Interest  at  4%  on  $2,500  in  bank,  one  half-year.       50 

Total $2,630 

Another  instalment  of  $50,000  is  due  the  sinking  fund  at  this 
time,  and  is  entered  as  before. 

§  231.    Entries  for  Investment  in  Issuing  Company's  Bonds 

The  trust  deed  in  many  cases  provides  for  the  redemption  of 
the  bonds  by  the  sinking  fund  trustee,  either  at  the  market  price 
or  at  a  fixed  price,  and  he  is  compelled  to  carry  out  such  pro- 
visions. In  a  true  sinking  fund  the  bonds  so  purchased  by  the 
trustee  will  be  kept  alive  as  investments  of  the  sinking  fund; 
whereas  if  the  fund  is  merely  a  bond  redemption  fund,  the  trus- 
tee will  turn  the  bonds  over  to  the  company  for  cancellation. 

To  exemplify  the  entries  for  the  purchase  of  such  bonds  for 
sinking  fund  investment,  we  will  carry  the  illustration  of  the 
Lenox  Iron  Works  a  step  further,  by  a  purchase  on  January  i, 
1924,  of  $50,000  of  the  company's  own  bonds  at  102^. 

The  entry  to  be  made  for  this  transaction  must  be  governed 
by  the  circumstances,  not  because  the  bonds  are  those  of  the 
issuing  company,  but  because  of  the  disposition  to  be  made  of 
the  $1,250  premium  paid  thereon.  The  company  is  the  loser  of 
this  amount  since  the  bonds  are  not  to  be  resold,  and  the  premium 
must  be  charged  off.  There  is,  however,  open  to  the  corporation 
a  choice  as  to  whether  this  premium  shall  be  disposed  of  at  once 
by  a  charge  to  Profit  and  Loss,  or  be  carried  as  a  deferred  expense 
and  amortized  over  the  life  of  the  bonds. 


1^42  CORPORATE  ACCOUNTING  [Bk.  HI- 

In  either  case  it  is  the  best  practice  to  carry  at  par  the  bonds 
so  purchased,  charging  the  premium  into  an  account  called  "Pre- 
mium on  Own  Bonds  Held  in  Sinking  Fund,"  or  some  other  de- 
scriptive title.    The  entry  at  the  date  of  purchase  is  as  follows : 

January  i,  1924 

Sinking  Fund  Investments $50,000 

Premium  on  Sinking  Fund  Investments If250 

To  Sinking  Fund  Cash $51,250 

For  purchase  of  $50,000  of  the  company's  5%  bonds  at  io2>^ 
by  the  trustee  for  sinking  fund  investment. 

The  Premium  on  Sinking  Fund  Investments  account  will  be 
closed  into  Profit  and  Loss,  or  its  amount  will  be  amortized 
over  the  remaining  life  of  the  bonds  by  periodical  charges  to 
Profit  and  Loss  or  to  Sinking  Fund  Income.  If  the  trustee's  fund 
is  to  be  maintained  at  a  definite  status  at  all  times,  the  company 
may  be  required  to  pay  over  to  him  additional  cash  to  reimburse 
him  for  the  amount  of  the  premium  payment. 

Federal  income  tax  laws  make  this  premium  an  expense  of 
the  year  in  which  the  corporation's  own  bonds  are  repurchased, 
and  do  not  allow  later  charges  on  account  of  amortization  to  be 
taken  as  a  deduction  from  taxable  income  in  the  year  in  which 
they  are  made.  For  this  reason,  in  order  to  keep  their  books  in 
accord  with  their  income  tax  returns,  a  great  many  corporations 
prefer  to  charge  the  premium  off  immediately.  The  United 
States  Steel  Corporation  charges  off  each  year  all  such  premiums 
(upward  of  $800,000  or  more)  on  bonds  purchased  and  held  by 
the  sinking  fund  trustee,  this  item  together  with  the  bond  inter- 
est being  entered  as  a  deduction  from  net  income. 

§  232.    Entries  for  Sinking  Fund  Reserve 

The  deed  of  trust  frequently  requires  an  amount  equal  to  the 
sinking  fund  instalment  to  be  set  aside  out  of  profits.s  To  carry 
out  this  provision  a  definite  amount  agreeing  with  the  sinking 
fund  payment  must  be  reserved  each  period,  whether  yearly  or 

'See  f  216;  also  Ch.  Ill,  "Reserve  Accounts." 


Ch.  23]  ENTRY  OF  FUND  TRANSACTIONS  1243 

oftener,  and  credited  to  a  reserve  account  set  up  for  that  purpose. 
Resorting  again  to  the  example  under  discussion,  we  will  assume 
that  the  Lenox  Iron  Works  is  required  to  set  aside  each  year  out 
of  profits  an  amount  equal  to  that  of  the  sinking  f  imd  instalments, 
$50,000  per  year.  In  that  event  it  becomes  necessary  to  with- 
draw the  required  amount  out  of  profits  by  the  following  entry: 

December  31,  192 1 

Profit  and  Loss  or  Surplus $50,000 

-.         To  Sinking  Fund  Reserve $50,000 

To  set  aside  profits  equal  to  the  sinking  fund  deposit  for 
redemption  of  $1,000,000  first  mortgage  5%  bonds,  in 
accordance  with  the  trust  agreement. 

Whether  or  not  this  reserve  shall  be  kept  in  harmony  with  the 
Sinking  Fund  account  depends  upon  the  trust  agreement.  In 
case  this  is  a  requirement,  it  is  obvious  that  every  dollar  added 
to  the  fund  must  also  have  an  equivalent  credit  to  the  Reserve 
account,  so  that  the  two  accounts  will  show  like  amounts  though 
on  opposite  sides.    This  plan  is  illustrated  in  the  following  entries. 

During  1922  the  sinking  fund  accumulates  a  profit  of  $2,000, 
which  was  credited  to  Income  and  which  must  be  reflected  in  the 
Reserve  account  as  well  as  in  the  Sinking  Fund  account.  This 
profit  was  credited  to  Sinking  Fund  Income,  which  account  has 
at  the  regular  time  been  closed  into  Profit  and  Loss.  We  may 
now,  therefore,  debit  Profit  and  Loss,  not  as  a  charge  against  the 
year's  profits  but  as  an  impounding  of  them,  or  debit  Surplus  as 
an  impounding  of  profits  in  general,  and  credit  the  reserve.  The 
following  entry  will  properly  record  the  regular  instalment  of 
$50,000  and  the  income  for  one  year  on  the  preceding  deposit : 

t.  December  31,  1922 

Profit  and  Loss  (or  Surplus) $52,000 

To  Sinking  Fund  Reserve $52,000 

To  set  aside  an  amount  equal  to  the  annual  deposit  to  the 
sinking  fund,  plus  the  profits  accumulated  for  the  year,, 
as  follows: 

Annual  deposit  to  sinking  fund $50,000 

Income    on    previous    balance    reported    by 

trustee 2,000 


1244  CORPORATE  ACCOUNTING  [Bk.  IH- 

Of  course,  if  the  Sinking  Fund  Income  account  was  closed 
into  the  reserve,*  no  further  credit  of  that  amount  to  the  reserve 
will  be  necessary. 

An  entry  similar  to  the  above  must  be  made  at  the  end  of 
each  year,  comprising  the  regular  instalment  and  all  accrued 
profits  for  the  year.  This  entry  presupposes,  of  course,  that  ad- 
ditions to  the  sinking  fund  have  already  been  charged  to  the 
trustee  and  credited  to  income  on  December  31,  1922.  As  in- 
terest accumulations  are  reported  by  the  trustee,  adjusting  entries 
are  made  to  the  Sinking  Fund  account;  but  under  the  plan 
adopted  it  may  not  be  necessary  to  credit  the  Sinking  Fund  Re- 
serve until  the  end  of  the  year,  at  which  time  the  entry  will  in- 
clude both  the  regular  $50,000  instalment  and  the  accrued  inter- 
est. If  it  is  desired,  as  is  frequently  the  case,  to  credit  earnings 
directly  to  the  Sinking  Fund  Reserve  account  instead  of  to  In- 
come, the  following  entry  would  be  required  for  the  $2,000  above 
reported : 

December  31,  1922 

Sinking  Fund  Cash $2,000 

To  Sinking  Fund  Reserve $2,000 

For  interest  accretions  to  the  sinking  fund  for  year,  as  per 
report  of  the  sinking  fund  trustee. 

If  the  Sinking  Fund  account  and  the  Sinking  Fund  Reserve 
account  are  to  be  kept  in  harmony,  certain  adjustments  may  be 
required  from  time  to  time,  as  in  the  purchase  of  bonds  of  the 
issuing  company  or  others  at  a  premium.  Referring  to  the  in- 
vestment of  $51,250  recorded  in  the  previous  section,  instead  of 
charging  this  premium  to  a  premium  account  it  may  be  charged 
directly  to  the  Reserve  account  by  such  an  entry  as  that  which 
foUows: 

January  i,  1924 

Sinking  Fund  Reserve $1,250 

To  Sinking  Fund  Cash $1,250 

(Full  explanation  here.) 


Ch.  23]  ENTRY  OF  FUND  TRANSACTIONS  1245 

This  entry,  if  used,  would  of  course  be  incorporated  in  the 
entry  referred  to  above.  The  amount  might,  if  desired,  be  first 
charged  to  the  Premium  account  and  in  turn  closed  into  the  Re- 
serve account.  There  are  many  ways  of  making  entries  and  it 
would  be  impracticable  to  enumerate  them  all. 

§  233.    Accounts  Kept  by  Sinking  Fund  Trustees 

It  is  necessary  for  the  trustee  of  any  fund  to  keep  full  and 
complete  accounts  so  that  the  condition  of  the  trust  can  be 
readily  ascertained  at  any  time.  The  accounts  of  the  trustee  and 
of  the  company  should  always  be  in  absolute  harmony  on  all 
matters  pertaining  to  the  bond  issue  and  the  sinking  fund. 

The  trustee  will  maintain  accounts  with  Cash  and  with  In- 
vestments, possibly  opening  a  separate  account  for  each  kind  of 
investment.  "Sinking  Fund  of  Blank  Company"  account  will  be 
credited  by  the  trustee  with  the  amounts  of  all  sinking  fund  in- 
stalments paid  to  him.  Its  only  debit  will  occur  at  the  time  the 
trustee,  at  the  maturity  of  the  bonds,  takes  them  up,  whether  he 
has  already  invested  his  cash  in  them  or  whether  they  are  still 
in  the  hands  of  scattered  holders.  The  trustee  of  a  bond  redemp- 
tion fund  would  debit  Bond  Redemption  Fund,  on  the  contrary, 
with  his  purchases  of  bonds  for  redemption. 

Interest  Payable  or  Coupons  Payable  account  (with  perhaps 
a  separate  account  for  each  series  of  coupons,  as  "Coupons  No. 
i")  is  credited  at  the  time  of  the  receipt  of  money  with  which  to 
pay  the  interest.  Cash  being  debited.  The  account  is  debited 
with  the  amounts  of  all  interest  paid  to  bondholders  or  coupons 
taken  up.  The  credit  balance  therefore  shows  the  amount  of  all 
unpaid  but  due  interest  for  which  the  trustee  has  received  the 
money  to  make  payments. 

§  234.    Entries  on  Books  of  Sinking  Fund  Trustee 

To  illustrate  the  entries  on  the  books  of  the  sinking  fund  trus- 
tee, the  transactions  in  connection  with  the  bond  issue  of  the 
Lenox  Iron  Works  (§  227)  may  be  again  taken.    The  first  pay- 


1246  CORPORATE  ACCOUNTING  [Bk.  III- 

ment  to  the  sinking  fund  trustee  was  $50,000  in  cash  on  July  i, 
1921,  this  payment  being  made  to  meet  the  semiannual  bond  in- 
terest. The  entry  on  the  books  of  the  Lenox  Iron  Works  was  as 
follows: 

July  I,  1921 

Bond  Interest $50,000 

To  Cash $50,000 

For  payment  of  semiannual  bond  interest  on  $1,000,000 
5%  bonds,  due  today  at  the  office  of  the  trustee,  The 
Grove  Street  Trust  Company  to  whom  the  check  has 
been  issued. 

The  corresponding  entry  on  the  books  of  the  sinking  fund 
trustee  is  shown  below: 

July  I,  1921 

Cash $50,000 

To  Coupons  No.  i  (Lenox  Iron  Works) $50,000 

First  deposit  of  cash  for  payment  of  Coupons  No.  i  on 
$1,000,000  coupon  bonds  of  the  Lenox  Iron  Works. 

The  Coupons  No.  i  account  will  obviously  remain  open  until 
all  the  coupons  are  paid.  As  payments  are  made,  the  trustee  of 
course  debits  the  Coupons  account  and  credits  Cash. 

Upon  receipt  of  the  first  sinking  fund  instalment  the  following 
entry  was  made  on  the  books  of  the  Lenox  Iron  Works. 

December  31,  1921 

Sinking  Fund  Cash $50,000 

To  Cash $50,000 

{Explanation.) 

The  corresponding  entry  on  the  books  of  the  sinking  fund 
trustee  is  as  follows: 

-^   ,  -,,     ^  December  31,  1921 

Cash $50,000 

To  Sinking  Fund  (Lenox  Iron  Works) $50,000 

First  sinking  fund  instalment  of  the  Lenox  Iron  Works  for 
redemption  of  $1,000,000  first  mortgage  5%  bonds  of 
1921,  due  January  i,  1941. 

The  succeeding  entries  of  the  sinking  fund  trustee  would,  as 
in  those  shown  above,  correspond  to  the  company's  entries. 


CHAPTER  XXIV 

REDEMPTION  OF  BONDS  ' 

§  235.    Plans  for  Redeeming  Bonds  ,  naijfjniob^yi     ,di'i  I, 

The  due  date  of  any  issue  of  bonds  is  stated  in  the  deed  of 
trust  and  also  on  the  face  of  each  bond.  The  deed  of  trust 
usually  provides  also  that  if  any  instalment  of  bond  interest  is 
not  paid  when  due,  and  default  continues  for  a  specified  length  of 
time,  the  principal  is  thereby  matured  and  must  be  paid.  In 
event  of  continued  default  in  either  the  principal  or  interest,  it 
is  usually  provided  that  foreclosure  may  follow,  or  perhaps  the 
trustee  is  authorized  to  take  possession  of  the  mortgaged  property 
and  operate  it  for  the  benefit  of  the  bondholders. 

The  method  of  redeeming  bonds  depends  largely  on  the 
nature  of  the  particular  bonds.  The  following  methods  are  in 
general  use: 

1.  Payment  in  cash  at  maturity  through  the  sinking  fund. 

2.  By  calling  certain  bonds  each  year  for  redemption.  Under 
this  method  the  numbers  of  the  outstanding  bonds  are  placed  in 
a  box  or  hat,  shaken  up,  and  a  given  number  of  them  drawn, 
those  drawn  indicating  the  bonds  which  are  to  be  redeemed. 
Legal  notice  of  the  numbers  drawn  for  redemption  is  given  to 
the  bondholders  by  advertisement  in  the  daily  papers,  and  the 
bonds  specified  cease  to  bear  interest  from  the  date  of  the  draw- 
ing, or  some  other  specified  date. 

3.  Refunding  at  maturity,  in  which  case  the  bonds  are 
canceled  and  new  ones  issued  in  their  place,  the  holders  of  the 
old  bonds  either  taking  new  bonds,  or  cash  secured  by  the  sale 
of  these  new  bonds,  in  exchange  for  their  old  bonds. 


*  See  also  Book  II,  Ch.  XI,  "Redemption  of  Bonds — binking  Funds." 

1247 


1248  CORPORATE  ACCOUNTING  [Bk.  III- 

4.  By  serial  payments.  Under  this  plan  serial  bonds  are 
issued,  payable  in  instalments  of  so  much  per  year  during  the 
currency  of  the  bonds. 

5.  By  conversion  into  stock  of  the  company,  either  at  a 
fixed  date  or  at  the  maturity  of  the  bonds,  or  at  some  other  con- 
venient time  prior  to  maturity. 

§  236.    Redemption  of  Bonds  through  Sinking  Fund 

Bonds  redeemed  through  the  sinking  fund  are  paid  at  ma- 
turity by  the  trustee,  who  then  passes  the  canceled  certificates 
over  to  the  issuing  corporation  for  final  record.  Sometimes  the 
canceled  bonds  are  burned,  though  more  frequently  retained  by 
the  company  as  a  permanent  voucher. 

The  book  entries  at  maturity  of  the  bonds  are  very  simple. 
To  illustrate  the  entries  necessary,  the  bond  issue  of  the  Lenox 
Iron  Works  may  again  be  taken.  This  consisted  of  $1,000,000  of 
first  mortgage  5%  sinking  fund  bonds  due  January  i,  1941. 
Assuming  that  the  bonds  have  matured  and  that  the  sinking 
fund  for  their  redemption  amounts  to  $992,000,  leaving  $8,000 
more  to  be  made  up  by  the  company,  book  entries  are  required 
as  follows: 

January  i,  1941 

Sinking  Fund  Cash $8,000 

To  Cash $8,000 

Cash  paid  over  to  the  trustee  of  the  sinking  fund  as  per 
request,  being  the  amount  still  required  by  him  for 
payment  of  $1,000,000  first  mortgage  bonds  maturing 
this  day. 

If  the  sinking  fund  had  been  scientifically  calculated  and 
maintained  at  all  times  at  a  given  rate  of  interest  without  loss, 
the  required  amount  for  the  redemption  of  the  bonds  should  be 
available  at  their  maturity  in  the  sinking  fund.  It  is,  however, 
for  obvious  reasons  seldom  that  the  sinking  fund  is  exactly  equal 
to  the  maturing  bonds.  When  a  shortage  occurs  the  company 
must  raise  the  additional  funds.     If,  on  the  other  hand,  the  fund 


Ch.  24]  REDEMPTION  OF  BONDS  1 249 

is  in  excess  of  the  required  amount,  such  excess  must  of  course 
be  returned  to  the  company  after  the  bonds  are  redeemed. 

Upon  receiving  notice  from  the  trustee  that  all  of  the  bonds 
have  been  redeemed,  the  following  entry  is  made : 

January  i,  1941 

First  Mortgage  Bonds $1,000,000 

To  Sinking  Fund  Cash $1,000,000 

For  payment  by  the  trustee  of  $1,000,000  first  mort- 
gage 5%  20-year  sinking  fund  bonds  of  1921  due 
this  day.  The  trust  deed  has  been  canceled  and 
the  mortgage  satisfied  of  record  in  the  county  re- 
corder's office. 

::  Through  the  above  entry,  both  the  bond  and  the  sinking 
fund  accounts  have  been  closed  out.  This  results  in  the  can- 
cellation of  two  main  accounts.  The  Sinking  Fund  Investments 
account  should  have  been  closed  into  the  Sinking  Fund  Cash 
account  when  the  trustee  turned  the  securities  into  cash;  the 
entry  above  being  preceded  by  the  following  entry  for  the 
amount  invested  in  securities : 

Sinking  Fund  Cash $900,000 

To  Sinking  Fund  Investments $900,000 

For  conversion  into  cash  by  the  trustee  of  sinking  fund 
securities  held  by  him  to  the  amount  of  $900,000. 

This  entry  is  made  regardless  of  whether  the  sinking  fund 
investments  are  bonds  of  the  issuing  company  or  of  other  com- 
panies. The  cancellation  of  all  three  accounts  involved  in  the 
above  entries  might  of  course  be  accomplished  through  the  one 
journal  entry  as  follows: 

First  Mortgage  Bonds $1,000,000 

To  Sinking  Fund  Investments $900,000 

Sinking  Fund  Cash 100,000 

(Full  explanation  here.)  , 

If  a  Sinking  Fund  Reserve  account  had  also  been  created,  it 
can  now  be  disposed  of,  as  there  is  no  further  need  of  preventing 
the  declaration  of  dividends  to  the  impairment  of  current  assets. 
The  Surplus  account  can  be  credited  with  the  amount  of  this 


1 250  CORPORATE  ACCOUNTING  [BL III- 

reserve.     Assuming  that  it  has  a  credit  balance  of  $1,000,000, 
the  following  entry  is  required : 

Sinking  Fund  Reserve $i,oc50,ooo 

To  Surplus $1,000,000 

(Full  explanation  here.) 

§  237.    Bonds  Drawn  by  Lot  for  Redemption 

When  bonds  are  to  be  redeemed  before  maturity,  the  sinking 
fund  trustee  either  advertises  for  the  desired  number  of  bonds  at 
a  stated  price,  draws  certain  bond  numbers  by  lot  for  redemption 
at  a  fixed  price,  or  buys  them  in  the  market  at  the  best  prices 
obtainable.  If  the  bonds  to  be  redeemed  are  drawn  by  lot,  in 
the  case  of  coupon  bonds,  notice  thereof  is  given  to  the  holders 
by  means  of  newspaper  advertisements;  in  the  case  of  registered 
bonds,  notices  are  sent  direct  to  the  holders.  When  bonds  of 
the  issuing  company  are  purchased  by  the  trustee,  they  are, 
according  to  the  provisions  of  the  trust  agreement,  either  retained 
as  a  sinking  fund  investment — unless  resold  later  at  a  higher 
price — or  are  handed  over  to  the  issuing  company  and  canceled. 
The  company's  bonded  indebtedness  is  in  the  latter  case  reduced 
to  the  extent  of  the  bonds  retired. 

The  investor  frequently  objects  to  the  plan  of  drawing  bonds 
for  retirement,  because  he  never  knows  when  his  number  may 
be  drawn.  He  must  therefore  be  on  the  lookout  at  each  interest 
period  for  the  announcement  of  drawings,  thereby  causing  a 
certain  amount  of  anxiety.  If  he  should  overlook  the  announce- 
ment, he  would  hold  his  bonds  and  be  deprived  of  the  use  of  his 
money  for  the  ensuing  six  months,  discovering  his  loss  at  that 
time  through  the  fact  that  his  coupons  came  back  unpaid.  Also 
the  plan  results  in  a  very  short  investment  period  for  those  whose 
bonds  are  called  first,  and  an  uncertain  investment  period  for  all 
the  holders  of  the  particular  bonds.  On  the  other  hand,  the  fact 
that  called  bonds  are  usually  purchased  at  a  premium  has  a 
tendency  to  offset  any  trouble  to  which  the  investor  may  be  put 
in  watching  for  the  newspaper  notices  of  calls. 


Ch.  24]  REDEMPTION  OF  BONDS  1251 

The  plan  of  selecting  bonds  for  redemption  by  lot  applies 
equally  as  well  to  debentures,  short-term  notes,  and  other 
obligations.  Bonds  of  clubs,  institutions,  office  buildings,  and 
the  like,  are  frequently  issued  under  this  plan  of  redemption. 

§  238.    Entries  for  Bonds  Redeemed  Before  Maturity 

The  entries  for  bonds  of  the  issuing  company  purchased  and 
held'  by  the  trustee  for  sinking  fund  purposes,  were  set  forth  in 
the  preceding  chapter.  When  the  company,  either  voluntarily 
or  because  of  a  stipulation  in  the  deed  of  trust  requiring  it  so  to 
do,  purchases  bonds  in  the  open  market  or  calls  them  before 
maturity  and  cancels  them,  a  different  principle  is  involved. 

The  security  to  bondholders,  however,  remains  the  same  in 
either  case;  indeed,  from  the  bondholders'  standpoint  the  can- 
cellation of  the  bonds  is  preferable,  since  his  margin  of  security 
automatically  increases  in  proportion  as  the  volume  of  out- 
standing bonds  decreases.  The  trust  agreement  may  stipulate, 
however,  that  as  bonds  are  called  for  redemption  and  canceled, 
certain  modification  of  the  security  held  may  be  made. 

If  no  bond  redemption  fund  were  required  by  the  deed  of 
trust,  or  if  one  were  required  and  the  company  in  addition  to 
its  stipulated  payments  to  this  fund  chose  to  purchase  and  cancel 
other  bonds,  the  entry  at  the  time  of  purchase  would  be  simply: 

First  Mortgage  Bonds $3,000 

Interest  on  Bonds 30 

Premium  on  Bonds  Purchased 150 

To  Cash $3,180 

Purchase  for  cancellation  of  $3,000  of  the  Company's  5% 
bonds  at  105  and  accrued  interest. 

But  if  the  trust  agreement  of  the  Lenox  Iron  Works  called 
for  annual  bond  redemption  instead  of  a  sinking  fund,  and  if 
under  this  agreement  the  trustee  of  the  bond  redemption  fund 
purchased  on  January  i,  1924,  $5o,cxx)  of  bonds2  and  turned 

»C/.  i  231. 


1252  CORPORATE  ACCOUNTING  [Bk.  III- 

them  over  to  the  company  to  be  canceled,  an  entry  would  be 
required  as  follows: 

January  i,  1924 

First  Mortgage  5%  Sinking  Fund  Bonds $50,000 

Premium  on  Bonds  Canceled 1.250 

To  Bond  Redemption  Fund  Cash $51,25^ 

Purchase  for  cancellation  of  $50,000  of  the  Company's  5% 
bonds  at  io2>^  through  the  trustee. 

If  the  trust  mortgage  provides  that  the  fund  shall  be  main- 
tained at  a  given  amount,  the  company  may  be  compelled  to 
reimburse  the  trustee  for  the  premium  payment.  This  premium 
of  $1,250  will  at  the  proper  time  be  closed  into  Profit  and  Loss. 

§  239.    Refunding  Bonds 

As  already  stated,  a  bond  issue  may  be  renewed  or  "funded" 
by  a  new  issue  of  bonds  with  equally  as  good  or  better  security. 
Nearly  all  railroad  bonds  are  issued  with  the  expectation  of 
refunding  at  maturity  and  when  the  company  is  of  unquestioned 
financial  strength  such  refunding  is  looked  upon  with  favor. 

For  illustration  of  the  entries  required  where  bonds  are 
refunded,  we  will  assmne  that  the  first  mortgage  5%  bonds  of 
the  Pleasant  Valley  Electric  Railway  Company  for  $10,000,000 
matured  July  i,  192 1,  and  that  they  were  refunded  by  part  of  a 
new  issue  of  consolidated  first  mortgage  5%  50-year  bonds  for 
$20,000,000.  The  following  entry  is  required  for  the  refunding 
operation : 

July  I,  1921 

First  Mortgage  5%  Bonds  (maturing) $10,000,000 

To   Consolidated   First   Mortgage   5%   Bonds 

(or  Cash) . $10,000,000 

Refunding  of  $10,000,000  first  mortgage  5%  bonds 
due  this  day  at  the  office  of  the  trustee,  the  Barton 
Trust  Company.  The  bonds  have  been  canceled 
and  returned  and  the  mortgage  satisfied  of  record. 

In  cases  such  as  this  the  new  bonds  may  either  be  exchanged 
for  the  old,  as  assumed  above,  or  they  may  be  sold  and  the  cash 
received  be  used  for  redeeming  the  maturing  obligations. 


Ch.  24]  REDEMPTION  OF  BONDS  1253 

§  240.    Redemption  of  Serial  Bondsiiriiiyiiu^j!  loi  zatV^H,    .i[ ' 

Serial  bonds  are  usually  paid  in  annual  instalrtients  of  given 
amounts  beginning  a  few  years  after  the  date  of  issue ;  therefore 
the  redeeming  process  is  a  continuous  feature  after  it  is  once 
started.  Like  other  mortgage  bonds,  serial  bonds  are  usually 
payable  at  the  office  of  the  company's  fiscal  agent  or  at  the  office 
of  the  trustee,  but  in  any  case  the  money  required  for  their 
redemption  is  paid  over  by  the  company  as  the  instalments 
mature. 

Assuming  that  the  first  mortgage  6%  serial  bond  issue  of 
$3,000,000  of  the  Georgian  Paper  and  Pulp  Company  is  payable 
in  instalments  of  $150,000  each  year  beginning  February  i, 
192 1,  and  that  the  date  for  paying  the  first  instalment  is  at  hand, 
the  following  retirement  entry  is  made : 

February  i,  1922  •  .,  ^^hfinff 

First  Mortgage  6%  Serial  Bonds $150,000 

To  Cash $150,000 

Payment  of  Instalment  No.   i  of  the  $.^,000,000  first 
mortgage  serial  6%  bonds. 

As  the  bonds  are  paid  they  are  canceled  and  handed  over  to 
the  company  for  record.  In  place  of  the  above  entry  two 
entries  may  be  substituted  if  desired,  one  crediting  Cash  and 
debiting  the  trustee  as  the  cash  is  paid  over,  and  the  other 
debiting  the  bond  account  and  crediting  the  trustee  as  the  bonds 
are  received  by  the  company. 

Under  the  trust  deed  the  company  has  the  privilege  of  paying 
off  additional  instalments  in  order  of  serial  numbers  (or  the 
reverse  order),  in  advance  of  maturity,  at  103  and  interest.  As 
already  explained,^  the  premium  paid  for  such  redemption  is  in 
turn  closed  into  Profit  and  Loss.  In  that  case  the  entry  differs 
from  the  above  only  with  respect  to  premium  paid,  and  is : 

First  Mortgage  6%  Serial  Bonds $150,000 

Premium  on  Redeemed  Bonds 4.500 

To  Cash $154,500 

(Full  explanation  here.)      ^»j  ,_,j^ 

» J  331. 


1254  CORPORATE  ACCOUNTING  [Bk.  HI- 

§  241.    Entries  for  Convertible  Bonds  ^^^  to  nobqmahail 

n  »  A  convertible  bond  is  one  which  under  prescribed  conditions 
carries  the  right  of  conversion  into  other  securities  of  the  same 
corporation.  These  convertible  bonds  may  be  exchanged  for 
stock  of  the  company  at  a  stated  price,  provided  the  holders 
thereof  care  to  take  advantage  of  the  privilege.  For  instance, 
the  convertible  4/4%  bonds  of  the  American  Telephone  and 
Telegraph  Company  can  be  exchanged  at  par  for  stock  of  the 
company  at  $120  per  share  until  March  i,  1925.  When  the  con- 
vertible bonds  are  issued,  provision  is  of  course  made  so  that  there 
may  be  a  sufficient  amount  of  unissued  stock  or  other  securities 
to  which  the  conversion  privilege  will  apply. 

The  entries  required  to  give  expression  to  such  a  conversion 
are  quite  simple: 

Convertible  Bonds,  etc $ 

To  Unissued  Stock  (or  other  security) $ 

Premium  on  Stock 

(Full  explanation.) 

§  242.    Redemption  of  Collateral  Trust  Bonds 

The  entries  for  the  redemption  of  collateral  trust  bonds  are 
not  different  from  those  for  the  redemption  of  ordinary  mortgage 
bonds,  except  that  the  security  which  had  passed  out  of  the 
company's  possession  at  the  date  of  issue  now  comes  back.  An 
extra  entry  is  required  to  record  this  transfer.  f/i-xyji 

Assuming  that  the  due  date  of  the  Harney  Electric  Conipaiiy's 
$1,000,000  20-year  collateral  trust  5%  gold  bonds,  interest  pay- 
able half-yearly,  has  arrived,  that  they  have  been  paid  by  the 
trustee,  and  that  the  collateral  has  been  released  to  the  company, 
the  entry  required  at  the  time  is : 

.'fno  flvodii  '>fli  ffi" 
July  I,  1936 

Collateral  Trust  5%  Bonds $1,000,000 

To  Cash $1,000,000 

Payment  of  $1,000,000  20-year  5%  collateral  trust 

bonds  matured  this  day  at  the  office  of  the  trustee,    '  '^^  ^^' '  ' ' 
the  Hudson  Trust  Company. 


Ch.  24I  REDEMPTION  OF  BONDS  1255 

If  desired,  this  amount  may  first  be  charged  to  the  trustee, 
if  payment  is  made  by  him,  and  be  followed  by  another  entry 
debiting  the  bond  account  and  crediting  the  trustee.  ,  ^.^ 

The  collateral  security  now  having  been  released  to  the  com- 
pany may  be  recorded  by  the  following  entiy:     ,    ^  ,^. ., 

July  I,  1936      t    \)iu()-r   *r  .  Iff} 

Investments 't^l  •^fi>,-  •  $1,340,000 

To  Pledged  Investments $1,340,000 

Return  of  collateral  pledged  with  the  Hudson  Trust 
Company  as  security  for  $1,000,000  collateral  trust 

bonds,  as  follows:     {Here  list  details  and  values  of  '''^  iii-imqw]\-i. 

stocks  and  bonds  returned.) 

This  returns  the  securities  to  the  Investments  account,  and 
they  are  now  free  for  use  in  other  ways  if  necessary.  The 
explanations  given  above  apply  also  to  secured  short-term  notes 
and  like  obligations. 

§  243.    Redemption  of  Short-Term  Notes 

Short-term  notes  are  either  secured  or  unsecured,  and  as  they 
mature  they  are  paid  like  other  bond  obligations,  and  the  book 
entries  required  are  similar  to  those  for  other  classes  of  bonds. 
If  the  notes  are  secured  by  a  deposit  of  collateral,  an  entry  should 
be  made  as  soon  as  the  collateral  is  returned,  removing  the  col« 
lateral  from  the  Pledged  Collateral  account  and  returning  it  to 
the  Investments  account,  as  in  the  case  of  collateral  trust  bonds. 
Unissued  or  nominally  issued  bonds  of  the  company  that  have 
been  pledged  as  security  for  bank  loans  or  other  obligations, 
should  in  like  manner  be  recorded  in  some  distinguishing  account. 

§  244.    Redemption  of  Equipment  Trust  Bonds  ,  * ;  , . >  ,. , . 

Equipment  certificates  are  usually  issued  in  series,  as  Series 
A,  B,  C,  etc.,  each  being  secured  by  a  given  portion  of  the 
equipment.  As  each  instalment  of  the  certificates  is  paid  by 
the  trustee  out  of  money  supplied  by  the  company,  the  equip- 
ment trust  certificates  are  canceled  and  returned  to  the  company. 
As  soon  as  a  series  is  paid  off,  which  may  require  two  or  three 


I2S6  CORPORATE  ACCOUNTING  [Bk.  m- 

instalmeiits,  the  equipment  thereunder  is  released  to  the  com- 
pany. It  is  then  transferred  from  the  trust  equipment  account 
to  the  free  equipment  account.  Assuming  that  upon  payment 
of  the  first  instalment  of  $1,000,000  of  an  equipment  trust  bond 
issue,  one-fifth  of  the  equipment  held  as  security  is  released  to 
the  company,  it  would  be  reflected  in  the  following  entries,  it 
being  assumed  that  the  released  equipment  is  of  the  value  of 
$2,000,000: 

July  I,  1922 

Equipment  Trust  Certificates $1,000,000 

To  Cash $1,000,000 

First  instalment  of  6%  equipment  trust  certificates 
paid  this  day,  etc. 

'■'  This  entry  is  then  followed  by  a  transfer  entry  somewhat  as 
follows :       '  ^^"^'  *^  •  -  ^mda  flSvIs ■kt: 

Equipment  Cars  (or  Locomotives) $2,000,000 

To  Equipment  Trust  Cars $2,000,000 

For  transfer  of  $2,000,000  of  equipment  released  under ' '-^^l^^^ 
equipment   trust   certificates.     {Full   explanation.)  moJ-Ji"' 

§245.    Redemption  of  Guaranteed  Bonds        -  '  '^  X 'iJ 

Guaranteed  bonds  are  issued,  as  a  rule,  by  subsidiary  or 
affiliated  companies,  and  should  be  redeemed  by  the  issuing 
company.  A  contingent  liability  is,  however,  incurred  by  the 
guaranteeing  company  as  soon  as  the  bonds  are  indorsed,  but  it 
is  not  usual  to  make  any  entry  in  the  books  of  account  at  the 
time.  A  complete  record  of  the  matter  is  of  course  made  in  the 
corporate  minutes.  If  no  entry  is  made  when  the  bonds  are 
indorsed  by  the  company,  then  no  entry  is  necessary  at  their 
maturity  so  long  as  they  are  duly  paid  by  the  issuing  company. 
On  the  other  hand,  if  an  entry  is  made  at  the  beginning,  an  off- 
setting entry  is  required  when  the  bonds  are  paid  by  the  issuing 
company. 

If  the  guaranteeing  company  is  required  to  make  payment 
for  all  or  any  part  of  the  bond  issue,  it  must  then,  of  course,  make 
an  entry  debiting  the  issuing  company  and  crediting  cash,  and 
will  look  to  the  issuing  company  for  reimbursement. 


Ch,  24]  REDEMPTION  OF  BONDS  1257 

§  246.    Bonds  in  Default 

In  case  of  default  in  the  payment  of  bonds,  or  even  in  the 
interest  thereof,  the  trustee  is  usually  empowered  by  the  deed  of 
trust  to  enter  upon  and  take  charge  of  the  mortgaged  property  for 
the  benefit  of  the  bondholders.  In  that  event  the  company  is 
forced  into  bankruptcy,  or  a  receivership,  or  a  reorganization  of 
some  kind,  unless  the  bondholders  consent  to  an  extension  or 
renewal,  or  to  some  other  plan  of  adjustment  that  will  permit  the 
company  to  continue  its  career. 

Bond  obligations  not  met  at  maturity  should  be  removed 
from  the  regular  bond  account  and  credited  to  some  other 
account  that  will  clearly  designate  the  nature  of  the  obligation, 
as: 

Four- Year  Secured  6%  Notes $600,000 

To  Matured  Four- Year  6%  Notes $600,000 

An  account  may  even  be  opened  for  "Defaulted  6%  Notes," 
"Overdue  6%  Notes,"  "Renewed  6%  Notes,"  or  "Extended  6% 
Notes,"  as  the  case  may  require. 


"lo't  yrrxioiq  hov 

";■.    ((;i.tj::;i;;i;^ir")-.   >:  ... 

odt  iiffiTjij  (liv/  {iiiij  Uvji  ■  uj  rujiq  i^rlJo  araoa  oi  lo  ,l£W3! 

.■fiOIBO  <J\  SV  -'■■     ■       '  

!<')/ORTrf    Dl'f   Mnnr!;-'    'rthlJjtBfn    )j;    ?;rrT   ton   r: 


C'O.o  :> 

<:s.o.,cx-'d'?- 

'".-i'.tM. 

,  '0  b'ji)i! 

::/.i 

■-'b,  yj  ~o<r"l  -^rfl' 


Part  V — Corporate  Combinations 


CHAPTER  XXV 
COMBINATION  BY  LEASE i 

§  247.    Leases 

A  common  method  of  securing  control  of  a  competing  concern 
is  to  rent  its  plant  or  property  for  a  term  of  years,  very  much  as 
one  person  would  lease  or  rent  properties  from  another.  This 
plan  is  extensively  used  by  transportation  companies  to  gain 
possession  of  connecting  lines.  By  this  method  the  competition 
of  the  owner  of  the  leased  property  is  eliminated  and  the  lessee 
company  obtains  valuable  connections  and  a  going  business  with- 
out incurring  the  cost  and  delay  of  construction.  The  lessor,  on 
the  other  hand,  besides  being  relieved  of  the  operation  of  its 
properties,  may  receive  more  satisfactory  returns  in  the  form  of 
rentals.  The  lessor  company  continues  to  maintain  its  separate 
existence,  but  its  activities  consist  merely  in  receiving  its  assets 
and  disbursing  its  income  in  the  form  of  expenses  and  dividends. 

Nearly  all  leases  require  the  operating  company  to  pay  taxes, 
insurance,  and  up-keep  expenses  of  the  leased  properties,  and  to 
undertake  other  obligations  of  a  more  or  less  rigid  nature.  In 
mining  operations  the  terms  of  the  lease  usually  require  the  pay- 
ment of  a  certain  amount  per  ton  on  the  output  of  ore,  with  a 
specified  minimum  output,  while  in  the  case  of  a  railroad  or 
similar  property  the  payment  is  likely  to  be  a  specified  rental  or 
a  guaranteed  dividend  on  the  lessor's  outstanding  stock,  with' 
perhaps  some  participation  in  profits. 


»SeeBookI,  »SS7.  ';"       •■     ''I  ■(  i'JU  Jvi^vJ'-j  jl' JV/.fr.,l 

I2S9 


l26o  CORPORATE  ACCOUNTING  [Bk.  HI- 

The  lessor  is  given  access  to  the  accounts  and  records  of  the 
lessee  as  far  as  they  relate  to  the  leased  property  during  the  life 
of  the  lease.  Leases  of  large  properties  are  usually  matters  of 
public  record  and  the  details  thereof  accessible  to  the  public. 

§  248.    Entries  for  Property  Leased 

Leased  properties  continue  in  the  ownership  of  the  lessor  and 
must  be  returned  at  the  expiration  of  the  lease.  Where  the 
properties  taken  over  are  of  such  a  nature  that  they  are  merged 
and  perhaps  consumed,  as  for  instance,  equipment  and  supplies, 
the  lessee  usually  absorbs  them  into  its  own  accounts  and  at  the 
expiration  of  the  lease  either  pays  for  them  in  cash  or  returns 
other  equivalent  assets.  The  assets  so  absorbed  may  be  charged 
to  the  property  accounts  already  in  the  ledger  and  credited  to  the 
lessor,  or  else  be  charged  to  separate  accounts. 

The  record  of  leased  property  stands  as  entered  until  the  lease 
expires,  while  repairs  and  minor  improvements  on  the  property 
are  usually  charged  to  operating  expenses.  Permanent  improve- 
ments would  usually  be  charged  against  the  lessor,  the  matter 
being  determined  by  the  terms  of  the  lease.  On  the  balance 
sheet,  leased  properties  and  the  owner's  credits  may  appear 
among  the  assets  and  liabilities  as  cancelling  amounts,  or  may  be 
entered  on  both  sides  "in  short,"  in  order  to  indicate  their  relation 
to  other  items;  or  they  may  be  mentioned  in  a  footnote  to  the 
balance  sheet,  or  even  be  omitted  entirely.  If  they  are  merged 
and  included  in  the  lessee's  properties,  a  footnote  may  not  be 
necessary,  but  the  lessor's  account  must  be  included  in  the 
liabilities. 

Corresponding,  though  reverse,  entries  should  be  made  on  the 
books  of  the  lessor  for  the  properties  conveyed  by  the  lease,  in 
case  it  is  decided  to  make  book  entries  at  all.  It  is  sometimes 
considered  good  practice  to  debit  the  leasing  company  and  credit 
the  property  leased.  Such  an  entry  might  be  suitable  where 
only  a  part  of  the  property  is  conveyed,  in  order  to  distinguish 
between  properties  leased  and  properties  operated. 


Ch.  25]]  COMBINATION  BY  LEASE  IJ^O^ 

§  240.    Entries  for  Guaranties  ,  _^ 

When  guaranties  of  interest  or  dividends  are  included  in  the 
terms  of  a  lease,  book  entries  are  not  absolutely  necessary  to 
record  the  contingent  liability  incurred ;  and  yet  it  is  good  business 
practice  so  to  record  such  liabilities  as  to  keep  the  obligation 
continually  before  the  stockholders. 

The  Pennsylvania  Railroad  Company  does  not  enter  such 
guaranties  in  its  ledger  accounts,  but  in  its  annual  report  a  com- 
plete list  of  them  is  included.  If  book  entries  are  made  for  guar- 
anties, they  must  obviously  be  for  record  only,  because  as 
contingent  entries  they  would  offset  each  other  in  the  accounts. 
In  the  annual  balance  sheet  they  should  be  exhibited  either 
among  the  accounts  (in  short  or  otherwise),  or  as  a  footnote 
thereto. 

§  250.    Lease  Terms 

To  illustrate  the  entries  required  when  properties  are  leased 
by  a  corporation,  assume  that  the  Vermont  Mining  and  Smelting 
Company  has  leased  a  mine  from  the  Union  Mining  Company  for 
a  term  of  30  years.  The  properties  taken  over  comprise  the  mine, 
valued  at  $400,000,  buildings  and  equipment  valued  at  $30,000, 
and  supplies  valued  at  $8,500.  At  the  termination  of  the  lease 
the  properties  are  to  be  returned  to  the  Union  Mining  Company 
in  as  good  condition  as  when  taken  over,  except  as  to  the  ore 
mined.  The  Vermont  Mining  and  Smelting  Company  agrees  to 
pay  as  rental  for  the  mine  a  guaranteed  annual  dividend  of  4%  on 
the  Union  Mining  Company's  capital  stock  of  $1,000,000  during 
the  life  of  the  lease,  and  a  royalty  of  10  cents  per  ton  for  every 
ton  of  ore  mined. 

The  Vermont  Mining  and  Smelting  Company  leases  also  a 
short  railroad  and  its  equipment,  valued  at  $3,000,000,  of  the 
Wilson  Transportation  Company.  The  lease  is  to  run  for  30 
years,  at  the  end  of  which  time  the  property  is  to  be  returned  in 
good  condition.  The  lessee  is  to  guarantee  during  the  existence  of 
the   lease   an   annual   dividend   of    6%  on   the   capital    stock 


1262  CORPORATE  ACCOUNTING  [Bk.  III- 

($2,000,000)  of  the  lessor  company  as  rental,  and  is  in  addition 
to  pay  all  taxes,  improvement  expenses,  and  interest  on  the  out- 
standing bonds,  and  to  make  all  needed  replacements.  , 

The  Vermont  Company  finds  it  necessary  to  expend  for  im- 
provements on  the  Union  Mining  Company  property  $100,000, 
and  on  the  railway  $400,000;  and  in  order  to  secure  funds  for 
this,  the  company  issues  $500,000  of  short-term  notes  payable 
$100,000  each  year  for  5  years  and  drawing  6%  interest.  The 
notes  are  secured  by  a  deposit  with  the  trustee  of  $500,000  stock 
of  the  Lone  Ridge  Mines  Company,  a  successful  subsidiary.  The 
notes  are  sold  at  95  to  a  banking  firm. 

The  output  of  ore  from  the  leased  mine  during  1921  is  122,000 
tons,  and  the  net  income  therefrom  to  the  lessee  after  paying 
operating  and  repair  expenses  is  $85,000,  out  of  which  the  rental 
must  be  paid.  The  Union  Mining  Company  is  able,  out  of  the 
rental  received,  to  apply  3%  of  the  value  of  the  mine  leased  on 
its  extinguishment  fund  and  also  to  apply  to  the  dividend  fund 
2K%  on  its  capital  stock. 

The  operations  of  the  leased  railway  for  the  year  are  shown  in 
the  following  summary :  .&.  1  iM\  t 

Gross  Freight  Earnings.  ..  ..;'.j'.... ....'.;  ..iV.'..i'.\;  1 .. .  $750,000 

Operating  Expenses •;';0.  .*/!  \ .'.'. car.  .^.?."} i:.  i . .  $230,000 

Replacements  and  Repairs 145,800 

Improvements,  etc.,  charged  off 14,000 

Guaranteed  Dividend  to  Lessor 1 20,000 

j:o          Total  DeductionS(vfMi^>4l*J'>lHfi»^«^«3Si•,|5•»fHm•5.ffeJ•^!0^•^l^^         SOQ.Soo 
Net  Earnings $240,200 

The  accounting  procedure  to  be  considered  in  connection  with 
the  foregoing  transactions  involves  entries  for : 

1.  Lease  of  the  mine  and  equipment. 

2.  Lease  of  the  railway  and  equipment. 

3.  Issue  of  notes  and  expenditures  for  improvements  on 

leased  properties. 

4.  Distribution  of  rentalsof  leased  properties  at  end  of  year. 


Ch.  25]  COMBINATION  BY  LEASE  1 263 

5.  Union  Mining  Company  at  the  beginning  and  end  of  the 

first  year. 

6.  Wilson  Transportation  Company  at  the  end  of  the  year's 

operations  under  the  lease,     ^a***^  loi  e^' 

§251.    Entries  for  Lease  of  Mine  ', 

It  is  natural  to  suppose  that  the  lessee  will  aim  to  secure  from 
the  mine  during  the  life  of  the  lease,  all  of  its  ore,  unless  the  lease 
contains  some  limitations.  The  outlay  for  improvements  and 
extensions  made  by  the  lessee  must  be  written  off  during  the  life 
of  the  lease  as  operating  expenses,  excepting  as  to  any  movable 
equipment  belonging  to  the  lessee.  The  mine  buildings  and 
equipment  are  valued  at  $30,000,  and  must  be  returned  when  the 
lease  expires.  The  supplies  taken  over  are  valued  at  $8,500,  and 
must  be  made  good  when  the  lease  expires.  Assuming  that  the 
Vermont  Company  decides  to  bring  these  properties  into  its  own 
accounts,  the  following  entry  is  made : 

Leased  Properties  of  Mining  Company $438,500 

To  Union  Mining  Company  for  Leased  Properties. . .  $438,500 

For  mine,  valued  at  $400,000,  buildings  and  equipment  at 
$30,000,  and  supplies  at  $8,500,  taken  over  under 
30-year  lease,  to  be  returned  at  expiration  thereof. 

It  will  be  seen  that  one  entry  offsets  the  other.  They  must 
stand  thus  in  the  ledger  accounts  until  the  lease  matures  and 
then  be  eliminated  by  a  counterbalancing  entry- al^ami   ad     '; 

Under  an  alternative  plan  that  is  also  good  practice,  ho  entry 
in  the  books  is  necessary  for  the  leased  properties,  save  the  record 
of  the  transaction  in  the  minutes  of  the  directors  and  stock- 
holders. rujnlinj(j/M    )fi  ! 

The  improvements  on  the  mining  property,  costing  $160,000, 
should  be  charged  to  "Improvements  Account  of  Union  Mine," 
and  then  written  off  one-thirtieth  each  year  during  the  life  of  the 
lease.  Any  improvements  of  succeeding  years  may  be  spread 
over  the  remaining  years  of  the  lease's  existence.  Expenditures 
or  the  up-keep  of  buildings  and  equipment,  replacements   and 


1264  CORPORATE  ACCOUNTING  [Bk.  III- 

supplies,  should  be  charged  Hke  the  regular  company  expenses  to 
certain  operating  expense  accounts. 

§  252.    Entries  for  Lease  of  Railway 

The  same  general  accounting  procedure  may  be  followed  for 
the  leased  railway  property  as  for  the  leased  mine.  Both  road 
and  equipment  must  of  course  be  kept  in  good  condition  during 
the  tenure  of  the  lease.  The  value  of  the  road  taken  over  may 
or  may  not  be  entered  upon  the  books  of  the  lessee,  but  it  is  ad- 
visable to  enter  the  equipment. 

Up-keep  and  operating  expenses  are  to  be  considered  as 
charges  against  current  operations,  as  is  the  guaranteed  6%  divi- 
dend of  $120,000  per  year.  All  expenditures  for  extensions  or 
improvements,  however,  must  obviously  be  spread  over  the 
period  of  the  lease  if  their  normal  life  will  extend  to  the  date  of 
expiration  of  the  lease;  otherwise  they  will  be  depreciated  at  the 
usual  rates.  In  either  event  they  will  be  completely  written  off 
when  the  lease  expires. 

Leased  Equipment  of  Wilson  Transportation  Company $ 

To  Wilson  Transportation  Company,  Leased  Equipment  $ 

For  equipment  taken  over  under  lease,  to  be  returned  at  the 
expiration  thereof  (Juil  details). 

It  is  probable  that  rolling  stock  and  any  other  properties  of 
the  lessee  company  used  in  the  operation  of  the  railroad  property 
will  be  transferred  to  the  leased  road,  and  then  taken  back  at 
the  expiration  of  the  lease. 

§  253.    Entries  for  Improvements  and  Note  Issue 

The  expenditures  for  improvements  on  leased  properties 
should  be  charged  against  the  improvement  accounts  of  the  re- 
spective properties  in  order  to  keep  the  different  expenditures 
separate  and  distinct.  The  security  back  of  the  note  issue  should 
be  listed  separately  in  the  explanation  of  the  journal  entry,  or 
else  a  notation  should  be  made  stating  the  disposition  of  the  col- 
lateral.   Everything  must  be  so  recorded  as  to  be  clearly  under- 


Ch.  25]  COMBINATION  BY  LEASE  1265 

stood.  Interest  on  the  notes  and  the  amortization  of  discount 
must  be  charged  each  year  as  operating  expenses  of  the  business. 
The  recording  entries  may  be  as  follows:  ! '         •! 

Cash $475,000 

Bond  Discount 25,000 

To  Collateral  Serial  Notes $500,000 

For  sale  to  bankers  at  95  of  $500,000  of  short-term  6% 
notes,  payable  $100,000  each  year  for  5  years,  secured 
by  a  deposit  with  the  trustee  of  $500,000  stock  of  the 
Lone  Ridge  Mines  Company. 

Pledged  Securities  for  Serial  Note  Issue $500,000 

To  Stocks  of  Other  Companies $500,000 

{Full  explanation  here.) 

Union  Mine  Improvements $100,000 

Wilson  Railway  Improvements 400,000 

To  Cash $500,000 

{Ftdl  explanation' here.)  - "^    *"  ■  ^  ■ 

§  254.    Adjusting  Entries  at  End  of  First  Year  ^j  ynfiofflai) 

The  entries  which  follow  indicate  adjustments  at  the  end  oi 
one  year  on  the  books  of  the  Vermont  Mining  and  Smelting  Com- 
pany. Only  such  entries  are  shown  here  as  affect  the  accounts  of 
the  properties  leased,  interest  on  bonds,  etc.,  being  omitted. 

December  31,  192 1 

Union  Mine  Operation $  3,500.00! 

Wilson  Railway  Operation 14,000.00 

To  Union  Mine  Improvements $  3i333-33 

Wilson  Railway  Improvements .'l-.'.''.'. . .'""'  '''  I3»333'33 

Discount 833.34 

To  write  off  1/30  of  improvements  and  discount  on  notes 

in  proportion  to  the  improvements,  1/5  and  4/5:  ,   ii..-;."!,  / 

Improvements  cost $500,000  "o  Vihm  \ti  vs'Mw'A 

Discount 25,000 

(i-J;  ■ 

Union  Mine  Operation $52,200 1  oX 

To  Union  Mining  Company $53,200 

For  royalties  and  guaranteed  dividends  for  192 1  on  leased 
mine,  as  per  terms  of  lease,  being  10  cents  per  ton  on 
122,000  tons  ore  mined,  $12,200,  and  4%  dividend  OA  ^o  «fto)  . 
$1,000,000  of  capital  stock,  $40,000.  ifa^Divib  inoln 


1206  CORPORATE  ACCOUNTING  [Bk.  IH- 

Wilson  Railway  Operation.  ;.'.(■.  lilt  X't'-, $120,000 

To  Wilson  Transportation  Company $130,000 

For  application  of  guaranteed  6%  dividend  on  Company's  . . 

outstanding  stock  after  payment  of  taxes,  improve-  "»     D1039i  tin  I 

ments,  operating  repairs,  etc.,  according  to  the  terms  of  rfscO 

the  lease.    6%  on  $2,000,000  capital  stock^$  120,000.  ,<y.,'(J  f  .  JT 

Union  Mining  Company $  52,200 

Wilson  Transportation  Company. 120,000 

To  Cash ; $172,200 

For  payment  of  royalties  and  dividends  for  leased  proper- 
ties, per  statement. 

Union  Mine  Operation .t'/V;  A''.". . .    $  29,300 

Wilson  Railway  Operation .'.  .W  ^.J'l'i'.V  '  240,200 

To  Profit  and  Loss !^.^^**  ''  $269,500 

For  net  earnings  after  paying  royalties  and  guaranteed 
dividends,  per  agreement. 

§  255.    Entries  for  Union  Mining  Company 

Entries  may  or  may  not  be  made  on  the  books  of  the  lessor 
company  to  show  the  execution  of  the  lease.  The  following  en- 
tries are  suggestive,  though  a  different  plan  might  be  followed. 
Only  the  accounts  affected  by  the  lease  are  included  in  the  entries, 
no  attention  being  given  to  accruals  or  intermediate  entries.        { 

Entry  when  lease  is  made:  '4     4^ 

January  i,  1921 
Properties  Leased  to  Vermont  Mining  and  Smelting  Com-  „      ., ,      .     , 

•^  00  -1,70  rtnl!/    iioi" 

pany $438,500 

To  Mining  Property $400,000 

Buildings  and  Equipment ,,.,.,.,. 30,000 

Supplies 8,500 

For  lease  of  properties  to  Vermont  Mining  and  Smelting  ..       „, 

Company,  as  per  terms  of  the  lease  (full  explanation.) 

Entries  at  end  of  first  year: 

December  31,  192 1 

Cash $52,200 

To  Income $52,200 

Income  from  mine  and  properties  leased  to  Vermont 
Mining  and  Smelting  Company,  as  per  terms  of  the 
lease: 

122,000  tons  of  ore  mined,  at  10  cents  per  ton. $12, 200 
Guaranteed  dividend  on  capital  stock 40,000 


Ch.  2s]  COMBINATION  BY  LEASE  1267 

Income $52,200 

To  Extinguishment  of  Mines  Reserve $12,000 

Dividends  Payable 25,000 

Profit  and  Loss \/.\.'.V'- 1  •'•  •  • 15,200 

For  disposition  of  income  from  leased  properties. 

§  256.    Entries  for  Wilson  Transportation  Company 

Since  all  of  the  property,  roadbed,  and  equipment  of  the  rail- 
way has  been  leased  to  the  Vermont  Mining  and  Smelting  Com- 
pany, it  is  apparent  that  no  separate  entries  are  necessary  in  the 
accounts  of  the  Wilson  Transportation  Company.  The  property 
accounts  stand  as  they  are  on  the  books,  representing  as  they  do 
the  investment  therein.  At  the  end  of  the  year,  however,  entries 
must  be  made  in  the  books  to  record  the  dividends  guaranteed 
by  the  Vermont  Mining  and  Smelting  Company. 

j^friNori   :  December  31,  i92rar,qfaoo  j^nibiof!  hn*  gni 

Cdsh. .'. .i.i-.-.n ....... vi.'ilji^.faoa .   $120,000  ■ " 

To  Income ,^t,j .,,..v,..  .j* .,»  j  ,^ .  $120,000 

Being  guaranteed  income  from  road  and  equipment  leased 
to  Vermont  Mining  and  Smelting  Company,  as  per 

terms  of  the  lease.  :j|.u.;   ^.lU  ,::>.)^     u;   \:..:»mi.i       . 

Income $120,000 

To  Dividends  Payable ./*,?. .'?  V.'.  .'P. . .  $120,000 

For  dividend  guaranteed  by  the  lessee,  Vennont  Mining. ioi J tltrj 
and  Snu^ltj^ig  fompany,  payable  January  25,  1922.    -^^     : 

'io-oj  uj  •/Hi'w'r.ru  -u:  .■•'■  :,. 

".T^woqloo:  irisn  niodw  nr  eiyblotUDoJ-^  '»rlj 


■M  vd  bolhii 
d  b^flailq 

:  •»iBio}D9ii<I  ?Mihrfx>hMnI  yd  flohBaidmoD    .Qr't  ^ 


CHAPTER  XXVI 
HOLDING  COMPANIES!  ^     .^  ^     ^      • 

§  257.    Definition  of  Holding  Companies 

While,  strictly  speaking,  a  holding  company  is  a  corporation 
created  for  the  purpose  of  dealing  in  the  securities  of  other 
corporations,  yet  if  the  state  laws  permit,  any  company  whose 
charter  so  provides  may  purchase  the  stocks  and  bonds  of  other 
companies.  In  some  cases  where  a  consolidation  of  two  or 
more  companies  is  desired,  one  of  the  consolidating  companies, 
possessing  a  liberal  charter,  may  serve  the  purpose  of  both  operat- 
ing and  holding  company.  For  accounting  purposes  a  holding 
company  may  be  considered  as  one  which  owns  or  controls  the 
stock  of  another  and  is  therefore  able  to  direct  its  policies. 

§  258.    Manner  of  Effecting  Control 

Ownership  of  a  bare  majority,  sometimes  even  less  than 
half,  of  the  stock  of  the  competing  companies  is  sufficient  for 
effective  control.  When  the  holding  company  itself  owns  less 
than  a  majority  of  the  stock  of  the  subsidiary,  control  is  usually 
maintained  through  the  apathy,  or  inability  to  co-operate,  of 
the  stockholders  in  whom  rests  the  "balance  of  power."  Some- 
times it  is  secured  and  maintained  through  ownership  of  addi- 
tional stock  by  interests  which  themselves  control  or  are  con- 
trolled by  the  holding  company.  Control  is  actually  accom- 
plished by  selecting  directors  who  will  pursue  the  desired  pohcies. 

§  259.    Combination  by  Interlocking  Directorates 

Combinations  may  be,  and  often  are  effected  by  means  of 
interlocking  directorates.     To  accomphsh  such  a  result  the  same 


>  See  also  Book  I,  Ch.  LVII,  "Holding  Companies,"  and  Book  II,  {{  42-49. 

1268 


Ch.  26]  HOLDING  COMPANIES  1269 

interests,  or  interests  working  in  harmony,  must  own  a  majority 
of  the  stock  of  each  of  the  companies  controlled.  Under  this 
method,  either  the  same  men  appear  as  directors  of  the  different 
corporations  to  be  controlled,  or  men  representing  the  interests 
which  control  the  allied  corporations  are  so  effectively  distributed 
through  the  various  boards  of  directors  as  to  control  the  corporate 
operations.  Each  company  is  to  all  intents  and  purposes  a 
separate  and  independent  company,  the  control  exercised  through 
its  board  of  directors  not  affecting  its  status;  yet  all  act  in 
harmony. 

Combination  by  interlocking  directorates  does  not  interest 
the  accountant  except  as  he  may  be  called  upon  to  prepare  a 
consolidated  balance  sheet  for  the  companies  controlled^  or  show 
the  relationship  of  these  companies  through  their  stockholdings. 

§  260.    Status  of  the  Subsidiary  Company 

The  sale  of  the  stock  of  a  company  to  a  holding  company  in 
part,  or  even  in  whole,  does  not  necessarily  affect  its  accounting, 
save  as  to  the  record  of  stock  transferred.  Nor  is  its  legal  status 
changed  in  any  way,  whether  or  not  it  becomes  a  subsidiary 
absolutely  under  the  control  of  the  holding  company.  The 
most  notable  example  of  holding  and  subsidiary  companies 
is  perhaps  found  in  the  case  of  the  United  States  Steel  Corpora- 
tion, which  is  not  an  operating  company.  All  dividends  de- 
clared by  the  constituent  or  operating  companies  are  paid  to  their 
own  stockholders;  and  the  holding  company,  ^though  controlling 
these  constituent  companies,  benefits  by  such  dividends  only  as 
a  stockholder  and  to  the  extent  of  its  holdings  of  their  stock. 

§  261.    Accounting  Procedure  of  Holding  Company 

The  example  which  follows  shows  the  accounting  procedure 
involved  where  a  corporation  has  been  organized  for  the  sole 
purpose  of  purchasing  the  stocks  and  bonds  of  other  companies. 

The    Karlow    Manufacturing    Company    was    incorporated 


sSee  Ch.  XXXIV,  -Consolidated  Statements." 


1 270  CORPORATE  ACCOUNTING  [Bk.  IH- 

July  I,  1 92 1,  for  the  purchase  of  stocks  and  bonds  of  other 
established  companies  as  a  means  of  providing  income  and  of 
harmonizing  conflicting  interests.     The  capital  stock  is  $1,000,- 

000.  composed  of  10,000  shares  of  the  par  value  of  $100  each, 
and  $950,000  of  this  capital  stock  has  been  subscribed  and  paid 
in.  Incorporating  expenses  amount  to  $10,000.  The  proceeds 
from  the  stock  subscriptions  have  been  used  for  the  purchase  of 
securities  as  of  July  i,  1 921,  as  follows: 

1.  $100,000  of  5%  first  mortgage  bonds  of  the  Vulcan  Iron  Works  at  95 

and  accrued  interest  for  three  months $    96,250 

2.  $200,000  of  refunding  5%  first  mortgage  bonds  of  the  Rapid  Transit 

Corporation  at  98  and  accrued  interest  for  three  months 198,500 

3.  2,000  shares  of  7%  cumulative  preferred  stock  of  the  Longworth 

Ste«l  Company  at  105,  ex-dividend 210,000 

4.  500  shares  of  6%  preferred  stock  of  the  Brownson  Trading  Company 

at  96  and  accrued  dividend  for  six  months  due  this  day 49,500 

5.  3,000  shares  of  common  stock  of  the  Rockway  Iron  Mining  Company 

at  par,  payable  one-half  down  and  the  balance  in  three  months .  .        300,000 

6.  1,000  shares  common  stock  of  the  Delaware  River  Power  Company  in 

exchange  for  a  similar  number  of  shares  of  this  Company 100,000 

$954,250 

This  requires  an  immediate  cash  expenditure  of  $714,250  for 
the  first  four  items  in  the  above  list  of  securities  purchased, 
totaling  $554,250,  plus  a  payment  of  $150,000  on  the  fifth  item 
and  $10,000  for  expenses  of  incorporation.  Stock  to  the  amount 
of  $100,000  must  also  be  issued  for  the  sixth  item.  This  leaves 
$135,750  of  cash  on  hand  toward  the  final  payment  of  $150,000 
on  the  fifth  item.  The  balance  of  $14,250  will  be  met  out  of 
receipts  of  income  during  the  first  three  months,  or  if  these 
should  fall  short  after  the  payment  of  operating  expenses  in- 
curred during  that  period,  a  short-time  loan  could  be  made. 

Dividends  and  interest  received  for  the  six  months'  period 
ending  December  31,  1921,  amount  to  $27,000;  bond  interest 
accrued  amounts  to  $3,750;  and  accrued  cumulative  dividends, 
to  $1,500.  The  operating  expenses  for  this  period  aggregate 
$2,800.     A  dividend  of  2%  on  the  company's  stock,  payable 


Ch.  2b\  HOLDING  COMPANIES  1 2  71 

January  15,  1922,  is  declared  by  the  directors  at  their  meeting  on 
December  31,  1921.  All  investments  are  to  be  carried  on  the 
books  at  the  purchase  price.  The  incorporating  expenses  are  to 
be  written  off  over  a  period  of  ten  years. 

§  262.    Accounting  Requirements 

The  entries  to  record  properly  the  transactions  of  this  example 
are  simple  and  need  not  be  set  out  in  full.  The  procedure  and 
book  records  required  at  the  time  of  incorporation  have  already 
been  fully  explained.  When  stocks  of  other  companies  are  pur- 
chased, it  is  customary  to  debit  the  cost  price  to  some  suitable 
account,  as  "Investments,"  "Stock  Investments,"  or  "Stocks  of 
Other  Companies."  A  like  procedure  is  followed  in  the  purchase 
of  bonds  of  other  companies,  substituting  the  word  "Bond"  for 
"Stock."  Sometimes  both  stocks  and  bonds  are  included  in  one 
account,  but  when  this  is  done  a  special  record  is  kept  to  show 
the  details  of  the  various  securities.^ 

As  has  been  stated,^  dividends,  even  on  preferred  stock  with 
a  fixed  dividend  rate,  become  an  actual  liability  only  at  the  time 
of  declaration  and  should  not  be  entered  as  an  accrual.  Com- 
panies such  as  this,  however,  frequently  accrue  such  dividends 
receivable,  feeling  that  their  investments  are  sound  and  will 
certainly  pay  the  dividend.  Such  accrued  dividends  should,  if 
entered,  be  carried  in  an  Accrued  Dividends  account.  Interest 
on  bonds,  however,  does  accrue  de  diem  in  diem  and  its  accrual 
is  unquestionably  a  proper  practice.  It  should  be  carried  in  an 
Accrued  Bond  Interest  Receivable  account.  The  income  from 
such  investments  may  be  credited  to  a  general  "Income"  account, 
or  separately  to  suitable  accounts  which  distinguish  between 
stock  dividends  and  bond  interest. 

The  income  and  expenditures  and  the  resultant  assets  and 
liabilities  of  this  company  at  the  close  of  the  first  half-year  are 
reflected  in  the  accompanying  income  account  and  balance  sheet: 


•See  IS  112,  113. 
«See8  u6. 


1272 


CORPORATE  ACCOUNTING 


[Bk.  ni- 


Harlow  Manufacturing  Company 

Income  Account 

For  Stx  Months  Ended  December  31,  1921 


Debits 

Credits 

July  I,  1921 

December  31,  192 1 

Bond  Interest  Accrued 

$  3.750 

Preferred  Dividends  Received 

$  8,500 

Dividends  Accrued 

1,500 

Preferred  Dividends  Accrued. 

1,500 

December  31,  1921 
Balance      (income      for  >    six 

27,000 

Bond  Interest  Received 

Bond  Interest  Accrued 

Dividends 

7,500 

3,750 

11,000 

months) 

Income  brought  down 

$32,250 

$32,250 

General  Expenses 

$2,800 

$27,000 

Incorporating  Expenses  Writ- 

ten Off  

1,000 
23,200 

Balance 

Net  Income  for  period 

$27,000 

$27,000 

$23,200 

Balance  Sheet,  December  31,  1921 
(End  of  first  six-month  period) 


Assets 

Cash  on  Hand 

Investments: 

Bonds  of  Other  Companies 
Stocks  of  Other  Companies 

Bond  Interest  Accrued 

Dividends  Accrued 

Incorporation  Expenses,  Bal- 
ance  


$     9,950 

291,000 

658,000 

3,750 

1,500 

9,000 
$973,200 


Liabilities 


Capital  Stock: 
Authorized.  . 
Unissued 


$1,000,000 
50,000 


Outstanding 

Dividend    No.    i,    payable 

January  15,  1922 

Undivided  Profits 


19,000 
4,200 

$973,200 


§  263.     Operating  Company  Purchasing  Controlling  Interest 

In  the  following  example  the  purchasing  company  is  itself 
actually  engaged  in  operating  its  plants,  but  by  the  purchase  of 


Ox.  26] 


HOLDING  COMPANIES 


1273 


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1274 


CORPORATE  ACCOUNTING 


[Bk.  in- 


stock  it  secures  control  of  a  company  engaged  in  producing  an 
article  needed  by  it  in  the  manufacture  of  railway  equipment. 
This  is  a  very  common  form  of  holding  company. 

The  United  Equipment  Company  has  purchased  $1,500,000 
of  the  outstanding  stock  of  the  Nelson  Car  Wheel  Company  at 
105,  ex-dividend.  As  payment  therefor  it  is  to  give  $1,000,000 
of  its  unissued  common  stock  at  125,  $150,000  of  its  unissued 
preferred  stock  at  no,  and  the  balance  in  cash.  The  financial 
statement  of  the  Nelson  Car  Wheel  Company  is  shown  on  the 
preceding  page.  The  balance  sheet  of  the  United  Equipment 
Company  is  as  follows : 

United  Eqihtment  Company 
Balance  Sheet,  July  i,  1921 


Assets 

Property,  Plants  and 
Equipment $8,324,500 

Inventories  of  Stock  and 

Material 3,240,800 

Investments  in  Stocks  and 
Bonds  of  Other  Com- 
panies          2,160,000 

Cash  on  Hand  and  in 
Banks 895,940 

Accounts  Receivable.  .  .  .         2,560,300 

Notes  and  Loans  Receiv- 
able          1,343,400 

Sinking     Fund     Deposit 

with  Trustee 326,900 

Other  Assets 857,190 


$19,709,030 


Liabilities 

Capital  Stock — Preferred      $4,000,000 

(Authorized     $5,000,000) 

Capital   Stock — Common        7,000,000 

(Authorized  $10,000,000) 

First   Mortgage    5%    20- 
Year  Bonds,  Outstand-  . 
ing 2,500,000 

(Authorized     $5,000,000) 

Notes  and  Bank  Loans.. .         1,680,000 

Accounts  Payable 1,740,300 

Accrued  Interest,  Taxes, 

etc 172,100 

Dividends  for  Half- Year 
Unpaid 420,000 

Sundry  Reserves 996,630 

Surplus 1,200,000 


$19,709,030 


The  points  of  interest  in  the  illustration  are  the  entries  on 
the  books  of  the  United  Equipment  Company  for  the  purchase 
of  stock,  and  the  entries  on  the  books  of  the  Nelson  Car  Wheel 
Company.     These  entries  are  shown  on  the  following  pages. 


Ch.  26]  HOLDING  COMPANIES  12) 5 

§  264.    Entries  on  Books  of  Purchasing  Company 

The  only  entries  on  the  books  of  the  United  Equipment 
Company  are  in  the  accounts  relating  to  capital,  cash,  invest- 
ments, and  premium.  The  premium  of  $75,c>oo  on  stock  pur- 
chased is  included  in  its  cost  and  charged  to  Investments,  thus 
reflecting  as  nearly  as  possible  the  market  value  of  the  stock. 

Investments  in  Subsidiary  Companies $1,575,000 

To  Stockholders  of  Nelson  Car  Wheel  Company. .  $1,575,000 

For  purchase  of  15,000  shares,  par  value  $1,500,000, 
of  the  capital  stock  of  the  Nelson  Car  Wheel  Com- 
pany at  105,  to  be  paid  for  as  follows: 
10,000  shares  common  stock  at  125.  . . .  $1,250,000 

1,500  shares  preferred  stock  at  no 165,000 

Cash  for  the  balance '. 160,000 

Total  investment $1,575,000 

Stockholders  of  Nelson  Car  Wheel  Company $1,415,000 

To  Capital  Stock — Common $1,000,000 

Capital  Stock — Preferred 150,000 

Premium  on  Stock  Sale 265,000 

For  issue  of  stock  to  the  vendors  of  the  Nelson  Com- 
pany stock,  as  above. 

Stockholders  of  Nelson  Car  Wheel  Company $160,000 

To  Cash *i6o,ooo 

For  settlement  of  balance  on  stock  purchased  of 
sundry  stockholders. 

A  more  conservative  practice  would  consider  that  the  stock 
of  the  Nelson  Car  Wheel  Company  cost  only  the  par  of  the 
stock  issued  for  it  plus  the  amount  of  cash  paid,  or  in  other  words 
that  the  premium  was  the  result  of  merely  a  trading  valuation. 
In  this  case  the  entries  would  be : 

Investments  in  Subsidiary  Companies $1,310,000 

To  Stockholders  of  Nelson  Car  Wheel  Company..  $1,310,000 

Stockholders  of  Nelson  Car  Wheel  Company $1,150,000 

To  Capital  Stock — Common $1,000,000 

Capital  Stock — Preferred 150,000 

Stockholders  of  Nelson  Car  Wheel  Company.  •. $160,000 

To  Cash $160,000 


1276  CORPORATE  ACCOUNTING  [Bk.  III- 

As  a  result  of  the  above  entries,  the  cash  of  the  purchasing 
company  is  reduced '  to  $735,940,  investments  increased  to 
$3,470,000,  outstanding  common  stock  increased  to  $8,000,000, 
and  outstanding  preferred  stock  increased  to  $4,150,000.  All 
other  items  in  the  balance  sheet  remain  as  previously  stated. 
New  certificates  of  stock  must  now  be  issued  to  the  selling  stock- 
holders of  the  Nelson  Car  Wheel  Company.  Suitable  entries 
must  also  be  made  in  the  official  records  of  the  company,  com- 
prising the  minute  book,  stock  register,  and  stockholders  ledger. 

§  265.    Entries  on  Books  of  Selling  Company  '^ 

No  entries  for  the  sale  of  its  stock  are  required  on  the  books 
of  account  of  the  Nelson  Car  Wheel  Company.  The  sale  was  a 
personal  matter  v/ith  the  stockholders  of  that  company  and  one 
in  which  no  official  action  is  required  by  the  board  of  directors. 
Any  necessary  entries  must  of  course  be  made  in  the  transfer 
book  and  stock  book,  and  new  certificates  be  issued  in  exchange 
for  those  canceled. 

If  for  convenience  or  any  other  reason  the  transactions  were 
handled  as  a  company  matter,  the  entries  in  the  general  ledger 
might  be  as  follows : 

July  I,  192 1 
Stock  Clearing  Account  (or  United  Equipment  Company)  $1,575,000 

To  Sundry  Stockholders $1,575,000 

For  sale  of  $1,500,000  stock  of  this  Company  by 
sundry  stockholders  to  the  United  Equipment  Com- 
pany at  105. 

Stock  of  United  Equipment  Company $1,415,000  ' 

Cash 160,000 

,    To  Stock  Clearing  Account  (or  United  Equipment 

Company) $1,575,000 

Stock  of  the  United  Equipment  Company  and  cash 
received  in  exchange  for  $1,500,000  of  stock  of  this 
Company,  as  above,  being  as  follows.: 
10,000  shares  common  stock  at  125.  ...  .  $1,250,000 
1,500  shares  preferred  stock  at  no.  . .  .  165,000 
Cash  for  the  balance ; . .        160,000 


iir, 


Ch.  26]  HOLDING  COMPANIES  1277 

Sundry  Stockholders $1,575,000 

To  Stock  of  United  Equipment  Company $1,415,000 

Cash 160,000 

For  stock  received  as  above  and  cash  turned  over  to 
the  sundry  stockholders,  as  per  agreement. 

§  266.    Parent  Companies  ^ 

The  term  "parent  company"  is  rather  loosely  used.  Gen- 
erally it  means  a  corporation  holding  the  patent  rights  to  some, 
invention  which  it  markets  through  subsidiary  companies, 
either  selling  the  product  to  them  or  allowing  them  to  manufac- 
ture it  on  a  royalty  basis. 

Each  investment  made  by  the  parent  company  in  an  under- 
lying company's  stock  may  be  charged  to  ''Investments" 
account,  or  to  a  special  account  carrying  the  name  of  the  particu- 
lar stock  purchased,  as  "Stock  of  Canadian  Motors  Corpora- 
tion." Sales  of  machines  may  be  made  to  subordinate  com- 
panies on  liberal  terms  of  credit,  and  settlements  made  at  con- 
venient times  as  collections  are  made  from  purchasers.  The 
parent  company's  income  is  derived  from  sales  to  subordinates, 
from  royalties  received  from  subordinates,  and  from  dividends 

on  its  investments  in  the  various  companies. 

_i 

»  See  Book  I,  §  537.  and  Book  II,  §  49. 


CHAPTER  XXVII 
COMBINATION  BY  MERGER  OR  PURCHASE^ 

§  267.    General  Principles 

Combinations  effected  by  lease  or  through  holding  companies 
require  the  continued  existence  of  all  the  combining  corporations. 
Combination  by  merger  or  purchase,  however,  is  usually  followed 
by  the  liquidation  of  all,  or  all  except  one  of  these. 

The  terms  "consolidation  by  merger"  and  "consolidation  by 
purchase"  are  rather  loosely  used  to  describe  the  selling  of  the 
assets,  tangible  and  intangible,  of  one  or  more  corporations  to 
another  corporation,  followed  by  the  dissolution  of  the  selling 
corporations.  In  either  case  there  is  a  purchase,  but  in  a  merger 
the  stockholders  of  the  selling  corporation  become  stockholders 
in  the  purchasing  corporation,  and  thus  retain  an  interest  in  the 
business;  whereas  in  a  consolidation  by  purchase  they  presum- 
ably receive  cash  for  their  interests  in  the  old  company  and  retire 
from  the  field.  In  either  case  it  is  usual,  as  stated,  to  dissolve 
the  selling  corporation,  else  we  have,  instead  of  a  merger,  merely 
a  sale  of  the  corporate  assets.  A  merger  therefore  implies  pay- 
ment in  stock  of  the  purchasing  corporation  (with  perhaps  some 
cash  also) ;  while  consolidation  by  purchase  involves  payment  in 
cash  or  other  assets  not  the  stock  of  the  purchasing  corpora- 
tion, unless  for  a  minor  part  of  the  purchase  price. 

§  268.    Transfer  of  Assets  in  a  Merger 

It  is  essential  for  the  accountant  to  recognize  the  principle 
that  a  combination  by  merger  or  purchase  is  distinguished  from 
other  forms  of  combinations  by  the  fact  that  it  is  the  assets  of 


1  See  Book  I,  i  {  556.  558. 

1378 


Ch.  27]  COMBINATION  BY  MERGER  OR  PURCHASE  1279 

the  retiring  corporation  which  are  taken  over  and  not  the  capital 
stock,  and  by  the  fact  that  the  retiring  corporation  is  dissolved. 
It  may  be  that  the  purchasing  corporation  first  secures  control 
by  buying  up  the  stock  of  the  company  to  be  dissolved.  In  this 
case  it  becomes  temporarily  a  holding  company,  but  unless  by 
exerting  its  control  it  effects  the  sale  of  the  assets  to  itself  and 
the  subsequent  liquidation  of  the  purchased  company,  there  is 
no  merger,  but  only  a  combination  by  means  of  a  holding 
company. 

The  responsibility  for  the  dissolution  of  the  old  corporation 
devolves  upon  those  who  are  its  stockholders  at  the  time  of  the 
sale  of  the  assets.  The  object  of  the  dissolution  is  to  escape  the 
necessity  of  filing  reports  for  a  corporation  which  has  gone  out 
of  business. 

The  assets  sold  nearly  always  include  all  inventories  and  fixed 
assets.  The  other  assets  may  or  may  not  be  included  in  the  sale. 
If  they  are  not,  the  old  corporation  must  realize  upon  those  it 
still  possesses  by  collecting  its  accounts  receivable,  selling  its 
Liberty  bonds,  etc.,  before  it  can  dissolve.  In  the  same  way,  the 
purchasing  company  may  or  may  not  assume  all  or  part  of  the 
liabilities  of  the  old.  Any  which  it  does  not  take  over  will  have 
to  be  paid  by  the  old  corporation  before  dissolution.  Any  mort- 
gage liabilities  will  of  course  follow  the  property  which  forms  the 
underlying  security. 

§  269.    Accounting  Features  of  Mergers  and  Purchases 

The  accounting  features  of  consolidations  by  merger  and  by 
purchase  differ  in  no  degree  from  each  other,  because  in  either 
case  the  assets  of  the  retiring  corporation  or  corporations  are  as- 
signed by  the  retiring  company  to  the  purchasing  corporation. 
The  accountant  must,  however,  ascertain  from  the  minute  books 
of  the  corporations  involved  and  from  the  agreements  executed 
in  accordance  therewith,  whether  the  assets  were  sold  immedi- 
ately, or  whether  the  succeeding  corporation  first  became  a  hold- 
ing company,  securing  control  by  the  purchase  of  the  stock  of 


l28o  CORPORATE  ACCOUNTING  [Bk.ni- 

the  other  company.     Sometimes  the  purchasing  corporation  is 

one  which  has  existed  and  operated  previously,  but  generally  and 

in  the  treatment  of  this  chapter  it  will  be  considered  as  a  new 

corporation  formed  especially  for  the  merger.    The  full  record  of 

the  transaction  should  be  shown  on  the  books  of  both  corpor^-T 

tions.  r*-tjro 

:bii;pil  ; 
§  270.    General  Procedure  for  Merger 

The  agreement  for  a  merger  may  stipulate  that  one  or  more 
of  the  merging  companies  shall  first  modify  in  some  way  its  exist- 
ing assets  or  liabilities.  Usually,  however,  the  new  corporation 
takes  over  at  once,  as  far  as  it  legally  can,  the  entire  rights, 
property,  privileges,  and  franchises  of  the  constituent  corpora- 
tions as  "going  concerns,"  continuing  the  business  of  each,  ful- 
filling all  existing  contracts,  collecting  all  outstanding  claims, 
and  discharging  all  the  current  liabilities.  This  is  a  form  of  com- 
bination that  has  in  many  cases  proved  effective  and  satisfac- 
tory. 

The  following  example  illustrates  the  manner  of  merging  sev- 
eral independent  concerns,  one  of  which  is  a  partnership.  The 
details  and  the  accounting  requirements  are  taken  up  in  proper 
sequence.  Although  this  example  is  made  somewhat  exhaustive 
in  order  to  bring  out  the  important  points,  it  is  of  course  impos- 
sible to  present  all  of  the  points  that  may  come  up  in  connection 
with  a  merger. 

§  271.    General  Conditions  of  the  Merger 

Three  corporations  and  a  partnership  are  to  be  combined. 
All  are  prosperous  manufacturing  concerns  in  the  same  or  allied 
industries.  They  are  to  become  incorporated  under  the  laws  of 
New  Jersey  as  the  "Long-Bain  Manufacturing  Company"  with 
an  authorized  capital  stock  of  $16,000,000,  of  which  one-half  is 
to  be  common  stock,  and  one-half  7%  cumulative  preferred 
stock;  par  value  of  shares,  $100  each.  There  is  also  to  be  an 
issue  of  first  mortgage  5%  30-year  sinking  fund  bonds  of  $5,000^- 


Ch.  27] 


COMBINATION  BY  MERGER  OR  PURCHASE 


128] 


000.  They  are  to  be  coupon  in  form  and  in  denominations  of 
1 1, 000  and  $10,000,  with  the  privilege  of  registration  as  to  princi- 
pal. 

§  272.    Statement  of  Concerns  to  be  Merged 

The  new  company  is  not  interested  in  the  valuation  at  which 
the  assets  are  carried  on  the  books  of  the  old  companies.  All 
that  concerns  it  is  their  real  worth,  as  determined  by  the  reports 
of  the  appraisers  and  accountants.  These  reports  show  the  fol- 
lowing valuations,  good-will  being  carried  for  the  present  at  the 
valuation  at  which  it  was  shown  on  the  books  of  the  two  com- 
panies which  carried  it. 

«■•  Statement  of  Merging  Companies 

january  i,  1922 


'-'^^•cdi 


Company 


Bain  Vine  Bell  & 

Company      Company       Davis 


Total 


Assets 
Cash $  572,800 


Notes  Receivable. . 

Accounts     Receiv- 
able   

Prepaid  Charges. . . 

Investments 

Stock  and  Material 

Supplies 

Pledged  Securities. 

Due     from     Bain 
Company 

Furniture  and  Fix- 
tures  

Patents,     Patterns 
and  Tools 

Buildings  and  Plant 

Good-Will 

Sinking  Fund 


340,600 

1,021,300 

46,200 

500,000 

964,300 

175,100 


85,000 
125,000 

450,000 
4,390,000 
1,000,000 

740,000 


$  272,500 
135,800 

492,750 
38,150 

150,000 

510,000 
51,900 

120,000 


62,000 

244,850 
3,359,000 


33,800  $  36,100 
69,100   114,000 


162,800 
9,200 

188^800 
7,800 


22,000 


82,400 
4,000 
25,000 
152,000 
12,400 
3S,ooo 

16,000 
14,000 


132,500  92,000 
450,000  110,000 
250,000   


$  915,200 
659.500 

1,759,250 

97,550 

675,000 

1,815,100 
247,200 
155,000 

101,000 

223,000 

919,350 
8,309,000 
1,250,000 

740,000 


Total $10,410,300  $5,436,950  $1,326,000  $692,900  $17,866,150 


1282 


CORPORATE  ACCOUNTING 


[Bk.  Ill- 


Long  Bain 

Company  Company 

Liabilities 

Secured  Loans.  ...  $ $     100,000 

Notes  Payable.  .  . .          685,000  270,000 

Accounts  Payable..          350,000  540,000 

Accrued  Charges.  .            37,900  11,640 

Reserve  for  Depre- 
ciation          345,100  120,500 

Reserve    for    Bad 

Debts 10,000  5,310 

Reserve  for  Insur- 
ance    105,500 

Mortgage  Payable 300,000 

Interest  Accrued  on 

Mortgage  Payable       4,500 

Dividend  Payable.          230,000  105,000 

First  Mortgage  5% 

Bonds 2,500,000  

Capital  Stock 5,000,000  3,500,000 

Surplus 1,146,800  480,000 

Total $10,410,300  $5,436,950 


Vine 
Company 


Bell& 
Davis 


Total 


$    30,000 

$ 

130,000 

150,000 

7S,ioo 

1,180,100 

202,600 

205,100 

1,297,700 

8,200 

6,200 

63,940 

54,000 

519,600 

1,200 

1,000 

17,510 
105,500 

250,000 

20,000 

570,000 

Soo 

5,000 

30,000 

365,000 
2,500,000 

600,000 

355,000* 

9,455,000 

30,000 

1,656,800 

$: 

1,326,000 

$692,900 

17,8^6,150 

*  Capital  to  credit  of  partners  at  this  date. 


Profits  for  Four 
Years: 

Long 
f  ompany 

Bain 
Company 

Vine 
Company 

Bell  & 
Davis 

Total 

For  Year  191 8. . . 
1919... 
1920. . . 
1921. . , 

.     $   550,000 
640,000 
680,000 
760,000 

$    290,000 
340,000 
430,000 
370,000 

$    45,000 
71,000 
5  7,000 
62,000 

$  22,500 
29,500 
26,400 
38,600 

$   907,500 
1,080,500 
1,193,400 
1,230,600 

Total 

$2,630,000 

$1,430,000 

$235,000 

$117,000 

$4,412,000 

Average 

•     $   657,500 

$    357,500 

$  58,750 

$  29,250 

$1,103,000 

All  the  merging  concerns  have  been  profitable  and  the  cor- 
porations have  been  paying  high  dividends.  All  but  the  Vine 
Company  have  allowed  a  large  proportion  of  their  profits  to  re- 


Ch.  27]  COMBINATION  BY  MERGER  OR  PURCHASE  1283 

main  in  the  business.    The  same  condition  exists  in  the  partner- 
ship of  Bell  &  Davis. 

§  273.    Terms  of  Merger 

The  four  concerns  sell  out  to  the  new  company  and  receive  in 
exchange  and  in  full  payment  for  their  respective  properties, 
stock  as  stated  below: 

Preferred  Common  Total 

To  Long  Company $4,000,000  $4,000,000  $8,000,000 

To  Bain  Company 2,500,000  2,500,000  5,000,000 

To  Vine  Company 450,000  450,000  900,000 

To  Bell  &  Davis 250,000  250,000  500,000 

To  the  underwriters  for  services 100,000  100,000  200,000 

$7i3oo,ooo      $7,300,000    $14,600,000 
To  be  sold  to  the  public 700,000  700,000        1,400,000 

Total  authorized  issue $8,000,000      $8,000,000    $16,000,000 

Each  company  is  to  pay  any  dividends  due  its  stockholders 
at  the  date  of  the  merger;  it  is  to  liquidate  its  secured  loans, 
thereby  releasing  the  pledged  securities,  and  then  convey  the  re- 
maining assets  and  liabilities  to  the  new  company  in  exchange 
for  the  stated  amounts  of  the  latter's  stock.  Each  company  is 
then  to  donate  to  the  new  corporation  for  working  purposes  10% 
of  the  common  stock  received  by  it  from  the  new  company;  and 
the  remainder  of  the  common  stock,  together  with  all  of  the  pre- 
ferred stock  received  by  the  corporations,  is  to  be  distributed  by 
them  among  their  respective  stockholders.  When  this  has  been 
done  the  companies  are  to  go  into  voluntary  liquidation  and  sur- 
render their  charters. 

The  outstanding  bonds  and  mortgages  and  accrued  interest 
of  the  merged  concerns  are  to  be  redeemed  with  an  equivalent 
amount  of  the  bonds  of  the  new  company;  and  in  the  case  of  the 
Long  Company,  in  addition  a  10%  bonus  of  conmion  stock  of 
the  new  company  is  to  be  given. 

The  Keystone  Trust  Company,  trustee  of  the  mortgage  deed 


1284  CORPORATE  ACCOUNTING  [Bk.  ni- 

and  of  the  sinking  fund  of  the  Long  Company,  is  to  act  in  a  simi- 
lar capacity  for  the  new  corporation.  ;  , 

The  present  sinking  fund  of  the  Long  Company  ($740,000)  is 
to  remain  in  the  hands  of  the  trustee  and  to  become  part  of  the 
sinking  fund  of  the  new  corporation.  Beginning  January  i,  1925, 
an  annual  deposit  of  $120,000  is  to  be  made  to  the  sinking  fund, 
and  a  reserve  of  $6,000  for  premium  on  bonds  purchased  by  the 
sinking  fund  trustee  is  to  be  set  aside  annually  out  of  profits  be- 
ginning December  31,  1925.  The  trustee  is  to  have  the  right 
to  purchase  for  investment,  in  the  open  market,  outstanding 
bonds  of  the  new  company  at  105  and  accrued  interest,  at  any 
interest  date  after  January  i,  1927.  At  the  discretion  of  the 
directors,  the  bonds  so  held  by  the  sinking  fund  trustee  may  be 
cancelled  at  par  on  the  books  of  the  company  or  may  be  permitted 
to  remain  therein  as  an  investment. 

Of  the  bonds  of  the  new  corporation  not  required  to  redeem 
the  outstanding  bonds  of  the  merged  companies,  $1,000,000  face 
value  have  been  sold  to  Mitchell  &  Stevens,  bankers,  at  90,  pay- 
able one-third  down  and  one-third  each  three  months  until  paid. 
Preferred  stock  $500,000  is  sold  for  cash  through  Bell  Brothers 
&  Company,  bankers,  with  a  50%  bonus  of  common  stock,  to 
provide  operating  capital. 

>  - .  ..•.,,  .., 
§  274.    Apportionment  of  Good- Will 

The  amount  of  stock  allowed  each  of  the  merging  concerns  is 
a  matter  for  mutual  agreement  and  may  be  determined  only 
after  much  negotiation.  The  amount  at  which  the  purchaser 
values  the  assets  other  than  good- will  may  be  one  extreme  in  the 
bargaining,  but  he  may'be  willing  to  pay  more  on  account  of  the 
going  value  of  the  business.  For  all  practical  purposes  the 
difference  between  the  purchase  price  of  the  assets  other  than 
good-will  and  the  total  amount  paid  is  the  valuation  placed  upon 
the  good-will.  The  price  thus  paid  for  the  good-will  of  each  of 
the  concerns  now  merging  is  determined  as  shown  in  the  following 
table : 


Ch.  27]  COMBINATION  BY  MERGER  OR  PURCHASE  1285 

Apportionment  of  Good- Will 
(showing  the  amount  paid  for  the  good-will  of  each  company) 

Long  Bain  Vine  Bell   & 

Company       Company      Company        Davis  Total 

Purchase  Price.. .  $8,000,000      $5,000,000       $900,000       $500,000    $14,400,000 
Net  Worth* 6,146,800        3,980,000         630,000         355,ooo       ii,iii;8oo 


Additional  Good- 
Will  (included  in 

Purchase  Price) .   $1,853,200  $1,020,000       $270,000       $145,000      $3,288,200 

Good-Will  includ- 
ed in  above  Net 
Worth 1,000,000       250,000       1,250,000 

■t , 


Total  Good-Will . .  $2,853,200    $1,020,000       $520,000       $145,000      $4,538,200 

§  275.    Requirements  for  the  Consolidation 

From  the  standpoint  of  the  accountant,  the  more  important 
matters  involved  in  the  Long-Bain  consolidation  are  as  follows: 

1.  The  procedure  necessary  to  complete  the  consolidation 

and  to  bring  about  the  dissolution  of  the  existing  con- 
cerns. 

2.  The  opening  entries  on  the  books  of  the  newly  incorpor- 
.,  ated  Long-Bain  Company,  assuming  that  a  new  set  of 

■  books  is  to  be  opened,  that  all  assets  and  liabilities  of 

the  Long  Company,  of  the  Vine  Company,  and  of  Bell 
&  Davis  are  to  be  included  in  the  new  ledger,  and  that 

;, ,,  ,         the  books  and  accounts  of  the  Bain  Company  will  be 

\i;'h  ^Ttft  continued  in  the  branch  office. 

J,  3.  The  arrangement  for  the  conduct  of  the  branches,  assum- 
ing that  the  plant  of  the  Long  Company  is  to  be  used 
as  the  head  office  and  all  the  other  concerns  operated 

ij,  as  branches. 

4.  The  closing  entries  of  the  Long  Company,  the  Vine  Com- 
pany, the  Bain  Company,  and  Bell  &  Davis,  at  the 


*  As  given  in  statement  in  i  372. 


1286  CORPORATE  ACCOUNTING  [Bk.in- 

time  of  dissolution  and  merger.     The  closing  of  the 
books  of  the  partnership  will  not  be  discussed  here. 
5.  The  consolidated  balance  sheet  of  the  new  corporation 
/. ,,  i      after  all  of  the  preceding  requirements  have  been  car- 
ried out. 

§  276.    Procedure  for  Consolidation 

1.  Agreement  of  Directors. — A  joint  agreement  by  the 
directors  of  each  constituent  company  and  the  partners  of  the 
associated  firm  must  be  entered  into,  fixing  the  terms  of  the 
consolidation. 

2.  Approval  of  Stockholders. — This  joint  agreement 
is  then  submitted  to  the  stockholders  of  each  company  at  a 
meeting  called  for  the  purpose,  of  which  due  notice  must  have 

been  given.  aottuMJognoD  9ii)  loi  alnsmaimjisJI    .><«$;  ^ 

3.  Application  for  New  Charter. — The  charter  of  the 
proposed  Long-Bain  Manufacturing  Company  must  be  prepared 
and  filed  with  the  secretary  of  state  of  New  Jersey,  and  all 
other  requirements  prescribed  by  the  laws  of  New  Jersey  must 
be  complied  with.  The  new  company  may  be  organized  as  en- 
tirely independent  of  the  consolidated  corporations,  or  the 
promoters  may  secure  authority  to  increase  the  stock  of  the 
Long  Company  from  $5,000,000  to  $16,000,000,  and  to  change 
its  corporate  name  to  the  Long-Bain  Manufacturing  Company. 

"' 4.  .Transfer  of  Property  to  New  Corporation. — All 
assets  and  liabilities  of  the  merged  concerns  must  be  transferred 
to  the  new  Long-Bain  Manufacturing  Company.  Personal 
properties  are  conveyed  by  assignment  or  bill  of  sale,  and  real 
properties  by  deed.  The  bank  balance  of  each  concern  must 
be  transferred  by  check.  All  negotiable  papers  must  be  indorsed 
over  to  the  new  company,  and  official  assignment  made  of  other 
documents  such  as  insurance  policies,  contracts,  etc.  The 
outstanding  mortgages  of  the  dissolving  companies  are  to  be 
exchanged  for  bonds  of  the  new  corporation  at  par. 

5.  Surrender  of  Old  Charters. — Where  the  corporations 


Ch.  27]  COMBINATION  BY  MERGER  OR  PURCHASE  1287 

to  be  taken  over  are  not  merged  directly  in  the  absorbing 
corporation,  and  are  not  to  be  kept  in  existence,  application  must 
be  made  to  the  state  by  each  corporation  for  permission  to  sur- 
render its  charter.  It  is,  however,  frequently  found  advisable 
to  keep  the  charters  of  the  subsidiary  merged  companies  alive 
in  order  to  prevent  competitors  from  adopting  the  names  and 
benefiting  by  their  former  connections.  As  an  alternative,  the 
names  of  the  merged  concerns  are  sometimes  carried  on  the 
stationery  of  the  new  corporation. 

The  partnership  of  Bell  &  Davis  has  power  either  to  dissolve 
or  to  sell  out  without  asking  authority  from  the  state. 

6.  Issue  of  Stock  and  Bonds  of  New  Company. — At 
the  time  the  properties  of  the  old  concerns  are  transferred 
to  the  Long-Bain  Manufacturing  Company,  stock  and  bonds  of 
this  company  are  issued  and  distributed  to  the  proper  persons  in 
accordance  with  the  terms  of  consolidation.  The  stock  appor- 
tioned to  each  company  may  be  handed  over  to  its  directors,  and 
be  by  them  distributed;  or  certificates  may  be  issued  direct  to 
each  individual  stockholder  for  the  exact  amount  due  to  him. 
Often  a  trustee  is  appointed  for  this  purpose,  to  whom  the  sep- 
arate stockholders  deliver  or  assign  their  stock  in  the  old  corpora- 
tions in  exchange  for  temporary  trust  receipts,  and  to  whom  the 
new  corporation  issues  the  stock  to  be  exchanged.  The  trustee 
then  delivers  the  new  stock  to  its  individual  owners  and  surren- 
ders the  old  stock  to  the  new  corporation  or  retains  it  for  cancella- 
tion. The  amount  of  common  stock  to  be  donated  back  to  the 
new  company  by  each  dissolving  concern  might  conveniently  be 
issued  by  the  new  company  to  the  trustee  in  separate  certificates. 

§  277.     (i)  Entries  for  Issuance  of  Stock  and  Bonds 

It  is  desirable  to  have  an  entirely  new  set  of  books  for  the 
newly  organized  corporation,  in  order  that  ample  and  careful 
arrangements  may  be  made  to  accommodate  the  larger  volume  of 
business  and  the  number  of  accounts  that  must  necessarily  follow 
such  an  amalgamation  of  interests. 


1288  CORPORATE  ACCOUNTING  [Bk.  III- 

The  opening  journal  entries  to  record  the  issue  and  disposi- 
tion of  the  capital  stock  and  to  bring  the  bond  issue  on  the  books 
of  the  new  corporation  are  as  follows : 

January  i,  1922 

Unissued  Common  Stock $8,000,000 

Unissued  Preferred  Stock 8,000,000 

To  Authorized  Capital  Stock — Common ■  $8,000,000 

Authorized  Capital  Stock — Preferred 8,000,000 

The  Long-Bain  Manufacturing  Company  has  been 
incorporated  with  a  capital  stock  of  $16,000,000  as 
shown  herewith.  It  is  to  take  over,  as  per  joint 
agreement,  the  assets  and  HabiHties  of,  and  merge, 
the  following  concerns,  to  which  full-paid  stock  is 
to  be  issued  in  full  settlement  as  shown: 

Preferred       Common 

Long  Company $4,000,000    $4,000,000 

Bain  Company 2,500,000      2,500,000 

Vine  Company 450,000         450,000  ' 

Bell  &  Davis 250,000         250,000  ,. 


Total  pa3Tnent $7,200,000    $7,200,000 

The  remaining  stock  is  to 

disposed  of  as  follows: 
To    the    underwriters    for 

services 100,000         100,000 

To  be  sold  to  the  public. . .        700,000         700,000 


Total  authorized  issue. .  $8,000,000    $8,000,000 

Long  Company $8,000,000 

Bain  Company .'  1 . ,  i ... . .  y .;.  Vi', .     5,000,000 

Vine  Company v,  i .  .^^w-f. ,-♦,•,  .y.         900,000 

Bell  &  Davis 500,000 

To  Unissued  Common  Stock $7,200,000 

Unissued  Preferred  Stock 7,200,000 

For  stock  issued  to  the  Directors  of  the  above-named 
concerns,  as  per  agreements  of  merger.  The  shares 
are  issued  at  pat  in  full  payment  for  the  respective 
plants  and  other  assets,  as  follows: 

Preferred       Common 

Long  Company 40,000  40,000 

Bain  Company 25,000  25,000 

Vine  Company 4,500  4,500 

Bell  &  Davis 2,500  2,500 


Ch.  27]  COMBINATION  BY  MERGER  OR  PURCHASE  1289 

Stock  Subscription  (or  The  Underwriters) $200,000 

To  Unissued  Common  Stock $100,000 

Unissued  Preferred  Stock 100,000 

For  subscriptions  to  1,000  shares  of  common  stock  and 
1,000  shares  of  preferred,  to  be  paid  for  in  pro- 
fessional services. 

This  issue  of  stock  might  be  charged  directly  to  organization 
expense  if  desired. 

The  following  entry  is  necessary  to  bring  the  bond  issue  on 
the  books: 

Unissued  Bonds $5,000,000 

To  First  Mortgage  Bonds $5,000,000 

Authorization  of  $5,000,000  of  first  mortgage  5% 
30-year  sinking  fimd  bonds  in  denominations  of 
$1,000  and  $10,000.  •'^ol,!,lo^'. 

§  278.     (2)  Entries  for  Assets  and  Liabilities  Taken  Over 

The  entries  for  issuance  of  stock  and  bonds  are  now  complete, 
and  the  next  step  is  to  take  over  the  assets  and  liabilities  of  the 
merging  concerns  in  full  payment  for  their  subscriptions.  A 
separate  entry  is  here  made  for  each,  though  it  is  obvious  that  the 
various  assets  and  liabilities  could  be  amalgamated  into  one  com- 
prehensive entry.  In  that  case  the  entry  would  state  the  aggre- 
gate of  the  items  taken  over,  instead  of  the  separate  amoimts 

Transfer  of  Long  Company's  assets  and  liabilities: 

Cash' $   342,800 

Notes  Receivable 340,600 

//     1'.  ■O,  i 

Accounts  Receivable 1,021,300 

Prepaid  Charges 46,200         ' ' 

Investments 500,000 

Stock  and  Material 964,300 

Supplies 175,100 

Due  from  Bain  Company 85,000 

Furniture  and  Fixtures 1 25,000 

Patents,  Patterns,  and  Tools 450,000 

Buildings  and  Plant 4,390,000 

Sinking  Fund , .  ^, . . .  „  ,. . ..... . . .  .-*|.,.  740,000 

Good-Will .'.......:............  .\ .... .  2,853,200 

»  After  the  payment  of  $230,000  in  dividends. 


I290  CORPORATE  ACCOUNTING  [Bk.  III- 

To  Notes  Payable $   685,000 

Accounts  Payable 350,000 

Accrued  Charges 37.90o 

Reserve  for  Depreciation 345,100 

Reserve  for  Bad  Debts 10,000 

Reserve  for  Insurance 105,500 

Bonds  of  Long  Company 2,500,000 

:  I              Long  Company 8,000,000 

The  above  assets  and  liabilities  of  the  Long  Company 
have  been  taken  over  this  day  at  the  valuations,     «nrwoH(»1  'iHT 

shown,  as  per  report  of  the  engineers  and  account-  ;       j      r 

ants,  in  full  payment  for  $8,000,-00  capital  stock  '>0a  OtU 

of  this  Company,  as  per  order  of  the  directors  and  dtji'iiH  bsUHiin'f 
agreements  previously  entered  into.     An  equivalent  r,p„^v)M  ^^nrf  fiT    ' 
of  common  and  preferred  stock  has  been  issued  in 
exchange  therefor,  as  per  agreement. 

Total  assets $12,033,500 

Total  liabilities 4>033i500 

Capital  issued. . .  ..^i^HL^sicl  htts €:  8.°oo.ooo  '^hina  (s)     .8^1:  g 

Transfer  of  assets  and  liabiliiies  of  Bell  b"  Davis.  i  ic»'l  fitiilin^  ^flT 

Cash^ f il-itj-  •'.i  •  $    6,100           ' '  ' 

Notes  Receivable ^  .»[,,». .  1 14,000 

Accounts  Receivable 82,400 

Prepaid  Charges 4,000 

Investments 60,000 

Stock  and  Material 152,000 

Supplies .7.. ...  '  I2,40P     ,  ^ 

Due  from  Bain  Company iTf!:  .T?.^  "'*  ''ig.SAt  ^'^ 

Furniture  and  Fixtures 14,009;^  Yo  "ti\i«  . 

Patents,  Patterns,  and  Tools 92,000               »  , 

Buildings  and  Plant 110,000.  .^l^^^q  ^^ 

Good-Will 145,000 

To  Notes  Payable $  75,100 

Accounts  Payable 205,100 

Accrued  Charges. 6,200 

Reserve  for  Bad  Debts 1,000 

Mortgage  of  Bell  &  Davis ,.,,:..,       20,000 

Interest  Accrued .  fxH  bas-           5°° 

Bell  &  Davis 500,000 

(Full  explanation,  as  above.) 

The  assets  and  liabilities  of  the  Vine  Company  are  transferred 


*  After  payment  of  $30,000  secured  loans. 


Ch.  2t]  combination  BY  MERGER  OR  PURCHASE  1291 

to  the  books  of  the  new  company  in  like  manner  after  the 
deduction  of  the  $30,000  to  be  paid  out  in  dividends. 

As  the  assets  and  liabilities  of  the  Bain  Company  are  to  be 
retained  and  carried  in  its  own  ledger,  they  are  not  to  be  taken 
into  the  home  office  accounts.  The  books  of  this  company  are 
to  be  kept  as  heretofore,  and  the  only  change  apparent  will  be 
that  of  ownership,  with  a  reflected  increase  in  capital,  surplus, 
and  good-will  accounts.  The  ownership  of  this  branch  will  be 
represented  in  the  home  office  books  in  a  distinguishing  account, 
as  "Bain  Plant,"  "Bain  Branch,"  "Investment  in  Bain  Plant," 
or  under  some  other  suitable  caption.  Since  this  plant  cost 
$5,000,000,  it  will  therefore  be  represented  at  the  same  valua- 
tion on  the  new  company's  books.    The  entries  are  as  follows: 

Bain  Plant  Investment $5,000,000 

To  Bain  Company , .        $5,000,000 

^'■>'  For  transfer  from  Bain  Company  of  all  assets,  liabili-        ^  ■iuoi^^t  v>v.  u;.^ 
!!:       ties,  etc.,  valued  at  $5,000,000,  as  per  statements  on  ■ '^  ■  '    f  ■     ■        1 

■i         file,  in  exchange  for  an  equivalent  of  stock  of  this 
Company,  as  per  agreement. 

Certain  of  the  assets  of  the  Bain  branch  might  with  advantage 
be  included  in  the  home  office  accounts,  in  which  case  the  above 
amount  would  be  correspondingly  reduced. 

At  this  time  the  following  entries,  which  are  self-explanatory, 
might  also  be  made: 

Incorporation  Expenses $25,000 

^  To  Cash $25,000 

For    incorporation    expenses    and    other    charges, 

including  professional   services  of  attorneys  and 

accountants. 

Treasury  Stock $720,000 

To  Donated  Capital  (or  Donated  Surplus) $720,000 

The  consolidating  companies  have  this  day  donated  to 
C'        the  Long-Bain  Company,  for  working  purposes,  one- 
tenth  of  their  holdings  of  common  stock — 10% 
of  $7, 2oo,ooo=$7 20,000,  entered  at  par  value. 

This  transaction  should  be  completed  before  the  final  issue 
of  certificates  has  been  made  to  the  various  stockholders. 


1292  CORPORATE  ACCOUNTING  [Bk.  III- 

§  279.     (3)  Entries  for  Retirement  of  Outstanding  Bonds  and 
Mortgages  of  the  Merging  Concerns 

First  entry:  . 

„        ,        -^  ^  nil     'WU     H)   ii-:)UiHUhli    Dili. 

Bonds  of  Long  Company. ............  ^. ......... , ...  $2,500,000 

Mortgage  of  Bell  &  Davis.  ... .  .J?^'^'^} .'. ...!..  20,000 

Interest  Accrued J .  v.'i F. 500 

Bain  Plant  Investment 304,500 

Mortgage  of  Vine  Company 250,000 

-"•• '       To  Unissued  Bonds $3,075,000 

-  <  For  refunding  of  all  outstanding  bonds  and  mortgages 

of  the  merging  concerns,  as  per  merger  agreement, 

entry  of  Bain  Plant  Investment  including  mortgage  u,      •    aii 

of  Bain  Company  and  accrued  interest  on  same 

$4,500. 


-rffoa  itibau 


Since  the  bonds  of  the  Long  Company  and  the  mortgages  of 
the  Vine  Company  and  of  Bell  &  Davis,  with  accrued  interest, 
have  been  included  in  the  accounts  of  the  new  company,  they 
can  be  readily  canceled  by  an  offsetting  entry.  This  is  not  true, 
however,  of  the  mortgage  of  the  Bain  Company  branch,  since  all 
accounts  are  retained  in  its  own  books.  The  outlay  on  account  of 
this  branch  must  then  be  regarded  either  as  an  additional  ex- 
penditure or  as  an  investment  and  charged  up  accordingly. 
Since  there  is  an  equivalent  issue  of  bond  obligations,  there  is  no 
additional  investment  of  the  company's  capital,  but  the  liability 
is  transferred  from  the  branch  books  to  the  home  office  books. 

Second  Entry:  .  ' 

Donated  Capital $250,000    i's^o^rf*'' 

To  Treasury  Stock $250,000 

A  bonus  of  donated  common  stock  given  to  holders  of 
refunded  bonds  of  the  Long  Company,  10%  of 
$2,500,000. 

§  280.     (4)  Entries  Relating  to  Sale  of  Securities 

Incorporation  Expenses $200,000 

To  Stock  Subscription  (or  Underwriters) $200,000 

Being  an  issue  of  stock  to  the  underwriters  of  this 
Company  for  services  rendered  in  organizing,  and  in 
full  payment  of  their  subscriptions: 

•^"^     1,000  shares  common $100,000 

1,000  shares  preferred 100,000    .'^H  c;;^^iiUltiO  '■■ 


Ch.  27]  COMBINATION  BY  MERGER  OR  PURCHASE  1293 

Mitchell  &  Stevens,  Bankers $900,000 

Discount  on  Bonds 100,000 

To  Unissued  Bonds $1,000,000 

For  sale  of  $1,000,000  par  of  bonds  to  bankers  at  90, 
payable  one-third  down  and  one-third  each  three 
months. 

Cash $300,000 

To  Mitchell  &  Stevens,  Bankers $300,000 

First  payment  of  one-third  on  account  of  bond  sale. 

Cash $500,000 

To  Unissued  Preferred  Stock $500,000 

For  sale  of  $500,000  par  of  preferred  stock  to  Bell 
Brothers  &  Company,  bankers.  Full  payment 
received  in  cash ;  50%  bonus  of  common  stock  given 
as  entered  below. 

Donated  Capital $250,000 

To  Treasury  Stock $250,000 

Bonus  of  common  stock  given  to  Bell  Brothers  & 
Company,  being  50%  of  cash  sale  of  $500,000  of 
preferred  stock. 

§  281.     (5)  Entry  in  Settlement  of  Intercompany  Obligations 

The  following  entry  in  settlement  of  intercompany  obligations 
would  be  made  as  soon  as  the  Bain  plant  is  in  a  position  to  spare 
the  cash.  This  indebtedness  could  have  been,  and  usually  is, 
settled  before  making  the  transfer;  otherwise  it  could  be  included 
in  the  regular  personal  accounts. 

Cash $101,000 

To  Due  from  Bain  Company $101,000 

To  settle  claims  owing  by  the  Bain  Company  at  time 
of  amalgamation,  and  which  were  carried  into  the 
accounts  of  this  Company  as  follows: 

Owing  to  I-X)ng  Company $85,000 

Owing  to  Bell  &  Davis 16,000 

There  is  nothing  special  to  be  done  with  the  sinking  fund  at 
this  time,  and  it  will  stand  on  the  books  of  the  new  corporation 
as  it  formerly  stood  on  the  books  of  the  Long  Company,  until 
additional  instalments  are  deposited  therein.     All  interest  ac- 


t294  CORPORATE  ACCOUNTING  [Bk.  Hl- 

oumulations  thereon  must  of  course  be  added  from  time  to 
time  as  they  are  reported  by  the  trustee. 

In  anticipation  of  the  bond  redemption  at  105,  the  company 
is  to  begin,  on  January  i,  1925,  to  set  aside  out  of  profits  an  an- 
nual reserve  of  $6,000  to  offset  bond  premium,  which  may  be 
credited  to  Reserve  for  Bond  Premium.  When  the  bonds  are 
called  at  a  premium,  such  premium  is  charged  against  the 
reserve. 

§  282.    Closing  Books  of  Dissolving  Companies 

There  are  two  main  systems  of  conducting  branch  houses: 
in  the  first,  all  accounts  are  kept  in  the  books  of  the  home  office 
and  all  collections  are  made  therefrom,  all  business  trans- 
acted at  the  branches  being  reported  daily  to  the  home  ofiice ;  in 
the  other,  all  accounts  and  records  are  kept  at  the  branch  offices 
and  reports  are  made  to  the  home  office  from  time  to  time. 

•  As  all  the  assets  and  liabilities  of  the  Vine  Company  and  of 
Bell  &  Davis  have  been  transferred  to  the  home  office  books,  it 
may  be  assumed  that  these  branch  ofl&ces  are  to  be  handled 
under  the  first  plan — ^practically  as  selling  agencies.  It  is  evident 
that  the  Bain  plant  is  to  be  handled  under  the  second  plan,  the 
assets  and  liabilities  being  continued  in  its  own  ledgers,  and  its 
own  complete  set  of  books  being  maintained  as  before.  There- 
fore, any  adjustments  necessary  in  the  transfer  of  ownership  and 
liquidation  of  certain  liabilities  must  necessarily  be  made  in  these 
books.  This  branch  wiU  keep  all  accounts  pertaining  to  its  busi- 
ness affairs  and  report  periodically  to  the  home  office. 

The  entries  required  on  the  books  of  Long  Company  to 
show  its  final  distribution  and  dissolution  are  shown  in  Chapter 
XXVIII.  Similar  adjusting  and  closing  entries  are  required 
on  the  books  of  the  Vine  Company,  setting  up  the  necessary 
accounts  for  clearing  the  transaction  and  distributing  the  newly 
acquired  stock.  Closing  entries  for  Bell  &  Davis  are  similar  to 
those  given  in  §§  1 58-161.  Since  the  operating  accounts  of  the 
Bain  Company  are  to  remain  on  the  books  of  the  branch,  it  is 


Ch.  27] 


COMBINATION  BY  MERGER  OR  PURCHASE 


1295 


manifest  that  only  certain  adjusting  entries  are  necessary  at 
this  time.     These  also  are  shown  in  Chapter  XXVIII. 

§  283.    Balance  Sheet  of  New  Corporation 

The  balance  sheet  which  follows  is  practically  a  trial  balance 
of  the  ledger  accounts  alter  the  incorporation  of  the  new  com- 
pany. 

Balance  Sheet 

or  THE  Long-Bain  Manufacturing  Company 

As  OF  January  i,  1922 

(After  incorporation   and   merging) 


Assets 

Liabilities  and  Capital 

Cash 

$  1,228,700 

Notes  Payable 

$     910,100 

Notes  Receivable 

523,700 

Accounts  Payable 

757.700 

Accounts  Receivable.  .  .  . 

1,266,500 

Accrued  Charges 

52.300 

Prepaid  Charges 

59,400 

Reserve  for  Depreciation. 

399,100 

Investments: 

Reserve  for  Bad  Debts.. . 

12,200 

Bain  Branch  Plant 

5,304,500 

Reserve  for  Insurance .  .  . 

105,500 

Stock  of  Other  Com- 

560,000 

Donated  Capital 

220,000 

panies 

First  Mortgage  Bonds .  .  . 

5,000,000 

Stock  and  Material 

1,305,100 

Authorized  Capital  Stock 

Supplies 

195.300 

— Preferred 

8,000,000 

Furniture  and  Fixtures.. . 

161,000 

Authorized  Capital  Stock 

Patents,     Patterns,     and 

— Common 

8,000,000 

Tools 

674,500 

Buildings  and  Plant 

4,950,000 

Sinking  Fund  Trustee .  .  . 

740,000 

Incorporation  Expenses. . 

225,000 

Discount  on  Bonds 

100,000 

Treasury  Stock 

220,000 

Unissued  Bonds 

925,000 

Unissued  Preferred  Stock 

200,000 

Unissued  Common  Stock . 

700,000 

Mitchell       &       Stevens, 

Bankers 

600,000 

Good-Will* 

3,518,200 

$23,456,900 

$23,456,900 

♦  Comprising  the  good-will  of  the  Long  Company,  the  Vine  Company,  and  of  Bell  &  Davis. 
The  good-will  of  the  Bain  Company  i§  included  in  the  account  of  the  Bain  branch  plant, 
shown  under  "Investments." 


Part  VI — Dissolution,   Reorganization, 
Receivership 


CHAPTER  XXVIII 
VOLUNTARY  DISSOLUTION  OF  CORPORATIONS 

§  284.    Introductory 

In  most  of  the  states  a  corporation  may  be  dissolved  by 
its  stockholders,  the  procedure  being  simple;  and  while  in  some 
states  unanimous  consent  is  required,  in  others  two-thirds, 
three-fourths,  or  even  a  bare  majority  is  enough  to  terminate  the 
corporate  existence. 

Many  of  the  smaller  corporations  end  their  existence  in- 
formally by  failure  to  pay  taxes  or  to  make  corporate  reports,  in 
consequence  of  which  the  state  forfeits  the  charters  under  which 
they  operate. 

In  case  of  voluntary  dissolution,  the  directors  are  the  trustees 
authorized  to  settle  the  company's  affairs,  and  they  may  bring 
this  about  in  the  simplest  manner  possible.  The  chief  difficulty, 
however,  lies  in  collecting  outstanding  accounts,  and  in  disposing 
of  properties  without  too  great  sacrifice. 

§  285.    Entries  for  Dissolution 

Theoretically  the  entries  for  the  dissolution  of  a  corporation 
are  very  simple.  Assume  for  illustration  the  case  of  a  corpora- 
tion with  tangible  assets  of  a  book  value  of  $50,000,  liabilities  of 
$15,000,  capital  stock  of  $20,000,  and  a  surplus  of  $15,000.  This 
corporation  decides  to  realize  on  its  assets,  pay  its  debts,  and  dis- 
solve.    It  sells  the  assets  for  $45,000,  pays  sale  and  dissolution 

1297 


1298  CORPORATE  ACCOUNTING  [Bk.  III- 

expenses  of  $2,000,  and  liquidates  its  liabilities  of  $15,000,  so  that 
it  has  $28,000  in  cash  remaining.  This  is  divided  among  the 
stockholders,  and  then,  by  following  the  prescribed  statutory 
procedure,  the  corporation  is  dissolved. 

As  the  assets  are  sold  Cash  is  debited  and  the  asset  accounts 
are  credited,  any  profit  realized  or  loss  sustained  by  selhng  above 
or  below  the  book  values  being  carried  to  Surplus.  As  the  debts 
are  paid.  Cash  is  credited  and  the  proper  liability  accounts 
debited.  The  trial  balance  of  the  books  just  before  dissolution 
(all  income  and  expense  accounts  having  been  closed  into 
Surplus)  will  be  as  follows: 

Cash $28,000 

Surplus $  8,000 

Capital  Stock .". . . .  20,000 

,T-:0  . 

$28,000  $28,000 

The  books  are  then  closed  by  the  entry: 

Surplus $  8,000 

Capital  Stock 20,000 

To  Cash $28,000 

To  record  distribution  of  the  company's  assets  prior  to  its 
dissolution. 

Complications  may  develop  in  the  entries  having  to  do  with 
the  realization  and  liquidation,  but  the  above  method  will  always 
apply.  The  liquidation  of  liabilities  may  proceed  as  fast  as  cash 
becomes  available. 

§  286.    Profit  or  Loss  on  Realization 

The  profit  or  loss  resulting  from  the  sale  of  the  assets  may  be 
handled  in  any  one  of  several  ways.  A  method  which  requires 
the  opening  of  no  new  accounts  is  illustrated  by  the  following 
example. 

Land  which  cost  $42,000  and  is  carried  on  the  books  at  that 
figure,  brings  $51,000.  The  gain  is  credited  to  Profit  and  Loss, 
the  entry  for  the  sale  being : 


Ch.  28]  VOLUNTARY  DISSOLUTION  1299 

Cash $51,000 

To  Land $42,000 

Profit  and  Loss 9,000 

{Full  explanation  here.) 

Another  way  of  handling  the  transaction  is  to  credit  such 
gains  or  debit  such  losses  to  an  account  known  as  "Loss  and  Gain 
on  Realization,"  in  order  that  the  results  of  the  realization  may- 
be separately  accumulated  on  the  books.  This  account  will  ulti- 
mately be  closed  into  the  regular  Profit  and  Loss  account,  or  else 
directly  into  Surplus. 

§  287.     Sale  of  Business  as  a  Going  Concern 

The  simplest  case  of  realization  arises  when  a  business  is  sold 
as  a  going  concern,  i.e.,  when  the  assets,  including  good- will  and 
trade-name,  are  sold  as  a  whole  to  another  person  or  corporation. 
The  purchaser  may  or  may  not  assume  the  liabilities. 

As  an  example  of  the  sale  of  a  going  business  we  shall  consider 
the  case  of  the  Long  Company,  whose  assets  have  been  purchased 
and  whose  liabilities  have  been  assumed  by  the  Long-Bain 
Manufacturing  Company  for  $4,000,000  of  the  common  and 
$4,000,000  of  the  preferred  stock  of  the  latter  company.  It  was 
agreed,  however,  that  the  Long  Company  should  donate  back  to 
the  purchasing  company  $400,000  of  the  common  stock  to  be 
sold  to  provide  working  capital  for  the  new  company. 

The  transactions  leading  up  to  this  sale  have  been  discussed  in 
the  preceding  chapter,  where  the  trial  balance  of  the  Long  Com- 
pany is  shown.  The  following  is  a  summary  of  that  trial  balance, 
showing  the  assets  and  liabilities  of  the  Long  Company  as  they 
appear  in  its  books  at  the  time  of  sale. 

Tangible  Assets '. $  g  ,410,300 

Good-Will 1,000,000 

Total  Assets $10,410,300 

Liabilities 4,263,500 

Net  Worth $6,146,800 


I300  CORPORATE  ACCOUNTING  [Bk.  III- 

§  288.    Adjusting  Entries  for  Long  Company 

In  the  purchase  agreement  it  was  stipulated  that  the  Long 
Company  should  first  reduce  its  liabilities  (and  its  assets)  by 
paying  off  a  dividend  due  in  the  amount  of  $230,000.  This  pay- 
ment gives  rise  to  the  first  entry  necessary  on  the  books  of  the 
Long  Company,  as  follows : 

First  Entry: 

Dividend  Payable $230,000 

To  Cash -I  $230,000 

For  payment  of  dividend  due  today. 

Since  the  Long  Company  is  to  receive  $8,000,000  in  stock 
for  its  net  assets  of  $6,146,800,  it  becomes  evident  that  the  differ- 
ence of  $1,853,200  is  the  price  being  paid  for  its  good-will  above 
the  $1,000,000  at  which  good-will  is  carried  on  its  books.  This 
additional  value  will  be  set  up  on  the  Long  Company  books  by 
the  following  entry : 

Second  Entry: 

Good-Will $1,853,200 

To  Surplus $1,853,200 

This  Company  has  agreed  to  sell  out  to  the  Long-Bain 

Manufacturing  Company  for  $8,000,000,  as  per  agree- 
ment executed  this  day  in  accordance  with  the  order 
of  the  Board  of  Directors.  Since  the  net  worth  of 
this  company  by  its  books  is  $6,146,500  and  the  sale 
price  of  the  net  assets  is  $8,000,000,  additional  good- 
will of  $1,853,200  must  be  set  up. 

§  289.    Transfer  of  Assets  and  Liabilities 

It  is  now  necessary  to  record  the  transfer  of  the  assets  and 
liabihties  under  the  agreement  with  the  Long-Bain  Manufactur- 
ing Company,  and  to  show  that  company's  payment  therefor  in 
stock.     This  is  accomplished  by  the  following  entries: 

Third  Entry: 

Long-Bain  Manufacturing  Company $12,033,500 

To  Cash $   342,800 

Notes  Receivable 340,600 

Accounts  Receivable 1,021,300 


Ch.  28|  VOLUNTARY  DISSOLUTION  1301 

Prepaid  Charges $      46, 200 

Investments   500,000 

Stock  and  Material 964,300 

Supplies 175,100 

Due  from  Bain  Company 85,000 

Furniture  and  Fixtures 125,000 

Patents,  Patterns,  and  Tools 450,000 

Building  and  Plant 4,390,000 

Sinking  Fund 740,000 

Good- Will 2,853,200 

1  or  all  assets  turned  over  in  payment  of  subscription  to 

$8,000,000  of  stock,  as  per  resolution  of  the  directors 

and  stockholders. 

Fourth  Entry: 

Notes  Payable $   685,000 

Accounts  Payable 350,000 

Accrued  Charges 37i900 

Reserve  for  Depreciation 345,100 

Reserve  for  Bad  Debts 10,000 

Reserve  for  Insurance 105,500 

First  Mortgage  Bonds 2,500,000 

To  Long-Bain  Manufacturing  Company $4t033,500 

For  all  liabilities  of  Long  Company  assumed. 

Fifth  Entry: 

Stock  of  Long-Bain  Manufacturing  Company $? ,000,000 

To  Long-Bain  Manufacturing  Company $8,000,000 

For  $8,000,000  of  the  capital  stock  of  the  Long-Bain 

Manufacturing  Company  received  this  day,  as  per 

agreement,  in  full  payment  for  plant,  assets,  and 

liabilities  turned  over  and  transferred  according  to 

legal  requirements: 

40,000  shares  common  stock $4,000,000 

40,000  shares  preferred  stock 4,000,000 


$8,000,000 

§  290.    Final  Entries  of  Long  Company 

A  trial  balance  of  the  books  of  the  Long  Company  at  this 
point  would  show  the  following  figures: 

Stock  of  I^ng-Bain  Manufacturing  Company $8,000,000 

Capital  Stock $5,000,000 

Surplus 3,000,000 


I302  COKPOKATE  ACCOUNTING  [Bk.  IH- 

The  company  has  now  no  further  functions  to  perform  except 
to  distribute  its  assets.  First,  $400,000  of  the  stock  of  the  Long- 
Bain  Manufacturing  Company  is  to  be  donated  back  to  that 
company.  After  this  is  done  the  remainder  may  be  divided 
among  the  stockholders.  The  following  entries  will  show  the 
transactions : 

Sixth  Entry: 

Surplus $400,000 

To  Stock  of  Long-Bain  Manufacturing  Company. .  $400,000 

For  donation  of  10%  of  the  allotment  of  $4,000,000 
common  stock,  to  be  used  by  the  Long-Bain  Com- 
pany for  working  purpxises 

Seventh  Entry: 

Capital  Stock $5,000,000 

Surplus 2,600,000 

To  Sundry  Stockholders $7,600,000 

For  allotment  of  stock  of  the  Long-Bain  Company  to 
the  individual  stockholders  in  proportion  to  holdings. 

The  distribution  of  stock  must  of  course  be  made  in  the  pro- 
portion decided  upon  by  the  stockholders  themselves,  and  it  is 
evident  that  uneven  amounts  of  both  classes  of  stock  will  obtain. 
In  some  cases,  to  make  an  equitable  adjustment,  money  will  have 
to  be  passed  for  the  equalization  of  shares. 

Eighth  Entry: 

Sundry  Stockholders $7,600,000 

To  Stock  of  Long-Bain  Manufacturing  Company.  . .  $7,600,000 

For  distribution  of  the  common  and  preferred  stock  of 
the  above  company  in  accordance  with  allotment 
agreement. 

There  is  now  no  balance  in  any  account  on  the  books  of  the 
Long  Company. 

§  291.    When  Asset  and  Liability  Accounts  Are  Not  Closed 

It  sometimes  happens  that  the  successor  business  desires  to 
take  over  and  continue  the  use  of  the  books  as  they  stand,  and 
does  not  wish  the  asset  and  liability  balances  closed  out.    Assume 


Ch.  28]  VOLUNTARY  DISSOLUTION  1303 

that  the  corporation  which  we  took  for  an  example  in  §  285, 
instead  of  attempting  to  sell  its  assets  piecemeal,  sold  as  a  going 
concern  for  $40,000  cash.  The  purchaser  is  the  New  Corpora- 
tion, organized  with  a  capitalization  of  $50,000,  fully  paid  in  cash. 
The  New  Corporation  does  not  wish  the  asset  and  liability 
accounts  closed,  as  it  wishes  to  use  the  same  books. 

Ordinarily,  of  course,  the  entries  for  the  incorporation  and 
opening  transactions  of  such  a  corporation  would  be  as  follows: 

Cash $50,000 

To  Capital  Stock $50,000 

Asset  Accounts  (separated) $50,000 

Good-Will 5,000 

To  Liability  Accounts  (separated) $15,000 

Cash 40,000 

The  showing  of  good-will  results  from  the  fact  that  net 
tangible  assets  of  a  value  of  $35,000  were  purchased  for  $40,000. 

In  this  case,  however,  the  asset  and  liability  accounts  (except 
Good- Will)  are  already  on  the  books,  exactly  offset  by  the  net 
worth  accounts  of  the  dissolving  corporation.  It  is  desired  to 
close  out  the  latter  group  instead  of  the  asset  and  liability  ac- 
counts, and  at  the  same  time  to  set  up  the  good-will  and  to  show 
the  organization  of  the  New  Corporation.  All  of  this  may  be 
done  in  one  entry,  as  follows : 

Good- Will $  5,000 

Surplus 15,000 

Capital  Stock . 20,000 

Cash 10,000 

To  Capital  Stock — New  Corporation $50,000 

Recording  the  purchase  of  the  net  assets  of  this  corporation 
for  $40,000  cash  paid  by  the  New  Corporation;  recording 
also  the  distribution  of  that  $40,000  to  the  stockholders 
of  this  Company  prior  to  its  dissolution;  setting  up  on 
the  books  the  $5,000  paid  for  the  good-will  of  the  company 
above  the  value  of  its  net  assets;  and  closing  its  Capital 
Stock  and  Surplus  accounts  in  favor  of  the  New  Corpora- 
tion, whose  authorized  stock  is  fully  paid  and  issued  as 
as  follows: 

(Insert  list) 


1304  CORPORATE  ACCOUNTING  [Bk.  lU- 

§  292.    Adjustments  of  the  Bain  Company 

A  more  complicated  case  of  the  same  kind  is  that  of  the  entries 
for  the  dissolution  of  the  Bain  Company,  which  merged  with  the 
Long  Company  to  form  the  Long-Bain  Manufacturing  Company. 
The  trial  balance  of  this  company's  books  is  presented  in  the  pre- 
ceding chapter,  and  need  not  be  repeated  here.  The  fulfilling  of 
the  conditions  of  the  sale  of  the  net  assets  of  this  company  is 
shown  in  the  following  entries,  the  explanatory  notes  in  connec- 
tion with  which  will  present  all  needed  details. 

In  the  first  place,  as  in  the  case  of  the  Long  Company  (whose 
closing  entries  were  given  in  §§  287^.),  the  Bain  Company  is  to 
receive  for  its  net  assets  stock  in  excess  of  their  book  value.  This 
excess  is  the  purchase  price  of  the  good- will  of  the  Bain  Company 
and  is  placed  upon  the  books  in  the  following  entry : 

Good-Will $1,020,000 

To  Surplus $1,020,000 

For  sale  value  of  plant  and  net  worth  in  excess  of 
present  book  value.     {Full  explanation  here.) 

The  Bain  Company  is  also  to  reduce  its  liabilities  (and  of 
course  its  assets  at  the  same  time)  by  paying  off  a  dividend  and 
certain  secured  notes  which  it  owes.  The  entry  of  these  pay- 
ments and  of  the  return  of  the  securities  pledged  as  collateral  for 
the  loan  is  shown  in  the  following  entries:  ,-»«)  "^cjn  tv.^no 

Dividend  Payable $105,000 

To  Cash $105,000 

For  pajmaent  of  dividend  due  today. 

Secured  Ix)ans $100,000 

To  Cash $100,000 

For  payment  of  secured  loans. 

Investments j.;i.  i  J-.i $120,000 

To  Pledged  Securities $120,000 

For  return  of  pledged  securities  upon  payment  of  loan. 

§  293.    Dissolution  of  the  Bain  Company 

The  above  entries  present  nothing  unusual.  The  entries  for 
the  dissolution  of  the  Bain  Company  differ  from  those  of  the  Long 


Ch.  28]  VOLUNTARY  DISSOLUTION  1305 

Company,  however,  because  the  Bq.in  Company's  office  is  to  be 
maintained  as  a  branch  office  for  the  Long-Bain  Manufacturing 
Company,  which  therefore  does  not  wish  the  asset  and  liability 
balances  closed  out.  The  net  worth  accounts  of  the  Bain  Com- 
pany must  be  taken  off  the  books  and  in  their  place  must  be  sub- 
stituted the  investment  of  Long-Bain  Manufacturing  Company 
in  the  branch.     The  entries  may  be  made  as  follows: 

Stock  of  Long-Bain  Manufacturing  Company. $5,000,000 

To  Long-Bain  Manufacturing  Company $5,000,000 

For  common  and  preferred  stock  of  the  Long-Bain 
Company  receiv'ed  in  full  payment  for  plant,  assets, 
and  liabilities: 

25,000  shares  common $2,500,000 

25,000  shares  preferred 2,500,000 

Surplus $250,000 

To  Stock  of  Long-Bain  Manufacturing  Company.  .  $250,000 

For  donation  of  2,500  shares  common  stock  back  to  the  , 

Long-Bain  Company  for  working  purposes. 

Capital  Stock $3,500,000 

Surplus 1,250,000 

To  Sundry  Stockholders $4,750,000 

For  allotment  of  stock  in  the  new  corporation,  in  pro- 
portion to  holdings. 

Sundry  Stockholders $4,750,000 

To  Stock  of  Ix)ng-Bain  Manufacturing  Company .  .  .  $4,750,000 

For  distribution  of  stock,  as  per  agreement  of  adjust- 
ments. 

§  294.    Balance  Sheet  of  the  Bain  Company  After  Adjustment 

The  Long-Bain  Manufacturing  Company  then  exchanges  its 
own  bonds  for  the  mortgage  note  owing  by  the  Bain  Company. 

Mortgage  Payable $300,000 

Interest  Accrued 4i50o 

To    Long-Bain   Manufacturing   Company    (Home 

Office) $304,500 

For  payment  of  mortgage  and  accrued  interest  by  the 
Long-Bain  Company  by  an  equivalent  exchange  of 
5%  bonds. 

\ 


i3o6 


CORPORATE  ACCOUNTING 


[Bk.  III- 


The  following  balance  sheet  of  the  accounts  as  shown  on  the 
books  of  the  Bain  branch  after  all  the  above  adjustments  have 
been  made,  is  given  to  show  how  the  net  worth  accounts  have 
disappeared  in  favor  of  the  proprietorship  interest  of  $5,304,500 
standing  to  the  credit  of  the  Long-Bain  Manufacturing  Com- 
pany. Certain  of  the  assets  could,  with  some  advantage,  be 
transferred  to  the  home  office  books  and  removed  from  the 
branch  ledger,  such  as  the  investments,  buildings  and  plant 
(particularly  the  real  estate).  Depreciation  reserve  and  good- 
will might  also  be  transferred.  This  would  leave  only  working 
accounts  on  the  branch  ledger,  and  a  credit  of  $776,000  to  the 
home  office.     The  entries  must  of  course  suit  the  conditions. 

Balance  Sheet  of  the  Bain  Branch 
(After  sale  to  the  Long-Sain  Company,  showing  open  ledger  accounts.) 


Assets 

Cash $     67,500 

Notes  Receivable 135,800 

Accounts  Receivable 492,750 

Prepaid  Charges 38,150 

Investments.  .  .  , 270,000 

Stock  and  Material 510,000 

Supplies 51,900 

Furniture  and  Fixtures.  .  .  .  62,000 

Patents,  Patterns,  and  Tools  244,850 

Buildings  and  Plant 3,359,000 

Good-Will 1,020,000 

$6,251,950 


Liabilities 

Notes  Payable $    270,000 

Accounts  Payable 540,000 

Accrued  Charges 11,640 

Reserve  for  Depreciation . .  .  120,500 

Reserve  for  Bad  Debts.  .  .  .  5,310 
Long-Bain  Company  Home 

OflSce  Account 5,304,500 


$6,251,950 


CHAPTER  XXIX 

REORGANIZATION  BY  AGREEMENT 

§  295.    Definition  of  Reorganization 

"A  reorganization  of  a  corporation  is  a  business  arrangement 
(i)  whereby  the  stocks  and  bonds  of  the  company  are  rearranged 
as  to  amount,  income,  or  priority,  or  (2)  the  property  is  sold  to 
a  new  corporation  for  new  stock  and  bonds,  or  (3)  the  property 
is  sold  by  foreclosure  of  a  mortgage  upon  it,  and  the  purchaser 
buys  for  himself  and  such  of  the  old  stockholders  and  bondhold- 
ers as  he  associates  with  him."i  Any  material  change  in  the 
ownership  of  the  stock  is  usually  accompanied  by  at  least  a 
partial  reorganization. 

§296.    Methods  of  Reorganization  ' 

run  f.?.'i] 

According  to  the  definition  there  are  two  kinds  of  reorganiza- 
tion by  agreement.  The  first  is  a  mere  readjustment  of  the  rights 
of  the  various  parties  interested,  i.e.,  by  the  stockholders  with 
the  co-operation  of  -the  bondholders  or  other  creditors,  without 
forming  a  new  corporation.  The  problems  given  in  this  chapter 
relate  to  such  readjustments. 

The  second  involves  the  formation  of  a  new  corporation  and 
the  voluntary  sale  of  all  the  property  of  the  old  corporation  to 
it  in  return  for  its  stocks  and  bonds.  The  accounting  prob- 
lems connected  with  this  method  of  reorganization  are  essen- 
tially similar  to  those  of  consolidation  by  merger  and  by  pur- 
chase.2 

Both  of  these  methods  are  called  reorganizations  by  agree- 

'  Cook,  on  Corp.,  {  883. 

»  See  Ch.  XXVII,  "Combination  by  Merger  or  Purchase." 

1307 


1308  CORPORATE  ACCOUNTING  [Bk.  111- 

ment,  in  contradistinction  to  reorganizations  as  the  result  of 
legal  compulsion  where  the  corporation  is  insolvent  and  its  prop- 
erty may  be  sold  to  pay  off  the  bondholders  and  creditors. 

When  the  property  of  a  corporation  is  sold  under  foreclosure 
proceedings,  the  entity  of  the  corporation  does  not  pass.  What- 
ever organization  is  effected  by  the  purchaser  to  operate  the 
plant,  property,  or  business  taken  over,  is  practically  a  new  or- 
ganization free  from  all  claim  or  liability  of  the  old  corporation. 
The  accounting  problems  relating  to  it  are  similar  to  the  prob- 
lems involved  in  opening  the  records  of  a  new  corporation. 

Reorganization  as  the  result  of  a  receivership  is  discussed  in 
the  following  chapter. 

§  297.    Reorganization  by  Reduction  of  Stock 

A  reorganization  by  agreement  may  involve  some  readjust- 
ment of  the  amount  of  the  stock  and  bonds  of  the  reorganized 
company.  A  reduction  of  capital  stock  is  not  as  simple  as  an 
increase,  because  in  reducing  stock  the  rights  of  creditors  must 
be  considered,  and  the  surrender  of  outstanding  stock  and  the 
issuance  of  a  less  number  of  shares  involve  some  cancellation  and 
reissue  of  stock  to  existing  stockholders.  As  an  illustration  of 
the  procedure  and  book  records  required  for  reducing  the  capital 
stock  of  a  corporation,  the  following  example  is  given: 

The  Harkness  Automobile  Company,"  whose  statement  is 
given  below,  was  formed  by  the  merger  of  several  automobile 
concerns.  At  the  time  of  the  combination,  good-will  was  placed 
at  $1,000,000  and  surplus  at  $340,000.  Since  then  regular  divi- 
dends of  7%  on  preferred  and  5%  on  common  stock  have  been 
paid,  excepting  the  one  recently  declared  and  shown  among  the 
liabilities.  An  audit  of  the  books  made  for  the  year  ending  June 
30,  192 1,  showed  that  obsolete  properties,  doubtful  accounts, 
and  valueless  investments  to  the  amount  of  approximately  $1,- 
000,000  would  have  to  be  written  off.  The  following  statement 
was  submitted  by  the  accountants  with  the  recommendation 
that  the  good-will  be  reduced  to  a  conservative  valuation: 


Ch.  29] 


REORGANIZATION  BY  AGREEMENT 


1309 


Harkness  Automobile  Company  and  Branches 

Balance  Sheet,  June  30,  1921 

(Before    reduction    of    capital) 


Assets 
Cost    of    Properties    and 
Equipment,  including 

Good-Will $  4,500,000 

Securities  Owned,  of  Sub- 
sidiary and  Other  Com- 
panies        1,300,000 

Sinking  Fund  Deposit.  . . .  220,000 

Cash 235,000 

Accounts  Receivable 1,172,300 

Notes  Receivable 1,370,000 

Material,  Supplies  and 

Finished  Parts 981,600 

Contract  Work  in  Course 

of  Construction 476,300 

Accrued  and  Prepaid  Items  58,400 


Total  Assets . 


.  $10,313,600 


Liabilities 
Capital  Stock: 

Preferred $  1,000,000 

Common 3,000,000 

Bonds  Outstanding 2,500,000 

Short-Term  Notes 500,000 

Accounts  Payable 1,525,900 

Notes  Payable  490,000 

Accrued  Items 31,200 

Bond     Interest,     payable 

July  1,  1921 62,500 

Dividend     Declared     and 

Unpaid 1 20,000 

Sundry  Operating  Reserves  189,000 
Indorsement  on  Notes  Dis- 
counted    850,000 

Surplus 45,000 

$10,313,600 


The  stockholders  have  decided  to  write  off  the  entire  $1,000,- 
000  of  good-will  and  to  add  $500,000  to  the  surplus  by  a  reduc- 
tion of  the  capital  stock.  The  common  stock,  therefore,  is  to  be 
reduced  to  $1,500,000,  while  the  cumulative  preferred  stock  is  to 
remain  as  before,  and  $500,000  is  to  be  added  to  the  Surplus 
account.. 


§  298.    Entries  for  Reduction  of  Stock 

As  the  new  common  stock  certificates  when  issued  will  be  for 
one-half  the  number  of  shares  canceled,  so  that  each  holder  there- 
of will  own  50%  of  his  former  holdings,  each  stockholder's  ac- 
count in  the  stock  ledger  should  be  debited  with  the  number  of 
shares  canceled,  and  new  certificates  of  stock  reissued  for  the 
balance,  the  old  ones  being  taken  up.  Another  plan  is  to  debit 
each  account  for  the  entire  number  of  former  shares  in  order  to 


13  lo  CORPORATE  ACCOUNTING  [Bk.  III- 

close  the  account,  after  which  the  account  is  credited  with  the 
actual  number  of  new  shares  issued. 

The  only  entry  required  to  be  made  in  the  general  ledger  is 
one  to  adjust  the  Capital  Stock,  Surplus,  and  Good- Will  accounts 
as  follows: 

Capital  Stock — Common $1,500,000 

To  Good-Will  (or  Plant) $i,ocx),ooo 

Surplus 500,00a 

To  record  the  requirements  of  a  charter  amendment 
granted  this  day,  reducing  the  number  of  shares  of 
common  stock  from  30,000  to  15,000  of  the  par  value 
of  $1,500,000. 

This  entry  also  cancels  the  entire  Good-Will  account  and 
creates  an  additional  surplus  of  $500,000. 

Other  methods  of  stating  the  journal  entry  might  be  used, 
keeping  in  mind  that  accounts  should  be  given  such  titles  as  will 
readily  identify  their  functions. 

§  299.    Status  after  Reorganization 

The  reduction  in  the  par  value  of  the  common  stock  held  by 
each  stockholder  does  not  mean,  however,  that  the  company's 
actual  net  worth  is  less  than  under  the  former  arrangement,  nor 
that  the  holder  of  stock  has  lost  anything  by  the  charter  amend- 
ment. His  shares,  the  book  value  of  which  was  formerly  below 
par,  are  now  shown  as  being  worth  considerably  above  par.  The 
net  worth  of  the  company  (capital  and  surplus)  is  now  $3,045,000, 
so  that  each  of  the  15,000  shares  of  common  stock  has  a  book 
value  of  $136.33  per  share.  The  book  value  of  the  preferred 
stock  remains  as  before  at  $100  per  share. 

This  company,  like  many  others,  has  overvalued  its  proper- 
ties and  has  issued  its  capital  stock  on  the  strength  of  such  valua- 
tion. The  properties  and  good-will  are  listed  at  "cost,"  that  is, 
after  allowing  for  depreciation ;  but  this  only  indicates  the  value 
placed  upon  them  at  the  time  of  purchase,  measured  in  shares  of 
the  purchasing  company,  which  evidently  was  too  high.  Stock, 
like  water,  must  find  its  level  sooner  or  later,  and  it  is  well  known 


Ch.  29]  REORGANIZATION  BY  AGREEMENT  1311 

that  the  stock  market  quotations  usually  show  it  very  close  to 
its  intrinsic  property  valuation  after  all  water  or  fictitious  value 
has  been  eliminated. 

Assuming  that  the  good- will  of  $1,000,000  was  largely  ficti- 
tious, it  is  apparent  that  the  real  value  of  the  stock  was  only 
$3,000,000,  or  $75  per  share;  if  the  good- will  was  represented  by 
common  stock,  then  the  market  value  of  the  common  stock  will 
be  reduced  by  one-third,  or  to  $66.67  P^r  share,  while  the  pre- 
ferred stock  will  remain  at  or  near  the  par  value.  By  reducing 
the  capital  stock  to  $2,500,000,  the  good-will  is  eliminated  and 
$500,000  added  to  the  Surplus  account,  with  the  result  that 
the  actual  capital  and  surplus  is  then  $3,045,000,  and  the  book 
value  of  all  the  stock  averages  slightly  over  $1 20  per  share. 

The  relative  value  of  preferred  and  common  stock  must  of 
course  depend  upon  the  status  of  the  preferred;  if  the  latter  is 
entitled  to  only  par  value,  $1,000,000  on  liquidation,  it  is  obvious 
that  the  15,000  shares  of  common  stock  must  be  worth  $2,045,- 
000,  or  about  $136  per  share,  and  the  preferred  sHghtly  above 
par  in  harmony  with  its  annual  earnings.  It  will  be  seen  that  the 
stock  reduction  and  elimination  of  good-will  do  not  enhance  the 
financial  stability  of  the  company  upon  which  its  credit  is  based. 
On  the  other  hand,  the  status  of  the  preferred  and  common  stock- 
holders remain  the  same  as  to  proprietorship  and  participation  in 
profits.  The  preferred  stock  will,  if  business  permits,  pay  its  7% 
dividend  or  $70,000  per  year,  while  the  remaining  profits  will  be 
available  for  the  common  stock  dividend. 

In  a  letter  sent  by  the  American  Milling  Company  to  its 
stockholders  asking  them  to  vote  on  a  proposed  reduction  in  the 
amount  of  capital  stock,  the  following  paragraph  appeared : 

The  good-will  and  patent  rights  add  nothing  to  a  solid  financial 
basis  on  which  to  operate  your  property  and  a  statement  containing 
items  of  this  character  injures  us  in  banking  circles  to  such  an 
extent  that  your  officers  are  handicapped  in  making  a  proper  finan- 
cial showing,  and  in  addition  to  this  we  are  compelled  to  pay  $2,800 
capital  stock  tax  per  annum  on  this  excess  which  would  be  saved 
to  you  by  making  the  change. 


CHAPTER  XXX 

RECEIVERSHIP  AND  REORGANIZATION 

§  300.    The  Receiver's  Accounts 

A  receiver  is  a  fiduciary  and  as  such  is  required  to  keep  careful 
record  of  his  transactions  and  to  render  frequent  accounts  during 
his  receivership.  There  is  no  prescribed  form  for  the  keeping  of 
a  receiver's  accounts.  The  accountant  may  use  his  own  judgment 
in  outlining  the  books  to  be  used  and  the  manner  of  keeping  them. 
The  availability  of  data  pertaining  to  the  trust  is  the  main  con- 
sideration, however,  and  should  be  so  regarded  in  planning  the 
records.  No  matter  what  method  of  account-keeping  is  used, 
the  receiver  is  required  to  state  the  assets  and  liabilities  of  the 
c6mpany  at  the  beginning  and  termination  of  his  receivership,  as 
well  as  the  various  intervening  transactions.  These  statements 
to  the  court  become  public  records  and  are  available  for  general 
inspection. 

The  receivership  forms  and  procedure  which  follow  are  in 
accordance  with  good  accounting  practice,  but  changes  will  be 
necessary  for  acceptance  in  some  states.  In  New  York  State, 
for  example,  the  form  of  account  required  by  the  courts  differs 
from  the  one  shown,  requiring  first  a  smnmary  of  the  entire 
matter,  while  full  particulars  are  contained  in  supporting 
schedules,  designated  A,  B,  C,  etc.  In  every  case  it  is  of  course 
required  that  the  matter  shall  be  set  forth  logically  and  clearly. 
In  many  states  there  are  no  specific  requirements  regarding  the 
form  in  which  the  accounts  of  receivers  shall  be  rendered,  the 
only  insistence  being  that  they  shall  be  true  and  readily 
intelligible.  Generally  speaking,  it  may  be  said  that  the  reports 
of  receivers  are  primarily  reports  of  the  handling  of  cash,  its 
receipt  and  its  disbursement. 

1312 


Ch.  3o]  RECEIVERSHIP  AND  REORGANIZATION  13 13 

§  301.    The  Company's  Accounts  during  Receivership 

The  general  books  of  an  embarrassed  company  may  be  ad- 
justed to  meet  the  new  condition  of  affairs,  but  in  most  cases  they 
are  continued  as  usual  until  it  is  known  what  is  to  become  of  the 
company.  If  they  are  to  be  kept  in  harmony  with  the  accounts 
of  the  receiver,  adjusting  entries  may  be  made,  one  of  which 
would  charge  the  receiver  with  the  assets  taken  over  by  him.i 
The  debit  balance  to  the  receiver's  accourit  will  stand  until  the 
end  of  the  receivership. 

Upon  termination  of  the  receivership,  when  the  assets  and 
liabilities  as  then  existing  are  turned  back  to  the  company,  as- 
suming that  business  is  to  be  continued,  entries  must  be  made 
debiting  the  asset  accounts  and  crediting  the  receiver  with  what 
he  turns  back.  The  receiver's  balance  will  at  that  time  be  either 
greater  or  less  than  the  amount  originally  shown,  and  the  differ- 
ence must  then  be  adjusted  into  Surplus.  This  difference  will  be 
the  result  of  loss  or  gain  during  the  receivership. 

If  the  capital  has  undergone  certain  changes,  which  is  usually 
the  case,  suitable  adjusting  entries  must  be  made  to  bring  it  into 
harmony  with  present  conditions  as  reflected  in  the  receiver's 
final  ofl&cial  report. 

§  302.    Statement  of  Affairs  r;MoT- 

As  soon  as  the  receiver  is  appointed,  he  is  required  to  make  an 
inventory  and  appraisement  of  the  estate,  showing  the  exact 
condition  of  the  insolvent  corporation.  This  is  known  as  a 
"statement  of  affairs,"  and  is  made  in  the  simplest  way  possible 
for  the  convenience  of  both  court  and  creditors.  With  the  state- 
ment of  affairs  is  frequently  presented  a  "deficiency  statement,  "2 
showing  the  company's  capital  impairment  and  how  the  deficit 
came  about.  I;;il  J'jn 

A  statement  of  affairs  is  somewhat  similar  to  a  balance  sheet. 
It  is  prepared  from  the  books,  schedules,  creditors'  claims,  etc.. 


■  See  I  314- 
» See  I  334. 


13 14  CORPORATE  ACCOUNTING  [Bk.  III- 

and  contains  on  one  side  all  liabilities,  distinguishing  between 
those  which  are  unsecured,  partially  secured,  or  fully  secured. 
Contingent  liabilities  should  also  be  shown  among  the  liabilities. 

On  the  other  side,  the  assets  of  the  concern  are  shown  at 
their  nominal  or  book  value,  and  also  at  the  value  which  they 
are  expected  to  realize.  Any  assets  which  have  been  ^ven  or 
pledged  as  security  for  creditors'  claims  are  separated  from  those 
which  are  available  for  distribution  among  the  unsecured  credi- 
tors. The  difference  between  the  two  sides  of  the  statement 
shows  either  the  nominal  net  surplus  or  net  deficiency. 

The  receiver,  or  his  accountant,  prepares  the  statement  of 
affairs  from  information  gleaned  from  the  various  sources  open 
to  him,  and  submits  it,  together  with  the  complementary 
deficiency  statement,  to  the  meeting  of  creditors.  He  submits 
also  his  inventory  and  appraisement  to  the  court  for  record  in 
the  court  journal.  It  is  apparent  that  the  receiver  should 
either  be  an  accountant  himself,  or  should  engage  the  services 
of  an  accountant  for  the  determination  of  the  company's  condi- 
tion and  for  compiling  the  many  various  details  that  will  be  found 
necessary  in  preparing  his  statements. 

§  303.    Illustration  of  Statement  of  Affairs  ^ 

To  illustrate  receivership  records  and  accounts,  let  us  assume 
that  the  Excelsior  Harvester  Company,  unable  to  meet  its  obliga- 
tions, was  placed  in  the  hands  of  a  receiver  on  July  i,  192 1.  A 
statement  of  affairs  prepared  for  it  is  given  below. 
)  It  will  be  noted  that  equities  only  are  shown  in  the  statement 
of  appraisal,  all  secured  liabilities  being  deducted  from  the 
assets  pledged  or  mortgaged.  Bonds  and  cash  held  by  the 
trustee  are  deducted  from  the  corresponding  liability,  and  that 
net  liability  from  the  value  of  the  mortgaged  asset.  In  the 
same  way  the  collateral  trust  bonds  are  deducted  from  the  value 
of  the  pledged  securities. 


»  other  examples  will  be  found  in  55  312,  320,  323  and  333-     Attention  is  especially  called 
to  the  example  in  {  333- 


Ch.  3o]  RECEIVERSHIP  AND  REORGANIZATION  13 15 

Statement  of  Excelsior  Harvester  Company 
At  beginning  of  Receivership,  July  i,  1921 

Assets  Book  Appraised 

Value  Value 

Real  Estate,  Plant,  etc $12,136,500 

Less:  Reserve  for  Depreciation 897,510 


$11,238,990 
Less:  First  Mortgage  Bonds.  .  .  $6,500,000 
Reduced  by:  Cash  and  Bonds 
in  hands  of  Trustee 2,296,200      4,203,800 


Company's  Equity $7,035,190    $  6,435,190 

Investments  in  Affiliated  Companies $  4,500,000 

Less:     Collateral    Trust    Bonds    Secured 

thereby 4,000,000 


Company's  Equity 500,000         

Merchandise  Inventory 2,178,960  2,100,000 

Accounts  Receivable 3,245,140  3,200,000 

Notes  Receivable  * 2,862,100  2,440,100 

Cash  on  Hand  and  in  Banks 97Sf85o  945,850 


Total $16,797,240    $15,121,140 


Liabilities  Book  Appraised 

Value  Value 

Bank  Loans  Unsecured $     500,000  $     500,000 

Notes  Payable 1,490,500  1,490,500 

Accounts  Payable 2,375,640  2,375,640 

Accrued  Charges 328,250  328,250 

Liability  on  Notes  under  Discount  (estimated) 60,000 


Total  Unsecured  Liabilities $  4,694,390    $  4,754,390 

Surplus 2, 102,850 

Capital  Stock — Preferred  7%  Cumulative 5,000,000 

Capital  Stock — Common 5,000,000 

Balance — Excess  of  Assets  over  Liabilities,  being  the 

Net  Worth  of  the  Corporation 10,366,750 


Total $16,797,240    $15,121,140 

*  Notes  under  discount  at  bank,  $400,000  additional. 


I3l6  CORPORATE  ACCOUNTING  [Bk.  III- 

§  304.     Result  of  Receiver's  Appraisal 

Upon  his  appointment,  July  i,  1921,  the  receiver  made  an 
appraisement  and  statement  of  the  company's  affairs  and  filed 
his  inventory  with  the  court.  It  revealed  the  following  con- 
ditions, all  of  which  are  included  in  the  above  statement: 

1.  That   the   real  estate   and  plant  valuation   should    be 

reduced  $600,000. 

2.  That  the  investments  had  declined  $500,000  below  the 

book  value  stated. 

3.  That  the  merchandise  inventory  should  be  reduced  to 

$2,100,000. 

4.  That  the   accounts  receivable  would  probably   realize 

$3,200,000. 

5.  That  notes  receivable  were  doubtful  to  the  extent  of 

$422,000. 

6.  That  $60,000  of  the  notes  under  discount  were  likely  to 

be  dishonored. 

7.  That  $30,000  for  dishonored  notes  of  a  customer  had 

been  charged  to  the  company's  account  by  the  bank. 

§  305.    The  Receiver's  Activities 

The  receivership  was  terminated  December  31,  192 1,  at  which 
time  a  reorganization  took  place.  The  statement  of  the  re- 
ceiver at  the  date  of  his,  withdrawal,  after  a  tenure  of  six  months, 
is  shown  herewith.  It  contains  the  adjustments  suggested  in 
his  statement  to  the  court,  in  addition  to  the  following  trans- 
actions carried  out  during  his  incumbency : 

I.'  $1,200,000  of  6%  receiver's  certificates  were  issued,  due 
in  four  months,  dated  August  i,  and  sold  at  98. 

2.  Building   extensions   previously    commenced    were,    by 

order  of  the  court,  completed  at  a  cost  of  $500,000. 

3.  The  factory  was  kept  running  at  a  considerable  reduction 

in  capacity. 


Ch.  3o]  RECEIVERSHIP  AND  REORGANIZATION  1317 

4.  Goods  were  sold  from  stock  for  cash  at  the  best  prices 

obtainable,  bringing  in  $287,680. 

5.  $1,724,440  of  the  accounts  receivable  were  collected. 

6.  There  was  collected  also  $1,050,880  of  the  notes  receiv- 

able, of  which  $75,000  applied  to  notes  written  ofT  as 
doubtful. 

7.  Accrued  charges  were  paid  for  taxes  and  labor  of  $81,100. 

8.  Material  for  use  in  factory  amounting  to  $268,200  was 

purchased  for  cash. 

9.  Various  expenses  paid  in  cash  amounted  to  $76,500,  legal 

fees  $22,500,  and  the  amount  drawn  by  the  receiver 
under  authority  of  the  court,  $10,000. 

§  306.    Accounting  Procedure 

In  some  cases  the  receiver  chooses  to  use  the  books  of  the 
company  as  the  means  of  recording  his  own  operations,  but  this 
is  not  considered  the  best  practice.  The  receiver's  records 
should  be  independent,  although  frequently  when  he  retains  the 
accounting  staff  of  the  company  it  is  found  simplest  to  keep  the 
receiver's  records  in  the  loose-leaf  binders  which  have  been  used 
by  the  company.  This  does  not  at  all  interfere  with  their  being 
independent  records. 

As  a  general  thing  the  books  of  the  receiver  as  he  opens  them 
do  not  show  the  liabilities  of  the  company  until  proper  proofs  of 
claim  have  been  filed  with  the  receiver  and  have  been  allowed  by 
him.  The  inventory  upon  which  the  receiver's  accounts  begin 
is  an  inventory  of  assets  only.-'  Debts  appear  only  through  their 
payment  or  their  allowance  by  the  receiver  in  case  he  wishes  to 
show  on  the  books  the  claims  which  he  has  allowed. 

§  307.    Receiver's  Entries  on  Taking  Charge 

The  appraisal  and  audit  of  July  i,  1921,  made  by  the  receiver 
shows  a  reduction  of  $1,676,100  in  the  value  of  the  assets  below 


•  Cf.  Wills,  Estates  and  Trusts,  by  Conyngton,  Knapp  and  Pinkerton,  p.  588. 


13 1 8  CORPORATE  ACCOUNTING  [Bk.  III- 

the  figures  at  which  they  have  been  carried  on  the  books.     This 
amount  is  made  up  of  the  following  reductions  in  value: 

Real  Estate  and  Plant.  . $  6cx>,ooo 

Investments 5ck3,ocx3 

Merchandise 78,960 

Accounts  Receivable 45,140 

Notes  Receivable 422,000 

Cash  in  Banks 30,000 

$1,676,100 

The  receiver  opens  his  separate  books  by  making  in  his  jour- 
nal an  entry  setting  up  these  assets  at  the  appraised  value.  In 
order,  however,  that  notes  and  accounts  receivable  appraised  at 
nothing  or  at  less  than  their  par  may  not  be  lost  sight  of,  the 
entire  previous  book  value  of  such  items  is  entered,  and  an 
"Allowance  for  Doubtful  Receivables"  account  is  set  up  for  the 
difference.  By  this  method  the  subsidiary  ledgers  will  show  all 
the  receivables  and  continued  efforts  vdll  be  made  to  collect 
them.  The  failure  to  realize  upon  those  which  were  considered 
bad  will  not,  however,  reflect  upon  the  receiver  inasmuch  as  he 
took  them  over  at  less  than  par.  The  dishonored  note  which 
had  been  deposited  by  the  company  before  the  receiver  took 
charge  is  likewise  entered  as  a  receivable,  and  included  in  the 
amount  of  the  reserve. 

The  deposits  of  cash  and  securities  with  the  trustee  of  the 
sinking  fund  and  the  securities  for  the  collateral  trust  bonds  are 
omitted  from  the  assets  with  which  the  receiver  charges  himself, 
as  they  have  gone  out  of  the  control  of  the  conipany  and  are  in 
the  hands  of  the  trustee  for  a  specific  purpose,  s 

As  an  offset  to  the  value  of  all  the  assets  taken  over  by  the 
receiver,  he  credits  Excelsior  Harvester  Company  with  the  ap- 
praised value  of  these  assets. 

The  receiver's  opening  entry  is  as  follows: 

Real  Estate,  Plant,  etc $6,435,190 

Merchandise  Inventory 2,100,000 

•  c/.  { 302. 


Ch.  30] 


RECEIVERSHIP  AND  REORGANIZATION 


1319 


Accounts  Receivable 3,245,140 

Notes  Receivable 2,892,100 

Cash  on  Hand  and  in  Banks 945,850 

To  Allowance  for  Doubtful  Receivables $     497,140 

Excelsior  Harvester  Company 15,121,140 

To  record  appraised  values  of  assets  and  liabilities  of 
the  Excelsior  Harvester  Company,  in  receivership, 
taken  over  this  day  by  decree  of  the  Court. 

§  308.    Entry  of  Receiver's  Transactions 

The  receiver  then  opens  such  nominal  accounts  for  Sales,  etc., 
as  are  necessary  to  record  the  transactions  which  occur  during 
his  incumbency  of  the  office.  In  order  to  make  the  record  as 
short  as  possible  for  purposes  of  the  explanation,  almost  all 
expense  items  are  lumped  into  one  Expenses  account.  Sufl&cient 
accounts  should  of  course  be  maintained  on  the  books  to  provide 
a  complete  classification. 

The  receiver  must  keep  a  strict  record  of  all  business  activities 
in  order  that  he  may  give  a  correct  account  of  them  to  the  court. 
Most  of  the  entries  will  be  made  in  the  cash  book,  though  certain 
of  them  will  properly  be  contained  in  the  journal.  The  result 
of  the  cash  entries  is  summarized  as  follows : 

Receiver's  Cash  Account 

(Being  a  record  of  his  transactions  from  July  i,  1921, 

to  December  31,  1921) 


Receipts 
Balance    Turned    over    to 

Receiver $   945,850 

Receiver's  Certificates 1,200,000 

Merchandise  Sales 287,680 

Accounts  Receivable 1,724,440 

Notes  Receivable 975,880 

Notes  Receivable  (Doubtful)  75 ,000 


$5,208,850 


Payments 

Discount  on  Receiver's 

Certificates 

Real  Estate  Operations.  . . . 

Accrued  Charges 

Merchandise  Purchases .... 

Expenses 

Legal  Expenses 

Salary  of  Receiver 

Receiver's  Certificates  Paid . 

Interest  on  above 

Balance  of  Cash  on  Hand . . 


^     24,000 

500,000 

81,100 

268,200 

76,500 

22,500 

10,000 

1,200,000 

24,000 

3,002,550 

$5,208,850 


13  20  CORPORATE  ACCOUNTING  [Bk.  III- 

In  addition  to  the  cash  entries  summarized  above,  the 
receiver  has  regularly  made  journal  entries  which  may  be  con- 
densed into  the  following: 

Excelsior  Harvester  Company $4i7S4»390 

To  Claims  Allowed $4,754,390 

Recording  claims  properly  presented  to  receiver  and 
regularly  allowed. 

Merchandise  Inventory *       $50,000 

Cost  of  Sales 218,200 

To  Merchandise  Purchases .  $268,200 

Bringing  Merchandise  Inventor>'  account  to  proper 
figure  and  charging  balance  of  purchases  into  Cost 
of  Sales. 

Allowancefor  Doubtful  Receivables. $75,000 

To  Recoveries  on  Doubtful  Receivables $75,000 

Charging  against  reserve  amount  collected  on 
doubtful  note  of 

Since  a  reorganization  of  the  company  is  expected  to  take 
place  under  a  reorganization  committee,  the  receiver  has  not 
made  any  settlement  disbursements  beyond  certain  preferred 
claims  shown  on  the  opening  statement  of  affairs  as  accrued 
charges. 

§  309.     Summary  of  Receiver's  Transactions 

When  all  the  above  transactions  have  been  posted  to  the 
ledger,  the  trial  balance  of  the  receiver's  books  before  closing  on 
December  31,  1 9 2 1 ,  is  as  follows : 

Trial  Balance,  December  31,  1921 

Dr.  Cr. 

Real  Estate,  Plant,  etc ^  6,935,190 

Merchandise  Inventory 2,150,000 

Accounts  Receivable 1,520,700 

Notes  Receivable 1,841,220 

Cash  on  Hand  and  in  Banks 3,002,550 

Allowance  for  Doubtful  Receivables $     422,140 

Excelsior  Harvester  Company 10,366,750 


Ch.  3o]  RECEIVERSHIP  AND  REORGANIZATION"  1321 

Claims  Allowed 4,673,290 

Discount  on  Receiver's  Certificates 24,000 

Cost  of  Sales 218,200 

Expenses 76,500 

Salary  of  Receiver 10,000 

Legal  Expenses 22,500 

Interest  on  Receiver's  Certificates 24,000 

Merchandise  Sales 287,680 

Recoveries  on  Doubtful  Receivables 7S.ooo 

$15,824,860    $15,824,860 


§  310.    Receiver's  Closing  Entries 

At  the  termination  of  his  activities  and  before  the  reorgani- 
zation takes  place,  the  receiver  closes  his  ledger  to  determine  the 
status  of  the  receivership.  Below  are  given  the  various  entries 
to  close  the  loss  and  gain  accounts. 

.>rj  «>j  binq 
Merchandise  Sales $287,680 

To  Cost  of  Sales $218,200 

Profit  and  Loss 69,480 

Closing  merchandising  accounts  and  showing  gross 

profit  on  sales. 

Recoveries  on  Doubtful  Receivables $75,000 

To  Profit  and  Loss $75,000 

Closing  former  account  to  show  gain  on  realiza 
tion  over  appraised  value  of  assets. 

Profit  and  Loss $157,000 

To  Discount  on  Receiver's  Certificates $24,000 

Expenses 76,500 

Salary  of  Receiver 10,000 

Legal  Expenses 22,500 

Interest  on  Receiver's  Certificates 24,000 

Closing  expense  accounts. 

Excelsior  Harvester  Company $12,520 

To  Profit  and  Loss $12,520 

Charging  the  net  loss  of  period  against  the  value 
taken  over  by  the  receiver. 


1322  CORPORATE  ACCOUNTING  [Bk.  IH- 

AUowance  for  Doubtful  Receivables $     422,140 

Claims  Allowed 4,673,290 

Excelsior  Harvester  Company 10,354,230 

To  Real  Estate,  Plant,  etc $6,935,190 

Merchandise  Inventory 2,150,000 

Accounts  Receivable 1,520,700 

Notes  Receivable. 1,841,220 

Cash  on  Hand  and  in  Banks 3,002,550 

Closing  the  books  of  the  receiver  and  showing  the 
assets  and  liabilities  turned  back  to  Excelsior 
Harvester  Company. 

§  311.    Receiver's  Statement  to  the  Court 

The  receiver  may  present  to  the  court  only  one  account  or 
statement,  known  as  the  "j&rst  and  final  account,"  or  he  may 
present  several.  An  auditor  is  usually  appointed  by  the  court 
to  audit,  examine,  vouch,  and  pass  upon  the  receiver's  accounts 
in  detail  and  to  report  to  the  court  before  distributions  are 
made,  or  dividends  paid  to  creditors.  The  auditor  causes  an 
advertisement  to  be  placed  in  the  papers,  giving  notice  that  he 
will  sit  on  a  certain  date  to  receive  claims  and  hear  complaints 
on  the  audited  statement.  The  hearing  may  even  be  adjourned 
one  or  more  times.  The  auditor  generally  makes  up  a  statement 
of  his  own  from  that  presented  by  the  receiver,  though  it  is 
usually  briefer  and  may  even  be  only  a  summary  of  the  receiver's 
transactions.  It  recites  in  brief,  as  a  rule,  the  activities  of  the 
receiver  as  an  introduction  to  the  audited  statement,  all  of  which 
is  later  filed  with  the  court,  to  be  kept  as  a  permanent  record. 

The  following  is  usually  a  satisfactory  form  for  the  general 
statement  of  account  rendered  by  the  receiver,  but  it  should  be 
remembered  that  some  of  the  states  have  specific  forms  estab- 
lished by  statute  which  are  required  to  be  filled  out.  Persons 
dealing  with  particular  judges  in  matters  having  to  do  with 
several  receiverships  learn,  too,  that  some  one  form  is  more 
satisfactory  to  a  certain  judge  than  is  another  form,  and  that  the 
favor  of  the  court  can  best  be  secured  by  submitting  the  report  in 
a  form  most  intelligible  to  and  best  liked  by  that  judge. 


Ch.3o]  RECEIVERSHIP  AND  REORGANIZATION  1323 

First  and  Final  Account  of  the  Receiver  for 

Excelsior  Harvester  Company 

December  31,  1 92 1 

Debits 

The  Receiver  Charges  Himself  as  Follows: 

Inventory  and  Appraisement  of  Assets  taken  over  July  i, 
1921: 

Equity  in  Real  Estate,  Plant,  etc $6,435,190 

Equity  in  Investments  of  Subsidiary  Companies (none) 

Merchandise  Inventory 2,100,000 

Accounts  Receivable 3,200,000 

Notes  Receivable 2,440,100 

Cash  on  Hand  and  in  Banks 945,850 

Total  Assets  taken  over $15,121,140 

Additions  to  Capital: 
For  Outlay  Increasing  Value  of  Real  Estate  and  Prop- 
erties    $    500,000 

Increase  in  Cash,  per  Cash  Account 2,056,700 

Increase  in  Value  of  Merchandise 50,000 

Total  Increase  in  Assets 2.606,700 

Total  Debits $17,727,840 

Credits 
The  Receiver  Credits  Himself  as  Follows: 

Claims  Allowed  and  Not  Paid,  as  per  schedule $4,673,290 

Assets  Realized  and  Collected  as  Follows: 

Accounts  Receivable  Collected $1,724,440 

Notes  Receivable  Collected 975,880 

Total  Realization 2,700,320 

Total  Credits 7i373.6io 

Present  Accountability $10,354,230 

This  general  statement  must  be  supported  by  exhibits  and 
schedules,  among  which  will  usually  be  found  a  balance  sheet,  a 


1324  CORPORATE  ACCOUNTINc;  [Bk.  Ill- 

statement  of  profit  and  loss  from  operations  (in  this  case  trading) , 
a  summary  of  the  cash  account,  and  lists  of  claims  allowed  but 
not  paid  and  of  claims  allowed  and  paid.  Satisfactory  forms  for 
the  more  important  of  these  are  presented  in  the  following 
sections  and  in  the  next  chapter. 

§  312.     Statement  of  Affairs  at  Termination  of  Receivership 

As  a  result  of  all  his  transactions,  the  receiver's  balance  sheet 
at  the  time  of  closing  will  appear  as  follows : 

Financial  Statement  of  Receiver  for 

Excelsior  Harvester  Company 

At  Termination  of  Receivership  Jurisdiction, 

December  31,  1921 

Assets 

Real  Estate,  Plant,  etc $12,036,500 

Less:  Resen'e  for  Depreciation. 897,510 

$11,138,990 

Less:  First  Mortgage  Bonds $6,500,000 

Reduced  by:  Cash  and  Bonds  in  hands  of 

Trustee 2,296,200      4,203,800 

Receiver's  Equity $  6,935,190 

Investments  of  Affiliated  Companies $  4,000,000 

Less:  Collateral  Trust  Bonds  Secured  thereby. 4,000,000 

Receiver's  Equity (none) 

Merchandise  Inventory . 2,150,000 

Accounts  Receivable - 1,475,560 

Notes  Receivable  * 1,464,220 

Cash  on  Hand  and  in  Banks 3,002,550 

Total $15,027,520 

Liabilities 

Bank  Loans  Unsecured $    500,000 

Notes  Payable 1,490,500 

*  Notes  under  discount  at  bank,  $400,000  additional. 


Ch.  30]  RECEIVERSHIP  AND  REORGANIZATION  1325 

Accounts  Payable 2,375,640 

Accrued  Charges 247,150 

Claims  on  Notes  under  Discount . ' 60,000 


Total  Liabilities t/z-H-  -^m-  V- 4,673,290 

Receiver's  Equity,  Excess  of  Assets  over  Liabilities $10,354,230 


§313.    Other  Exhibits  and  Schedules  -•"* 

The  statement  of  profit  and  loss  and  the  lists  of  claims  need 
not  be  given  here,  as  they  present  no  unusual  difficulties.  The 
summary  of  the  cash  account  may  be  in  the  form  given  in  §  308, 
or  the  opening  balance  and  later  receipts  may  be  listed  at  the  top 
of  the  page  and  the  disbursements  at  the  bottom,  the  total  of  the 
latter  being  subtracted  from  the  total  of  the  former  to  obtain  the 
closing  balance. 

A  schedule  which  it  is  always  wise  to  append  is  an  analysis 
of  the  receiver's  equity,  or  his  account  with  the  company  for 
which  he  is  acting  as  receiver.  This  acts  in  a  way  as  a  recon- 
ciliation of  certain  supporting  schedules  with  the  balance  sheet, 
and  may  be  in  the  following  form : 

Analysis  of  Receiver's  Equity 

Equity  at  begmnmg  of  receivership $15,121,140 

Loss  from  operations $      1 2,520 

Claims  allowed l-JfrttmH* 4,754,39o 

Total  deductions ^:)'. . .  ':..:.. .  r.i.. T 4,766,910 


Equity  at  termination  of  receivership $10,354,430 

§  314.     Adjustment   of   Company's   Books   on   Appointment   of 
Receiver 

The  books  of  the  embarrassed  company  are  frequently  left 
in  the  condition  that  prevailed  when  the  receivership  began.  In 
that  case  no  entries  of  any  kind  are  made  until  the  time  of  reor- 
ganization, when  the  abandoned  accounts  may  be  adjusted  to  the 


1326  CORPORATE  ACCOUNTING  [Bk.  ni- 

ne W  conditions.  Sometimes  it  may  be  thought  advisable,  how- 
ever, to  adjust  the  accounts  at  both  the  beginning  and  end  of 
receivership  jurisdiction.  This  is  assumed  to  have  been  done 
with  the  books  of  the  Excelsior  Harvester  Company. 

By  referring  to  the  appraisement,  it  will  be  seen  that  numer- 
ous adjustments  of  values  were  made.  The  losses  sustained 
thereby  should  be  adjusted  into  Surplus  account  in  order  to 
bring  the  ledger  into  agreement  with  the  property  valuations 
taken  over  by  the  receiver. 

§  315.    Entries  to  Adjust  Asset  Values 

Shrinkages  in  asset  values  as  shown  by  the  appraisement  are 
adjusted  through  the  following  entry  on  the  books  of  the  com- 
pany: ■'  ■''   '■  '  "'''''-  '•-----■ 

July  I,  1921 

Surplus ' ,.,. $1,736,100 

To  Real  Estate,  Plant,  etc. .  .  :<:•.  TJ^K ,iV. ; /J}i.. .  $600,000 

Investments .!..•.':•..;. ... . .  500,000 

Merchandise,  etc 78,960 

Accounts  Receivable 4Sii40 

Notes  Receivable 422,000 

Cash 30,000 

Notes  under  Discount 60,000 

To  adjust  losses  and  shrinkage  in  assets,  per  appraise- 
ment of  receiver. 

It  will  be  seen  that  this  adjustment  reduces  the  surplus  of  the 
company  from  $2,102,8506  to  $366,750,  which  with  the  capital 
stock  of  $1,000,000  makes  up  the  net  worth  of  $1,366,750  shown 
in  the  appraisal. 

Closing  entries  should  then  be  made,  charging  the  receiver 
with  the  equity  in  the  assets  taken  over,  as  follows: 

.  r    .,  ,  July  1. 1921 

Receiver.  . '.'.... $15,121,140 

To  Real  Estate,  Plant,  etc $6,435,190 

Merchandise  Inventory 2,100,000 

*  As  shown  in  {  303. 


Ch.  30]  RECEIVERSHIP  AND  REORGANIZATION  1327 

Accounts  Receivable 3,200,000 

Notes  Receivable. 2,440,100 

Cash  on  Hand  and  in  Banks 945,850 

To   record    transfer  of   Company's   assets   to   the 
receiver,  as  per  order  of  the  Court. 

The  receiver's  account  in  the  company's  ledger  now  shows  a 
debit  balance  of  $15,121,140,  corresponding  with  the  amount  of 
his  account  with  the  company  in  the  receiver's  ledger. 

The  company's  accounts  after  transferring  the  assets  to  the 
receiver  appear  as  follows: 

Trial  Balance,  July  i,  1921 

Receiver $15,121,140 

Real  Estate,  Plant,  etc 5,101,310 

Sinking  Fund  Investments 2,000,000 

Sinking  Fund  Cash 296,200 

Investments  in  Affiliated  Companies. . . .  '.'.".l'^.'.  i^-^^/?. . .     4,000,000 

Reserve  for  Depreciation .!  1 ..;;.;.: .  $     897,510 

First  Mortgage  Bonds  Outstanding 6,500,000 

Collateral  Trust  Bonds  Outstanding 4,000,000 

Bank  Loans  Unsecured 500,000 

Notes  Payable i ,'!,,' i! '4 1,490,500 

Accounts  Payable .-...► 2,375,640 

Accrued  Charges 328,250 

Notes  under  Discount 60,000 

Capital  Stock — Preferred 5,000,000 

Capital  Stock — Common 5,000,000 

Surplus 366,750 

$26,518,650    $26,518,650 


§  316.    Entry  of  Claims  Approved  by  the  Receiver 

Under  the  above  plan  the  liabilities  are  not  credited  to  the 
receiver  on  the  company's  books.  It  is,  however,  usually 
thought  advisable  to  credit  him  with  them  as  he  reports  to  the 
court  that  he  has  approved  the  claims,  thus  keeping  the  com- 
pany's account  with  the  receiver  in  accord  with  the  receiver's 
account  with  the  company.  Such  an  entry  would  be  in  the 
following  form:  .cuiqiut  oJai  i  til  bnv.  .ftoJ  Dnn  liXo-i  ' 


1328  CORPORATE  ACCOUNTING  [Bk.  III- 

Biank  Loans  Unsecured $    500,000 

Notes  Payable 1,490,500 

Accounts  Payable 2,375,640 

Accrued  Charges 328,250 

Notes  under  Discount 60,000 

To  Receiver $4,754,390 

Crediting  receiver  with  claims  allowed  by  him  and 
closing  those  accounts  on  the  Company's  books. 

After  the  liabilities  have  been  credited  to  the  receiver's  ac- 
count, entry  will  be  made  of  claims  paid  by  the  receiver  until  the 
assets  and  liabilities  are  taken  back  on  the  company's  books. 

§  317.    Entry  of  Receiver's  Profit  or  Loss 

In  order  to  preserve  the  completeness  of  the  company's  own 
records,  it  is  good  practice  to  enter  on  the  company's  books  the 
gain  or  loss  shown  by  each  report  approved  by  the  court,  so  that 
following  each  such  report  the  Receiver  account  on  the  com- 
pany's books  will  still  equal  the  amount  shown  by  the  receiver's 
account  with  the  company.  This  entry  would  be  taken  from  his 
operating  statement,  and  in  the  present  instance  would  be  as 
follows : 

Discount  on  Receiver's  Certificates $  24,000 

Cost  of  Sales 218,200 

Expenses 76,500 

Salary  of  Receiver 10,000 

Legal  Expenses 22,500 

Interest  on  Receiver's  Certificates 24,000 

To  Merchandise  Sales $287,680 

Recoveries  on  Doubtful  Receivables 7S.ooo 

Receiver 12,520 

Recording  operations  of  the  receiver  and  crediting  his 
account  with  the  loss  sustained. 

Entries  of  this  type  would  be  allowed  to  accumulate  on  the 
books  until  the  close  of  the  corporation's  fiscal  period,  or  such 
other  time  as  it  seemed  desirable  to  close  the  books,  when  the 
income  and  expense  accounts  so  opened  would  be  closed  into 
Profit  and  Loss  and  that  account  into  Surplus.     In  the  present 


Ch.  3ol  RECEIVERSHIP  AND  REORGANIZATION  1329 

instance,  of  course,  if  the  company's  ordinary  book-closing  date 
is  December  31,  the  entry  made  above  would  be  immediately 
reversed,  except  that  the  $12,520  credited  to  the  receiver  in  the 
entry  would  in  the  reversal  be  debited  to  the  Profit  and  Loss 
account. 

.ml: 

§  318.    Entry  at  Close  of  Receivership 

It  is  not  ordinarily  advisable  for  the  rompany  to  take  the 
assets  back  into  its  ledger  accounts  until  the  reorganization  takes 
place.  At  that  time  the  various  adjustments  should  of  course 
be  made  in  order  to  reopen  the  ledger  in  harmony  with  the 
reorganized  conditions.  If  it  is  thought  desirable,  however,  to 
take  the  assets  and  liabilities  as  shown  by  the  receiver's  final 
statement  into  the  company's  ledger  accounts,  with  the  idea  of 
making  reorganization  adjustments  later,  the  journal  entry 
would  be : 

Real  Estate,  Plant,  etc $7,832,700 

Merchandise  Inventory 2,150,000 

Accounts  Receivable 1,475,560 

Notes  Receivable 1,464,220 

Cash 3,002,550 

To  Bank  Loans  Unsecured $      500,000 

Notes  Payable 1,490,500 

Accounts  Payable 2,375,640 

Accrued  Charges 247,150 

Reserve  for  Depreciation 897,510 

Notes  under  Discount 60,000 

Receiver 10,354,230 

To  record  existing  assets  and  liabilities  on  books  of  the 
Company  on  termination  of  receivership  (preceding 
the  reorganization  adjustments). 

The  Surplus  account  now  shows  a  credit  balance  of  $354,230, 
thus  indicating  a  heavy  shrinkage  as  a  result  of  the  receivership 
and  its  resulting  destruction  of  values.  After  the  reorganization 
takes  place,  these  ledger  accounts  will  of  course  be  readjusted  to 
harmonize  with  the  new  conditions  as  adopted  by  the  committee 
of  reorganization. 


I330  CORPORATE  ACCOUNTING  [Bk.  IH- 

In  the  case  of  railways  and  public  utilities,  there  is  good  reason 
for  keeping  the  company's  books  continuously  during  the  re- 
ceivership regardless  of  the  receiver's  records,  since  it  is  usually 
a  foregone  conclusion  that,  because  of  their  necessary  service  to 
the  community,  they  will  continue  operations  as  usual,  both 
during  and  subsequent  to  the  receivership  jurisdiction. 


CHAPTER  XXXI 
RECEIVERSHIP  AND  SALE 

§  319.    Introductory 

Reorganization  following  the  appointment  of  a  recei  /er  and 
the  necessary  accounting  procedure  have  been  set  forth  in  the 
preceding  chapter.  If,  as  may  happen,  a  reorganization  cannot 
be  effected,  it  becomes  the  duty  of  the  receiver  to  sell  sufficient 
of  the  property  to  pay,  first,  the  expenses  of  the  receivership 
and  sale,  and  second,  the  creditors  of  the  corporation.  He  is 
not  required  to  sell  all  the  assets  if  the  sale  of  only  a  part  will 
place  the  corporation  in  a  solvent  condition.  If  he  does  not 
sell  all  the  assets,  the  remainder  will  revert  to  the  corporation, 
or  if  any  cash  remains  from  the  piroceeds  of  those  he  does  sell, 
the  corporation  will  be  entitled  to  it. 

In  the  example  which  is  presented  the  same  general  prin- 
ciples which  were  set  forth  in  the  preceding  chapter  will  of  course 
apply,  but  in  order  to  present  another  method  of  handling  the 
transactions  it  will  be  assumed  in  this  case  that  the  receiver 
makes  his  entries  on  the  books  of  the  bankrupt  company  instead 
of  opening  a  new  set. 

§  320.    Statement  of  Affairs 

The  Willis  Grocery  Company  was  placed  in  the  hands  of  a 
receiver  on  April  i,  1922,  at  the  request  of  creditors.  William 
Hart  was  appointed  receiver  with  full  authority  to  continue  the 
business  under  court  supervision  and  to  conserve  the  company's 
property,  in  the  hope  of  effecting  a  favorable  settlement  with  the 
creditors.  Following  is  the  statement  of  affairs  prepared  by  the 
receiver: 


1331 


1332  CORPORATE  ACCOUNTING  [Bk.  III- 

StATEMENT   of   .\frAIRS 

Willis  Grocery  Company 
William  Hart,  Receiver 

.\PRIL    I,    1922 

Appraised    Shrink- 
Asscls  Book  Values  Values         age 

■  Buildings  and  Properties $50,000 

Less:  Mortgage 25,000 

Company's  Equity $  25,000     $  18,800  $  6,200 

Store  Equii)mcnt 10,000  8,000  2,000 

Delivery  Equipment 10,000  8,000  2,000 

Merchandise \  . . . . .'.  75,6oo  65,600  10,000 

Produce .''X  .'.'. .  ^?.';  ...... : . .'. .'. .  .'.v.!  1I1850  9,850  2,000 

Accounts  Receivable 85,410  81,140  4,270 

Notes  Receivable 12,500  10,700  1,800 

Bonds  of  Other  Corporations,  Pledged.  .    $25,000 
Less:  Liability  thereon 10,000 

Company's  Equity iS»ooo         12,000         3,000 

Cash 5,820  5,820       

$251,180     $219,910     $31,270 

General 
Liabilities                                               Book  Values  Claims 

Mortgage  Note  on  Real  Estate .c,'  .';fi  t  A.t »  a:;!.,  . .     $  25,000 
Deducted  Contra 25,000     mfVjaty  If/ 

Notes  Payable  Secured $  10,000 

Deducted  Contra 10,000     

Notes  Payable  Unsecured $  15,000  $  15,000 

Accounts  Payable 9I1460       91,460 

Capital  Stock $150,000 

Less:  Deficit 5,280 

Net  Worth 144,720     1 13,450 

$251,180  $219,910 


Ch.  31]  RECEIVERSHIP  AND  SALE  1333 

§  321.    Receiver's  Entries  on  Taking  Charge 

The  receiver  plans  in  this  case  to  record  his  operations  on  the 
books  of  account  used  previously  by  the  Willis  Grocery  Com- 
pany. Under  these  conditions  his  official  transactions  are 
entered  up  as  would  be  any  ordinary  business.  The  adjusting 
entries  to  harmonize  the  balances  in  the  accounts  with  the 
revised  statement  of  conditions  are  given  below.  The  plan  fol- 
lowed in  this  instance  might  not  apply  in  every  case,  but  it  is 
simple  and  can  be  readily  understood.  It  will  be  noted  that 
when  the  receiver  continues  to  use  the  corporation's  books  the 
liabilities  all  show  from  the  first. 

April  I,  1922 

Surplus  and  Deficit. .....; $31,270 

To  Merchandise $10,000 

Produce 2,000 

Accounts  Receivable 4,270 

Notes  Receivable 1,800 

Buildings  and  Properties 6,200 

Store  Equipment 2,000 

Delivery  Equipment 2,000 

Bonds  of  Other  Corporations 3,000 

To  record  the  shrinkage  in  asset  values  as  shown  by  ap- 
praisal, and  to  harmonize  the  balances  in  the  accounts 
with  the  receiver's  statement  of  affairs. 

The  ledger  now  shows  an  impairment  or  deficit  of  $36,550. 
With  an  outstanding  capital  of  $150,000,  this  leaves  an  equity  of 
only  $113,450.  The  Capital  Stock  and  Surplus  and  Deficit 
accounts  should  not  appear  in  the  receiver's  ledger  at  all,  and 
therefore  are  closed  out  by  journal  entry,  leaving  instead  a  credit 
balance  of  $113,450  to  Willis  Grocery  Company  account.  The 
required  journal  entry  would  be  as  follows : 

April  I,  1922 

Capital  Stock $150,000 

To  Surplus  and  Deficit $  36,550 

Willis  Grocery  Company 1 13,450 

To  close  the  Capital  Stock  and  Surplus  and  Deficit  ac- 
counts and  to  open  Willis  Grocery  Company  account  to 
show  the  receiver's  equity. 


1334 


CORPORATE  ACCOUNTING 


[Bk.  IIT- 


§  322.    Entries  to  Record  Operation  under  Receivership 

The  receiver,  after  complying  with  all  legal  requirements, 
continued  the  business  for  five  months  in  an  effort  to  put  the 
company  on  its  feet,  but  without  success.  His  transactions  up 
to  September  i  are  shown  below.  At  that  date  the  receiver 
reported  to  the  court  his  inability  to  make  the  business  suc- 
cessful. 

The  recording  of  the  receiver's  activities  would  be  made  in 
the  cash  book  and  journal.  The  cash  book  entries  are  sum- 
marized in  the  Cash  account  given  below  and  the  closing  journal 
entries  follow: 

Receiver's  Cash  Account 
April  i  to  September  i,  1922 


Receipts 
Balance  taken  over  April  i, 

1922 $    5,820 

Notes  Receivable 5.5°° 

Accounts  Receivable 22,640 

Sales  of  Merchandise S3. 75° 

Sales  of  Produce 24,800 


$112,510 


Disbursements 

Merchandise  Purchases $    9,620 

Produce  Purchases 13,110 

Payment  of  Wages 4,000 

Operating  Expenses 4.S00 

Expenses     and     Salary     of 

Receiver 1,500 

Total $  32,730 

Balance  in  Hands  of  Receiver  79,780 


$112,510 


Closing  Journal  Entries 

September  i,  1922 

Produce  Sales; $24,800 

Merchandise  Sales 53.75° 

To  Produce  Purchases 

Merchandise  Purchases 

Profit  and  Loss 

Recording  gross  profit  on  sales  of  produce  and  merchandise 
and  reducing  Purchases  accounts  to  present  inventory 
values. 


$20,460 

S3,220 

4,870 


Ch.  31]  RECEIVERSHIP  AND  SALE  1335 

Profit  and  Loss $10,000 

To  Wages $4,000 

Expenses 4,Soo 

Receivership  Expenses 1,500 

To  close  above  accounts  into  Profit  and  Loss. 

Willis'  Grocery  Company $  5,130 

To  Profit  and  Loss . .      $  5, 130 

To  close  Profit  and  Loss  account  into  Willis  Grocery  Com- 
pany account. 

§  323.    Receiver's  Statement  before  Sale 

The  posting  of  the  entries  above  furnishes  the  figures  for  the 

following  statement  as  of  September  i,   1922.     This  statement 

of  affairs,  when  presented  to  the  court,  would  probably  be 

supported   by   schedules  of   the   transactions  of  the  receiver 

(§333  f-)  or  the  court  might  not  wish  these  until  the  receiver 

was  ready  to  render  his  final  report.  .'t^a^sM  »rij  ^tJ  ^1«8     -^^i  '< 

Statement  of  Affairs 

Willis  Grocery  Company 

William  Hart,  Receiver 

September  i,  1922 

Assets 

Buildings  and  Properties • $43,800 

Less:  Mortgage  Thereon 25,000 

Company's  Equity ..T. '.!'..  ..I."...! $  18,800 

Store  Equipment ....;...... 8,000 

Delivery  Equipment 8,000 

Merchandise 22,000 

Produce 2,500 

Accounts  Receivable 58,500 

Notes  Receivable 5,200 

Bonds  of  Other  Corporations,  Pledged $22,000 

Less:  Liability  Thereon .,. .      10,000 

Company's  Equity 12,000 

Cash 79.780 

$214,780 


1336             CORPORATE  ACCOUNTING  [Bk.  III- 

Liabilities 

Mortgage  Note  on  Real  Estate $25,000 

Deducted  Contra 25,000        

Notes  Payable  Secured $10,000 

Deducted  Contra 10,000         

Notes  Payable  Unsecured .  . $  15,000 

Accounts  Payable 91,460 

Net  Worth 108,320 

$214,780 


As  the  capital  stock  is  $150,000  and  the  net  worth  but 
$108,320,  the  above  statement  shows  a  deficit  of  $41,680.  In 
other  words,  the  stockholders  have  $108,320  of  their  capital  left. 

§  324.     Sale  by  the  Receiver 

The  proposals  for  reorganization  which  have  been  made  have 
not  been  acceptable  to  the  unsecured  creditors  or  to  the  stock- 
holders, and  the  receiver  has  been  unable  to  secure  a  satisfactory 
offer  for  the  sale  of  the  business  as  a  going  concern.  On  Septem- 
ber I,  1922,  the  court  therefore  orders  him  to  dispose  of  the  stock 
of  merchandise  on  hand  and  discontinue  the  business.  This 
involves  the  collection  of  the  receivables  and  the  sale  of  a  suffi- 
cient quantity  of  the  other  assets  to  cover  the  liabilities  and  the 
expenses  of  receivership.  Any  remaining  assets  could  then  be 
returned  to  the  stockholders. 

In  this  case,  however,  the  stockholders  did  not  desire  to  con- 
tinue a  losing  business  with  impaired  capital,  and  therefore 
decided  to  dissolve  the  corporation,  directing  the  receiver  to  dis- 
tribute the  remaining  assets  direct  to  the  stockholders.  The 
court  made  its  order  to  the  same  effect,  and  in  accordance  there- 
with the  receiver  conducted  a  special  sale  to  dispose  of  the  mer- 
chandise and  produce,  selling  the  last  below  cost.  He  also 
secured  purchasers  for  the  fixed  assets- at  various  prices,  and  as 
he  collected  cash  he  proceeded  to  liquidate  the  liabilities.     His 


Ch.  31]  RECEIVERSHIP  AND  SALE  1337 

most  difficult  task  was  the  collection  of  the  debts  due  the  insol- 
vent company,  and  the  slowness  with  which  these  were  realized 
upon  made  his  task  a  long  one. 

§  325.    Loss  and  Gain  on  Realization  Account 

In  this  illustration  the  profit  and  the  loss  on  realization  is 
carried  to  a  "Loss  and  Gain  on  Realization"  account,  which  is 
merely  an  ordinary  Profit  and  Loss  account  used  only  for  those 
losses  and  gains  resulting  from  realization.  As  each  asset  is 
disposed  of,  the  receiver  debits  Cash  with  the  amount  received, 
credits  the  asset  account  with  the  appraised  value,  and  enters  the 
difference  to  Loss  and  Gain  on  Realization  as  a  debit  if  it  is  a  loss, 
or  as  a  credit  if  it  is  a  gain. 

It  is  assumed  that  the  receiver  sells  the  store  equipment, 
valued  at  $8,000,  for  $9,000.     The  entry  for  this  is  as  follows: 

Cash $9,000 

To  Store  Equipment $8,000 

Loss  and  Gain  on  Realization ,....,..  1,000 

(Ftill  explanation  here.)  '7  V>  "^^ ' 

The  next  entry  records  the  compromising  by  the  receiver  of 
an  account  receivable  of  $320,  which  had  been  appraised  at  its 
face  value.  A  dispute  arose  regarding  the  account,  and  the 
receiver  agreed  to  accept  $275  in  full  of  the  claim.     The  entry  is: 

Cash $275 

Loss  and  Gain  on  Realization 45 

To  Accounts  Receivable $320 

(Full  explanation  here.) 

The  receiver  is  able  to  sell  the  real  estate  for  $20,000  cash, 
the  purchaser  assuming  the  mortgage.  For  this  transaction  he 
makes  the  entry: 

Cash $20,000 

Real  Estate  Mortgage  Note 25,000 

To  Buildings  and  Properties $43,800 

Loss  and  Gain  on  Realization 1,200 

Real  estate  sold  for  $20,000  cash  to  John  Williams  who 
assumes  the  mortgage  liability. 


1338  CORPORATE  ACCOUNTING  [Bk.  HI- 

§  326.    Liquidation  of  Liabilities 

As  the  receiver  has  a  large  amount  of  cash  he  will  probably 
be  willing  to  make  a  partial  payment  on  the  liabilities.  In  doing 
this  he  must  use  care  to  pay  the  preferred  claims  first  in  the  order 
of  their  preference.  He  must  also  be  careful  not  to  pay  any 
creditor  a  larger  percentage  of  the  amount  due  him  than  he  does 
another  creditor  of  equal  rank.  The  entries  for  the  payments  of 
"dividends,"  as  they  are  frequently  called,  to  creditors  will  ap- 
pear in  the  cash  book  and  will  be  credits  to  Cash  and  debits  to 
the  liability  accounts.  In  the  present  instance,  when  the  receiver 
has  paid  off  all  the  liabilities,  the  total  of  the  cash  book  entries, 
except  for  that  secured  by  the  mortgage  on  the  real  estate,  will 
be  equivalent  to  the  following: 

Nbtes  Payable  Secured $10,000 

Notes  Payable  Unsecured 15,000 

Accounts  Payable 91,460 

To  Cash $1 16,460 

§  327.    Expenses  of  Realization 

During  the  process  of  winding  up  the  affairs  of  the  company 
the  receiver  has  had  to  incur  certain  expenses  for  selling,  labor, 
advertising,  etc.  These  may  be  charged  to  a  Receivership  Ex- 
pense account,  to  separate  expense  accounts,  or  even  to  the  Loss 
and  Gain  on  Realization  account  (though  preferably  not),  and 
the  various  cash  book  entries  recording  them  would  have  in  the 
aggregate  the  following  effect : 

Receivership  Expense $S,ooo 

To  Cash $5,000 

In  this  statement  of  expenses  the  receiver  has  included  only 
the  nominal  salary  allowed  him  as  a  drawing  account  by  the 
court  upon  his  appointment.  When  he  makes  his  report  it  is 
probable  that  he  will  be  allowed  additional  compensation. 
The  court  will  also  determine  the  amount  of  the  fee  to  be  allowed 
the  attorneys. 


Ch.  31]  RECEIVERSHIP  AND  SALE  1339 

§  328.    Receiver's  Closing  Entries 

At'  the  time  of  rendering  his  final  report  the  receiver  has 
turned  all  the  assets  into  cash  and  paid  all  the  liabilities  and  ex- 
penses of  receivership.  His  trial  balance  at  that  time  is  assumed 
to  be  as  follows: 

Debit        Credit 

Cash $110,320 

Receivership  Expense S.ooo 

Loss  and  Gain  on  Realization $     7,000 

Willis  Grocery  Company 108,320 

$115,320     $115,320 


The  amount  of  the  credit  to  the  Willis  Grocery  Company  is 
still  the  net  worth  of  that  company  as  shown  by  the  statement 
of  affairs  of  September  30. 

When  the  receiver  renders  his  report  he  will  close  the  Receiv- 
ership Expense  account  and  the  Loss  and  Gain  on  Realization 
account  into  the  Willis  Grocery  Company  account,  showing  an 
increase  in  the  stockholders'  equity  by  the  amount  of  his  net 
gain  on  the  realization  of  the  assets  over  the  expense  of  receiver- 
ship.   The  entry  will  be: 

Loss  and  Gain  on  Realization ti:...r;i  i ; $7,000 

To  Receivership  Expense $5,000 

Willis  Grocery  Company 2,000 

To  close  the  nominal  accounts  into  the  Company's  equity 
account,  which  is  thereby  increased  by  the  amount  of  the 
receiver's  gain  over  appraised  values. 

The  additional  allowances  made  by  the  court  to  the  receiver 
and  the  attorneys  total  $4,000,  and  the  receiver  is  ordered  to  pay 
them  and  to  pay  over  the  remaining  $106,320  to  the  corporation. 

The  payment  of  this  $4,000  to  himself  and  the  attorneys  must 
now  be  debited  directly  to  the  Willis  Grocery  Company  account 
as  the  nominal  accounts  are  closed.  Any  other  adjustments 
made  necessary  by  the  act  of  the  court  after  the  receiver's  final 
report  was  filed  would  be  handled  in  the  same  way.  The  entry  in 
this  instance  would  be: 


1340                                CORPORATE  ACCOUNTING  [Bk.  III- 

Willis  Grocery  Company <i»i7iik^.liiVmO :4\l.^\    $4,000 

'^°  ^^'^ ;  -A  •  -i  v:.  1/I--  -^M-  ji-f!  'tr  ;l;mt  ■  hr.w  ^^.ooc 

For  payment  of  the  balance  of  the  cash  to  the  corporation  a 
similar  entry  will  be  made : 

Willis  Grocery  Company $104,320 

To  Cash $104,3  20 

There  is  now  no  balance  in  any  account  and  the  receiver  re- 
turns the  books  to  the  corporation. 

§  329.    Dissolution  Following  Bankruptcy 

The  insolvency  or  bankruptcy  of  a  corporation  does  not  nec- 
essarily involve  dissolution.  Unless  formal  proceedings  are  taken 
to  dissolve  the  corporation,  it  will  survive  and  may  be  again 
used  as  a  business  organization.  As  there  is  a  possibility  of  the 
officers  and  stockholders  being  involved  in  penalties  and  liabili- 
ties by  the  continuance  of  an  inactive  corporation,  it  is  safer  to 
go  through  a  formal  dissolution  when  the  corporation,  is  not  to 
be  used  again  for  active  business  purposes.  '^"^'^.Z      ^^  ^'^^' 

In  the  present  instance  there  would  perhaps  be  no  real  neces- 
sity for  entering  on  the  books  of  account  the  transactions  having 
to  do  with  the  dissolution,  as  the  entries  are  merely  formal  and 
the  transactions  will  be  fully  shown  by  the  minutes.  It  is,  how- 
ever, preferable  to  make  the  entries  that  the  record  may  be  com- 
plete.   They  will  be  shown  in  the  following  sections. 

§  330.    Entry  of  Assets  on  Corporation  Books  after  Receivership 

Since  the  receiver  has  permanently  closed  the  books  of  the 
company,  it  is  necessary  for  the  corporation  to  reopen  them 
in  order  to  make  any  further  entries.  The  assets  of  the  corpora- 
tion consist  solely  of  the  cash  turned  over  by  the  receiver. 
There  are  no  liabilities  except  the  capital  stock  of  $150,000.  The 
difference  between  the  amount  of  cash  and  the  par  value  of  the 
stock  is  the  deficit  of  the  corporation,  and  the  entry  re-establish- 
ing the  accounts  would  be  as  follows:  ;  i-';;.*,,  -.,  m.  ..(u 


Ch.  31]                              RECEIVERSHIP  AND  SALE  1341 

Cash .'Jy^H  .9^.13.;    $104,320 

^«fi"^ TjYb  '/ah  iwsrftjiat/'i^,  r     ^5,680 

To  Capital  Stock $150,000 

Re-establishing  on  the  books  the  assets  and  capital  of  the 
Willis  Grocery  Company  prior  to  distribution  and 
dissolution. 

§  331.    Entries  for  Distribution  and  Dissolution 

The  stockholders  expend  $320  in  the  expenses  of  dissolution 
and  divide  the  remainder  in  proportion  to  the  stockholdings. 
The  ordinary  cash  book  entries  will  cover  the  payment  of  the 
expenses,  Deficit  being  debited.  The  distribution  will  also  be 
handled  by  a  cash  book  entry,  Capital  Stock  being  debited  with 
$150,000,  and  Deficit  credited  by  a  contra  entry  with  the  amount 
needed  to  close  the  account,  $46,000.  The  entry  will  have  the 
following  effect: 

Capital  Stock $150,000 

To  Cash $104,000 

Deficit 46,000 

^  For  distribution  of  cash  among  the  stockholders  in  pro- 
portion to  their  holdings;  and  for  closing  the  capital 
accounts. 

All  book  accounts  of  the  dissolving  company  are  now  closed, 
and  the  company's  charter  is  surrendered  by  due  process,  which 
varies  in  the  different  states. 

§  332.     When  the  Corporation  Is  Not  Dissolved 

In  the  above  example  it  was  assumed  that  the  stockholders 
of  the  corporation  wished  the  receiver  to  sell  all  the  assets  in 
order  that  the  corporation  might  be  dissolved  rather  than  con- 
tinue a  losing  business  with  impaired  capital.  If  this  had  not 
been  so,  the  receiver  would  only  realize  on  a  sufficient  amount 
of  the  assets  to  liquidate  the  liabilities  and  to  pay  the  expenses 
of  receivership.  The  remainder  of  the  assets  would  then  be  re- 
turned to  the  corporation.  Such  a  case  is  analogous  to  a  receiver- 
ship followed  by  reorganization,  and  the  same  principles  apply. 


1342  CORPORATE  ACCOUNTING  Bk.  UT- 

§  333*    Report  of  the  Receiver 

The  remaining  sections  of  this  chapter  are  devoted  to  the  pres- 
entation of  a  more  complete  illustration  of  the  accounting  fea- 
tures of  the  reports  rendered  by  the  receiver  to  the  court.  A 
complete  copy  of  the  inventory  and  appraisal  made  for  the  re- 
ceiver should  accompany  the  statement  of  affairs,  but  as  this 
contains  nothing  of  accounting  interest  it  is  omitted. 

The  following  statement  of  affairs  is  more  complex  and  its 
style  more  formal  than  those  which  have  appeared  previously. 
Its  form  is  that  which  is  generally  adopted  in  practice. 

LoNGWORTH  Store  Company 

Statement  of  Affairs 

At  Date  of  Failure,  May  i,  192 i 

Book   Estimated 

Assets  Value    to  Realize 

Cash  on  Hand $  5i5oo     $  5,500 

Property 14,000         9,000 

Notes  Receivable,  good 4.250         4,250 

Customers: 

Good 1,000         1,000 

Doubtful 600            200 

Bad 1,000         

Merchandise 24,650       15,000 

Securities $28,000  28,000 

Pledged  with  Partially  Secured  Creditors,  per  contra. .        3,000 


$25,000 
Pledged  with  Fully  Secured  Creditors  for  Debts  of 

^'7'°°° • XV K^vi-^imnr  ■  ■    ^^'°°°  aarfw 

Surplus  of  Securities,  per  contra 8,000 


Total . , $79,000     $42,950 


Deduct:  Amounts  Due  Preferred  Creditors,  per  contra VipJUS:^  700 

Assets  Available  for  Dividends $42,250 

(Equivalent  to  a  dividend  of  92.05%  on  claims  of  45,900,  exclusive 
of  realization  expenses.) 
Deficiency  to  Creditors 3,650 

$45,900 


Ch.  31]  RECEIVERSHIP  AND  SALE  1343 

Gross     Expected 
Liabilities  Amount    to  Rank 

Preferred  Creditors: 

Wages,  Salaries,  Taxes,  deducted  from  assets  contra $      700 

i-'ully  Secured  Creditors: 

On  Book  Accounts $17,000      17,000 

Estimated  Value  of  Securities 25,000 

Surplus,  to  contra $  8,000 

Partially  Secured  Creditors: 

On  Book  Accounts $23,900     23,900 

Estimated  Value  of  Securities 3,000  $20,900 

Unsecured  Creditors:  

On  Book  Accounts 25,000       25,000 

Total $66,600 

Liabilities  Due  to  Ranking  Creditors $45,900 

Capital  Stock $25,000 

Less:  Deficit 1 2,600 

Capital 12,400 

Total $79,000 

§  334'    Statement  of  Deficiency 

Another  schedule  which  is  usually  filed  at  the  same  time  as 
is  the  statement  of  affairs,  is  variously  known  as  the  statement 
of  deficiency,  deficiency  statement,  or  deficiency  account.  The 
purpose  of  this  exhibit  is  to  display  the  items  making  up  the  de- 
ficiency to  creditors  as  shown  on  the  statement  of  affairs.  It 
shows  to  what  extent  the  capital  has  been  impaired  if  there  is 
a  nominal  net  ^rplus,  or  how  far  the  company  falls  short  of 
being  solvent  if  there  is  an  actual  deficit. 

The  deficiency  statement  usually  begins  with  the  net  worth 
of  the  corporation  as  shown  by  its  books  at  the  time  of  the  last 
closing,  adjusts  that  net  worth  for  profits  made  or  losses  incurred 
since  that  time,  and  for  dividends  declared,  and  then  further  ad- 


1344  CORPORATE  ACCOUNTING  "       [Bk.  III- 

justs  this  net  worth  according  to  the  book  values,  by  showing 
the  effect  thereon  of  the  changes  in  valuation  occasioned  by  the 
receiver's  appraisal.  The  final  figure  thus  obtained  is  the  de- 
ficiency to  creditors  as  shown  on  the  statement  of  aftairs. 

The  following  statement  of  deficiency  is  prepared  in  what  is 
known  as  the  report  form:  i-.'ii^'y\4- 

LoNGWORTH  Store  Company 

Deficiency  Account 

At  Time  of  Failure,  May  i,  1921 

(Being  an  analysis  of  tlie  deficiency  to  creditors  as  shown  in  rj 

the  statement  of  affairs.) 

Capital  Stock $25,000 

Surplus,  December  31,  1920 1,050 

Net  Worth  by  Books,  December  31,  1920 $26,050 

Interim  Dividends  Paid  to  May  i,  1921 $6,250 

Trade  Losses  to  May  i,  192 1 7.400 

Total  Deductions  by  Book  Values 13,650 

Net  Worth  by  Books  at  Date  of  Failure $12,400 

Shrinkage  in  Book  Values  of  Assets  as  Shown  by  Appraisal: 

Property $5,000 

Merchandise 9,650 

Customers'  Accounts 1,400 

Total  Shrinkage 16,050 

Deficit  to  Creditors  as  Shown  by  Statement  of  Affairs.  ....;.  t..y  .  ^  $  3,650 

From  the  above  statement  of  affairs  and  deficiency  statement 
it  will  be  seen  that  the  capital  and  surplus,  amounting  to  $26,050, 
have  been  wiped  out,  and  $3,650  of  the  assets  besides. 

§  335-    Deficiency  Statement  in  Account  Form 

L  .  The  statement  of  deficiency  is  sometimes  shown  in  account 

form,  in  which  case  the  net  worth  by  the  books  at  the  date  of 


Ch.  31]  RECEIVERSHIP  AND  S-\LE  1345 

the  last  closing  and  any  additions  thereto  are  credits,  and  losses, 
dividends,  and  shrinkage  are  debits.  The  balance,  if  it  falls  on 
the  credit  side,  is  the  deficiency  to  creditors  as  shown  by  the 
statement  of  affairs;  if  it  falls  on  the  debit  side  it  is  the  nominal 
net  surplus  as  shown  by  that  statement. 

§  336.    Receiver's  Cash  Account 

The  activities  of  the  receiver  in  realizing  upon  assets  and  in 
liquidating  liabilities  are  set  forth  in  the  following  Cash  account. 
Several  months  are  usually  required  for  the  settlement  of  an 
estate  in  bankruptcy,  and  during  that  period  two  or  more  divi- 
dends may  be  paid  to  creditors. 

First  and  Final  Account  of 

Alfred  S.  Dickinson,  Receiver  in  Bankruptcy 

FOR  THE  Estate  of  Longworth  Store  Company,  Bankrupt 

May  I,  1922 

The  Trustee  Charges  Himself  with: 

Cash  Taken  Over $  S»5oo 

Proceeds  of  Sale  of  Property 9,000* 

Profit  on  Sale  of  Property i.ooo 

Proceeds  of  Sale  of  Merchandise 15,000* 

Profit  on  Sale  of  Merchandise 1,000 

Amounts  Collected  from  Notes  Receivable 4, 250 

Amounts  Collected  from  Customers 1,200 

Amounts  Collected  from  Customers  in  Excess  of  Estimate 50 

Proceeds  of  Sale  of  Pledged  Securities  (less  claims  of  Secured  Creditors, 

$20,000,  per  contra) 28,000 

Total  Debits $65,000 


The  Trustee  Takes  Credit  for: 

Payment  of  Preferred  Claims $      700 

First  Dividend  to  Unsecured  Creditors,  being  50%  on  $45,900 22,950 

Payment  to  Fully  Secured  Creditors  from  Sale  of  Pledged  Securities, 

per  contra 1 7,000 

*  These  are  the  amounts  as  per  statement  of  affairs. 


1346             CORPORATE  ACCOUNTING  [Bk.  Hl- 

Payftient  of  Partially  Secured  Creditors,  or  Portion  Secured  from  Sale 

of  Pledged  Securities,  per  contra 3,000 

Expenses  of  Administration  and  Commission  to  Trustee 2,500 

Total  Credits $46, 150 

Final  Dividend  of  41.07%  by  Order  of  Court 18,850 

Total  Payments $65,000 

Summary 

Total  Receipts  of  Cash $65,000 

Total  Payments  to  Secured  and  Preferred  Creditors  and  for  Expenses. . .  23,200 

Total  Dividends  to  Creditors,  being  91.07% $41,800 

Receiver's  Cash  Account 


Receipts 

Amount  on  Hand $  5,500 

Sale  of  Property 10,000 

Sale  of  Merchandise 16,000 

Notes  Receivable 4,250 

Customers'  Accounts 1,250 

Sale  of  Securities 28,000 


$65,000 


Payments 

Preferred  Claims $      700 

First  Dividend  50% 22,950 

Secured  Claims 17,000 

Secured  Claims 3,000 

Expenses  and  Commissions.  .  .  2,500 
Dividend,  41.07%  Final  Settle- 
ment   18,850 

$65,000 


Vouchers  for  all  cash  disbursements  should  be  ready  for  the 
court's  inspection  personally  or  through  auditors  at  all  times 
during  the  receivership. 


§  337-    The  Realization  and  Liquidation  Statement 

The  realization  and  liquidation  statement,  or  "account"  as  it 
was  formerly  called,  is  not  an  account  to  be  used  on  the  books. 
Rather,  it  is  an  accounting  for  the  assets  turned  over  to  the  re- 
ceiver and  for  liabilities  liquidated.  This  account,  or  state- 
ment, can  be  readily  understood  by  reference  to  the  accompany- 
ing illustration. 


Ch.  31] 


RECEIVERSHIP  AND  SALE 


1347 


The  realization  and  liquidation  statement  may  be  con- 
sidered as  a  statement  of  the  company's  account  with  the 
receiver,  in  which  the  receiver  is  charged  with  all  the  assets 
of  the  company  turned  over  to  him,  and  credited  with  all  the 
liabilities  to  be  liquidated  by  him.  He  is  in  turn  credited  with 
the  amounts  which  he  realizes  from  the  assets,  and  debited  with 
the  liabilities  which  he  discharges.  He  is  charged  with  any 
amount  by  which  he  was  able  to  sell  the  assets  for  more  than 
their  appraised  value  (gain  on  realization),  and  credited  with 
any  amount  by  which  the  assets  failed  to  yield  him  their  ap- 
praised value.  He  is  debited  with  the  expenses  of  conducting 
the  receivership,  and  credited  with  the  payments  he  makes  on 
those  expenses. 

The  balance,  if  the  credits  exceed  the  debits,  is  necessarily 
the  actual  deficiency  to  creditors  after  liquidation,  or  if  the 
debits  exceed  the  credits,  the  balance  will  be  the  amount  dis- 
tributable among  the  stockholders. 

The  realization  and  liquidation  statement  may  therefore  be 
described  as  a  summary  of  the  receiver's  transactions  in  selling 
the  assets  and  collecting  debts  due  to  the  bankrupt,  and  also 
of  the  liabilities  paid  by  him.  It  is  used  much  more  frequently 
in  Great  Britain  than  in  the  United  States. 

Expressed  in  tabular  form,  its  debits  and  credits  are  as  follows : 

Realization  and  Liquidation  Statement 


Debit:  Credit: 

With  assets  to  be  realized.  With  liabilities  to  be  liquidated. 

With  liabilities  liquidated.  With  proceeds  of  assets  realized. 

With    expenses    of    realization    and         With  loss  due  to  liquidation, 
liquidation.  With  supplementary  credits,  if  any. 

With  gain  on  realization  credited  to 
Capital  account. 

With  supplementary  charges,  if  any. 

In  the  following  illustration  the  assets  and  liabilities  are 
shown  separately  for  greater  convenience  in  illustrating  the  divi- 
sions and  cancellations: 


1348 


CORPORATE  ACCOUNTING 


IBk.  III- 


Realization  and  Liquidation  Account 

OF  Longworth  Store  Company 

As  OF  May  i,  1922 

Account  of  Assets 


To  be  Realized: 

Cash  (see  Cash  Account) 

Property $  9,000 

Merchandise iS.cxxj 

Securities 28,000 

Notes  Receivable 4,250 

Customers'  Accounts 1,200 

Total $S7i4SO 

Gain  on  Realization: 

Increase  in  Value  of  Prop- 

perty  over  Appraisement .        i  ,000 

Increase  in  Value  of  Mer- 
chandise over  Appraise- 
ment         1,000 

Customers'  Increase 50 


$S9.Soo 


Realized: 

. ..( 4 

Property $10,000 

Merchandise 16,000 

Securities .i../..\!.(,i.  28,000 

Notes  Receivable  .■..,;,.,.,  4r2So 

Customers'  Accounts 1.250 


-ill 


ud  MT 


$59,500 


Account  of  Liabilities 


Liquidated: 

Preferred  Claims 

Secured  Creditors 

$      700 
20,000 
22,950 
18,850 

To  be  Liquidated: 

Preferred  Claims 

Secured  Creditors 

Unsecured  Creditors 

Partially  Secured  Creditors . 

Total 

Supplementary  Credits: 
Commission  and  Expense  of 
Trustee 

$      7o<7 
20,000 

First  Dividend  to  Creditors . 
Second  Dividend  to  Creditors 

25,000 
20,900 

Total 

Commissions  and  Expenses .  . . 

Balance — Loss    to    Creditors, 

carried  to  Capital  Account. . 

$62,500 
2,500 

4,100 

$66,600 
2,500 

$69,100 

$69,100 

Part  VII — Corporation  Statements 


CHAPTER  XXXII 
CLOSING  THE  BOOKS 

§  338.    The  Annual  Closing 

At  the  end  of  each  fiscal  year,  or  oftener,  it  is  customary 
to  ''close  the  books,"  that  is,  "close  the  ledger."  Where  it 
can  be  done  conveniently,  it  is  usual  and  advisable  to  make 
the  fiscal  year  correspond  with  the  calendar  year;  but  in  many 
cases  it  is  preferable  to  have  the  fiscal  year  end  at  a  time  when 
business  is  slack,  or  when  the  inventory  can  be  taken  with  the 
least  labor.  In  the  dry-goods  business,  for  instance,  the  fiscal 
year  might  be  made  to  close  just  before  the  fall  merchandise 
comes  in,  when  the  stock  is  low,  so  that  the  physical  inventory 
may  be  taken  with  comparative  ease. 

At  the  closing  date  it  is  the  practice  to  prepare  such  state- 
ments, usually  profit  and  loss  statement  and  balance  sheet,  as 
will  clearly  exhibit  the  business  operations  of  the  company  for 
the  year  and  also  show  its  true  financial  condition  at  the  end 
of  the  year. 

§  339.    Monthly  Statements 

Financial  statements  do  not,  however,  in  themselves  necessi- 
tate a  closing  of  the  books.  In  fact,  they  are  usually  made  up 
monthly,  quarterly,  or  half-yearly  for  the  purpose  of  supplying 
information  which  the  officers  and  directors  need  before  the  time 
of  the  annual  closing.  This  does  not  mean  that  the  ledger  is 
closed,  or  that  changes  are  made  in  any  of  the  accounts,  but 

1349 


13  so  CORPORATE  ACCOUNTING  [Bk.  ni- 

simply  that  the  required  balances,  inventory  totals,  and  accrued 
items' are  compiled  from  the  books  and  records  as  they  stand, 
and  are  presented  in  condensed  form  to  the  corporation  officials. 
A  complete  profit  and  loss  statement  can  be  made  each  month 
with  but  little  extra  work,  if  the  amount  of  the  inventory  is 
available. 

In  many  companies,  however,  it  is  the  practice  to  make 
adjusting  entries  each  month  to  bring  the  ledger  into  harmony 
with  the  monthly  profit  and  loss  statement  and  balance  sheet. 
In  that  case  all  prepaid  and  accrued  items,  as  interest,  insurance, 
taxes,  must  be  considered.  The  distribution  of  overhead  ex- 
penses is  also  a  feature  of  great  importance  in  the  case  of  manu- 
facturing establishments,  but  as  all  of  these  matters  are  of 
general  accounting  interest  and  not  distinctively  corporate, 
they  cannot  be  discussed  at  length  here. 

§  340.    Procedure  in  Closing  the  Books 

;,  ,.The  steps  to  be  taken  in  the  annual  closing  of  the  books  are 
briefly  as  follows : 

1.  Take  trial  balances  of  all  ledgers  and  see  that  the  totals 

of  the  trial  balance  of  each  subsidiary  ledger  are  in 
accord  with  its  controlling  account  in  the  general 
ledger. 

2.  Determine  the  inventories  of  merchandise,  properties, 

suppHes,  etc.,  making  adjustments  where  necessary, 
and  enter  them  in  the  respective  accounts. 

3.  Compute   the   prepaid   and   accrued   items   and   make 

entries  to  the  proper  accounts. 

4.  Determine   depreciation   of  properties   and   make   the 

necessary  entries. 

5.  Enter  all  proper  additions  to  reserves  of  every  nature. 

6.  Close  the  nominal  accounts  into  Profit  and  Loss  account. 

7.  Carry  the  net  profit  or  loss  to  Surplus  account  or  to 

Undivided  Profits  account. 


Ch.32]  CLOSING  THE  BOOKS  13  5 1 

8.  Balance  and  rule  the  nominal  accounts  and  bring  down 

the  balances  where  they  exist. 

9.  Make  a  second  or  "after  closing"  trial  balance  of  the 

ledger,  in  which  the  only  balances  now  are  those  of 
assets  and  liabilities. 

The  same  procedure  is  followed  when  an  actual  closing  of  the 
ledger  is  made  monthly. 

§  341.    Closing  the  Ledger 

The  ledger  must  be  closed  systematically  with  the  various 
nominal  or  profit  and  loss  accounts  properly  subdivided.  For 
example,  all  accounts  directly  affecting  production  costs  should 
be  closed  into  the  Manufacturing  account,  in  order  to  determine 
the  exact  cost  of  the  finished  stock;  and  all  selling  expenses, 
administrative  expenses,  etc.,  should  be  carefully  classified  and 
closed  in  accordance  with  the  degree  of  information  required  and 
the  plan  of  the  bookkeeping  system.  The  net  profit  must  of 
course  be  clearly  stated,  and  sometimes  the  gross  profit  as  well. 
It  is  not  necessary  to  close  the  real  or  asset  and  liability  accounts, 
except  when  they  are  balanced  by  settlement  or  adjustments, 
or  when  forwarding  them  to  another  page  or  to  another  ledger. 

When  closing  the  ledger,  transfers  of  the  nominal  accounts 
to  the  summarizing  accounts  and  to  the  Profit  and  Loss  account 
should  be  made  by  journal  entry  instead  of  directly  on  the  face 
of  the  ledger  without  supporting  journal  entries  or  explanation. 
The  journal  thus  collects  all  of  the  items  and  provides  a  means 
of  showing  what  makes  up  each  ledger  entry  and  why.  The 
journal  explanation  may  be  very  brief,  but  should  be  clear  and 
unmistakable  for  the  benefit  of  others  who  may  have  to  refer 
thereto.  .    ,  ,        ,.,,        ',''■, 

The  methods  of  closing  the  accounts  peculiar  to  corporations 
have  already  been  discussed  in  connection  with  the  treatment 
of  the  accounts  themselves.  While  some  of  the  most  difficult 
problems  in  accounting  arise  in  connection  with  closing  the 


1352  CORPORATE  ACCOUNTING  [Bk.  III- 

books,  yet  these  are  not  matters  of  such  exclusive  corporate 
interest  that  they  can  be  gone  into  here. 

§  342.    Closing  the  Profit  and  Loss  Account 

The  outstanding  difference  between  corporation  book- 
closings  and  those  of  partnerships  and  individual  proprietorships 
is  in  the  accounting  treatment  of  net  profits  when  their  amount 
has  been  ascertained.  In  the  case  of  partnerships  and  individ- 
ually owned  businesses,  just  as  in  the  case  of  the  corporation, 
profits  are  determined  by  closing  all  items  of  income  and  expense 
into  the  Profit  and  Loss  account.  In  the  books  of  the  pro- 
prietorship this  account  is  then  closed  out  by  an  entry  which 
removes  its  balance  to  the  proprietor's  Capital  account.  In  the 
same  way  the  balance  of  the  Profit  and  Loss  account  of  a  partner- 
ship is  closed  out  by  a  journal  entry  into  the  capital  accounts 
of  the  partners,  being  divided  among  these  accounts  according 
to  the  profit-sharing  ratio  of  the  partners.  The  net  worth  of  the 
business  is  thus  reflected  directly  by  the  capital  accounts,  which 
are  increased  by  profits  earned  and  reduced  by  losses  sustained. 

In  corporations,  however,  a  rigid  separation  is  maintained 
between  the  capital  stock  values — which  correspond  in  a  general 
way  to  the  original  investment  of  proprietor  or  partners — 
and  profits  and  losses,  the  balance  in  the  Profit  and  Loss  account 
being  closed  into  Surplus,  Earned  Surplus,  or  Undivided  Profits 
account,  depending  on  the  accounting  scheme  of  the  corporation. 
Profits  and  losses  of  corporations  are  thus  kept  entirely  separate 
from  the  investment  of  the  stockholders. 

§  343.    Entries  for  Closing  into  Surplus 

If  a  profit  has  been  made  during  the  accounting  period,  the 
balance  in  the  Profit  and  Loss  account  will  of  course  be  on  the 
credit  side.     The  entry  closing  such  a  balance  will  be: 

Profit  and  Loss $43iOOo 

So  Surplus $43,000 

To  close  the  amount  of  the  year's  profit,  as  shown  by  the 
Profit  and  Loss  account,  into  Surplus. 


Ch.  32]  CLOSING  THE  BOOKS  1353 

If  a  loss  has  been  sustained  the  balance  will  be  on  the  debit 
side  of  the  Profit  and  Loss  account,  and  the  entry  will  be : 

Surplus $13,000 

To  Profit  and  Loss $13,000 

To  charge  the  amount  of  the  year's  loss,  as  shown  by  the 
Profit  and  Ix)ss  account,  against  Surplus. 

If  the  corporation  has  its  surplus  classified  by  the  various 
sources  from  which  it  arose, 1  Earned  Surplus  account  would 
receive  the  profit  or  loss.  If  the  account  is  called  ''Undivided 
Profits"  instead  of  "Surplus,"  the  entry  would  be  the  same 
except  for  the  change  in  name. 

As  has  been  said,  Surplus  account  is  sometimes  called 
"Surplus  and  Deficit"  to  make  the  title  descriptive  of  both 
kinds  of  balances  which  may  appear  therein.  This  is  more 
usually  true  of  corporations  which  sustain  a  loss  the  first  year 
and  consequently  have  a  deficit  at  the  time  when  the  account 
is  first  needed,  than  it  is  of  those  which  have  profits  at  the  time 
of  the  first  closing. 

If  the  books  are  actually  closed  monthly,  the  income  and 
expense  accounts  being  charged  or  credited  into  Profit  and  Loss 
at  each  trial  balance  time,  it  is  not  the  usual  practice  to  transfer 
the  month's  profit  or  loss  into  Surplus  immediately.  The  plan 
is  favored  of  allowing  the  profits  and  losses  of  an  entire  fiscal 
period  to  accumulate  in  the  Profit  and  Loss  account,  and  at  the 
end  of  that  period  to  close  the  aggregate  net  balance  into  Surplus 
by  whichever  of  the  above  entries  is  applicable. 


1  See  Ch.  IV,  "Classification  of  Surplus." 


CHAPTER  XXXIII 

FORMS  OF  STATEMENTS 

§  344.    Corporate  Reports 

There  are  two  types  of  corporate  reports  and  statements: 
those  rendered  by  the  directors  and  corporate  officials  to  the 
stockholders  and  governmental  authorities,  and  those  rendered 
by  the  accounting  department  of  the  corporation  to  the  execu- 
tives. It  is  to  the  latter  class  that  the  present  discussion  will  be 
directed. 

§  345.    Necessity  for  Reports 

To  manage  the  business  intelligently  it  is  essential  that  cor- 
porate officials  be  constantly  informed  as  to  the  financial  status 
and  progress  of  the  concern.  In  the  case  of  the  small  corporation 
where  the  executives  are  in  intimate  touch  with  the  daily 
activities  of  the  business,  monthly  or  even  quarterly  statements 
of  income  and  profit  and  loss  and  balance  sheets  are  adequate 
to  give  them  sufficient  information  to  run  the  business  properly. 

In  the  case  of  the  large  corporation,  however,  where  the 
scope  of  activity  and  the  volume  of  business  is  such  that  it 
is  absolutely  impossible  for  the  executive  to  keep  in  close 
personal  touch  with  the  various  details  of  the  business,  it  is 
the  duty  of  the  accounting  department  to  provide  suitable 
statements  and  statistical  data  to  keep  him  thoroughly  informed. 
In  an  organization  of  this  type  it  may  be  necessary  to  have 
daily  reports  showing  in  memorandum  form  the  essential  facts 
of  the  business  such  as  the  sales,  purchases,  collections,  expendi- 
tures, bank  balances,  manufacturing  or  operating  details; 
weekly  or  monthly  statements  of  cash  receipts  and  disburse- 
ments; monthly  statements  of  income  and  profit  and  loss,  and 

1354 


Ch.  33]  FORMS  OF  STATEMENTS  1355 

balance  sheets,  together  with  such  other  statistical  information 
as  may  be  needed. 

§  346.    Form  of  Statements 

There  are  no  generally  accepted  or  standard  forms  for  cor- 
porate statements.  Indeed  it  may  be  truthfully  said  that  no 
standard  form  could  be  designed  which  would  be  suitable  to 
all — or  even  a  majority — of  cases.  The  best  education  in  the 
preparation  of  statements  is  a  study  of  those  which  are  con- 
sidered fairly  representative  of  the  best  practice.  Modifications 
will  often  prove  necessary  to  meet  the  needs  of  particular  cases, 
but  when  making  these  modifications  the  accountant  must  be 
most  careful  to  see  that  the  statements  rendered  will  not  be 
misleading,  and  that  they  convey  their  information  in  as  interest- 
ing and  clear  a  manner  as  possible. 

The  expression  "a  good  statement"  has  two  meanings.  It 
means  a  statement  which  shows  a  sound  or  good  condition,  and 
it  also  means  a  statement  which  is  well  prepared.  Very  often 
the  statement  which  is  ''good"  by  the  first  meaning  will  not  be 
really  effective  unless  it  is  "good"  by  the  second  meaning  also., 

Facts,  or  results,  can  be  expressed  clearly  enough  in  either 
statement  or  graphic  form;  but  unless  the  statement  is  neat  and 
attractive  it  may  fail  entirely  as  to  result.  Why?  Because  a  badly 
arranged  and  carelessly  executed  statement  is  like  a  poor  window 
display — it  fails  to  catch  the  eye  and  engage  the  direct  attention 
desired.  A  well  conceived  and  neatly  typed  statement  attracts 
immediate  interest  as  a  stunning  window  display  often  stops  the 
passer-by  in  his  tracks.  .  .  . 

Make  them  hit  home  by  dressing  them  up.  You  can't  compel 
attention  unshaven  and  unshined,  no  more  can  written  or  graphic 
statements  unless  they  are  given  the  benefit  of  careful  attention  to 
every  detail  that  goes  to  make  up  the  factor  of  Psychology — attrac- 
tiveness of  form.  But  the  moral  need  not  be  lost  on  those  who  have 
to  read  and  study  statements.  They  can  insist  on  the  kind  that 
compel  attention  and  achieve  results.  A  lot  of  the  rest  represent 
wasted  effort,  ink  and  paper.^ 

'  "The  Psychology  of  a  Good  Statement,"  by  Neill  Hutchings,  Administration,  Feb.  1922, 
pp.  207-208. 


1356  CORPORATE  ACCOUNTING  [Bk.  III- 

§  347.    Balance  Sheets 

Federal  Reserve  Board 

Assets 

Cash: 

la.  Cash  on  hand — currency  and  coin .■•,,, 

lb.  Cash  in  bank ' , , 

—\?    s  tip  on 

Notes  and  accounts  receivable:  ' 

3.  Notesreceivableof  customers  on  hand  (not  past  due).. .    'tX^  •/IW*.- • 
S.  Notes  receivable  discounted  or  sold  with  indorsement 

Or  guaranty 

7.  Accounts  receivable,  customers  (not  past  due) 

9.  Notes    receivable,  customers,  past    due  (cash    value, 

$■■■) 

II.  Accounts  receivable,  customers,  past  due  (cash  value, 

I-.) ■ 


Less: 

13.  Provisions  for  bad  debts 

I  s .  Provisions  for  discounts,  freights,  allow- 
ances, etc 


Inventories:  ij    /")'{['. 

17.  Raw  material  on  hand ,"" 

19.  Goods  in  process . . . ., , 

21.  Uncompleted  contracts 

Less  payments  on  account  thereof •.•^jv. 

23.  Finished  goods  on  hand 

Other  quick  assets  (describe  fully) : 


J  U'-mifi^ 


Total  quick  assets  (excluding  all  investments) 

Securities: 

25.  Securities  readily  marketable  and  salable  without  im- 
pairing the  business 

27.  Notes  given  by  officers,  stockholders,  or  employees  .  . . 
39.  Accounts  due  from  officers,  stockholders,  or  employees. . 

Total  current  assets 


Fixed  assets: 

31.  Land  used  for  plant 

33.  Buildings  used  for  plant 

35.  Machinery 

37.  Tools  and  plant  equipment 

39.  Patterns  and  drawings 

41.  Office  furniture  and  fixtures 

43.  Other  fixed  assets,  if  any  (describe  fully) 


Less: 

45.  Reserves  for  depreciation  . 


Total  fixed  assets , 


Deferred  charges: 

47.  Prepaid  expenses,  interest,  insurance,  taxes,  etc  , 
Other  assets  (49) 


Total  assets. 


ch.  33]  forms  of  statements  1357 

Form  of  Balance  Sheet 
Liabilities 

Bills,  notes,  and  accounts  payable: 
Unsecured  bills  and  notes — 

2,  Acceptances  made  for  merchandise  or  raw  material 

purchased 

4.  Notes  given  for  merchandise  or  raw  material  pur- 
chased   

6.  Notes  given  to  banks  for  money  borrowed 

8.  Notes  sold  through  brokers 

10.  Notes  given  for  machinery,  additions  to  plant,  etc. 

12.  Notes  due  to  stockholders,  officers,  or  employees 

Unsecured  accounts — 

14.  Accounts  payable  for  purchase  (not  yet  due) 

16.  Accounts  payable  for  purchases  (past  due) 

18.  Accounts  payable  to  stockholders,  officers,  or  em- 
ployees   


Secured  liabilities — 

20a.  Notes  receivable  discounted  or  sold  with  indorse- 
ment or  guaranty  (contra) 

20b.  Customers'  accounts  discounted  or  assigned 
(contra) 

20c.    Obligations  secured  by  liens  on  inventories 

2od.  Obligations  secured  by  securities  deposited  as 
collateral 


22.     Accrued  liabilities  (interest,  taxes,  wages,  etc.)- 
Other  current  liabilities  (describe  fully) : 


Total  current  liabilities , 


Fixed  liabilities: 

24.  Mortgage  on  plant  (due  date ) 

26.  Mortgage  on  other  real  estate  (due  date )  . .  . . 

28.  Chattel  mortgage  on  machinery  or  equipment   (due 

date ) 

30.  Bonded  debt  (due  date ) 

32.  Other  fixed  liabilities  (describe  fully): 


Total  liabilities  , 


Net  worth: 

34.  If  a  corporation — 

(a)  Preferred  stock  (less  stock  in  treasury)  , 
(6)  Common  stock  (less  stock  in  treasury)  . 
(c)   Surplus  and  undivided  profits 


Less: 


(d)  Book  value  of  good-will . 

(e)  Deficit 


96.  If  an  mdividual  or  partnership— 

ia)   Capital 
b)  Undistributed  profits  or  deficit. 

Total , 


1358  CORPORATE  ACCOUNTING  [Bk.  III- 

FORM 

C.  C.  Childs 
St.  Louis, 
Balance 
December 


Assets 

Cash: 

Cash  in  Offices $      12,750.00 

Cash  in  Banks 94,675.91 


Total  Cash $ 

Notes  and  Accounts  Receivable: 

Accounts  Receivable,  Customers',  Not  Due   $    637,982.26 
Accounts  Receivable,  Customers',  Past  Due  51,447-35 

Railroad  and  Insurance  Claims 11,170.17 


Total  Outside  Receivables $    700,599.78 

Less:  Allowance  for  Doubtful  Receivables 44,728.12 


Total  Outside  Receivables,  Good 655,871.66 

Inventories: 

Raw  Material $    573,742.32 

Goods  in  Process 187,707.84 

Finished  Goods ..•..■...■.•.......         1,432,772.13 


Total  Merchandise  Inventories 2,194,222.29 

U.  S.  Liberty  Loan  Bonds 160,400.00 

Total  Quick  Assets ....■.■.■..•.■ '  $3,117,919.86 

Officers  and  Employees'  Accounts  and  Stock  Subscriptions.  ...... . . . .  114,740.24 

Total  Current  Assets $3,232,660.10 

Fixed  Assets: 

Land $    249,592.67 

Buildings $    580,910.21 

Less:  Allowance  for  Depreciation 156,209.38 


Buildings,  Net  Value 424,700.83 

Office  Furniture  and  Fixtures $      19,085.04 

Less:  Allowance  for  Depreciation 9,782.15 


Office  Furniture  and  Fixtures,  Net  Value 9,302.89 

Factory  Fixtures $    197,627.76 

Less:  Allowance  for  Depreciation 102,622.07 


Factory  Fixtures,  Net  Value 9S.005.69 

Machinery  and  Tools $1,583,754.68 

Less:  Allowance  for  Depreciation . '. 538,632.60 


Machinery  and  Tools,  Net  Value . 1,045,122.08 

Automobiles  and  Trucks $      55,182.79 

Less:  Allowance  for  Depreciation 20,464.21 

Automobiles  and  Trucks,  Net  Value 34,718.58 

Total  Fixed  Assets 1,858,442.74 

Deferred  Charges: 

Supplies  Inventory $      47,337.92 

Prepaid  Insurance  .  ■ 21,904.95 

Prepaid  Royalties S, 000.00 

Total  Deferred  Charges 74,242.87 

Total  Assets $5,165,345.71 


Ch.  33]  FORMS  OF  STATEMENTS  1359 

B 

AND  Company 
Missouri 

Sheet 
31,  1921 

Liabilities  and  Capital 

Current  Liabilities  (Unsecured): 

Notes  to  Banks $    180,000.00 

Accounts  Payable,  Trade 178,046.58 

1..  Accounts  Payable,  Sundry 160,689.44 

Total  Current  Liabilities  (Unsecured) $    518,736.02 

Fixed  Liabilities: 

First  Mortgage  Bonds  Outstanding,  due  193S $    800,000.00 

Less:  Sinking  Funds  in  Hands  of  Trustee: 

Cash $        2,436.07 

Investments 349,600.00 


Total  Sinking  Funds 352,036.07 

Net  Fixed  Liabilities 447.963.93 

Accrued  Liabilities: 

Interest,  Taxes,  etc.  (inclttding  Federal  Income  Tax) S14, 495-65 

Total  Liabilities $1,481,195.60 

Net  Worth: 

Preferred  Stock,  Authorized $5,000,000.00 

Less:  Unissued $3,000,000 

In  Treasury 1,000,000    4,000,000.00 


Outstanding $1,000,000.00 

Plus:  Subscribed 100,000.00 


Total  Preferred  Capital  Stock $1,100,000.00 

Common  Stock  of  No  Par  Value,  50,000  shares  authorized, 

20,000  shares  outstanding 800,000.00 


Total  Capital  Stock $1,900,000.00 

Earned  Surplus  (available  for  dividends). .    $1,432,150.11 
Reserve  for  Sinking  Fund 352,000.00 

Total  Surplus 1,784,150.11 

Net  Worth 3,684,150.1 1 


Total  Liabilities  and  Capital $5ti65.34S-7i 


1360  CORPORATE  ACCOUNTING  [Bk.  III- 

The  balance  sheet  is  usually  considered  the  most  important 
financial  statement.  While  there  is  and  can  be  no  standard 
form  of  balance  sheet,  yet  many  accountants  are  endeavoring, 
so  far  as  is  practicable,  to  standardize  on  that  shown  in  Form 
A  (see  pages  1356-57)- 

This  form  was  first  suggested  in  the  Federal  Reserve  Bulletin 
as  "a  tentative  proposal  submitted  by  the  Federal  Reserve 
Board"  for  the  consideration  of  bankers,  merchants,  manu- 
facturers, and  accountants.  In  designing  the  form  and  in 
drawing  up  the  excellent  suggestions  for  the  preparation  of  bal- 
ance sheet  statements  which  accompany  it,2  the  Board  had  the 
co-operation  of  some  of  the  leading  accountants  of  the  country, 
and  it  is  therefore  probable  that  this  form  more  nearly  meets 
general  authoritative  approval  than  any  other.  Form  B  shows 
a  corporate  balance  sheet  prepared  along  the  lines  of  these  in- 
structions. 

§  348.    Capital  Stock  on  the  Balance  Sheet 

The  instructions  for  the  preparation  of  the  approved  Federal 
Reserve  form  of  balance  sheet,  which  accompany  the  form, 
provide  that  "on  the  balance  sheet  each  class,  if  more  than  one, 
of  stock  must  be  stated,  giving  the  amount  authorized,  issued, 
and  in  treasury,  if  any."    This  is  the  usual  practice,  as  follows: 

Capital  Stock: 

Common — Authorized $10,000,000 

Less:  Unissued 5,000,000 

Common  Stock  Outstanding $5,000,000 

Preferred — Authorized $10,000,000 

Less:  Unissued $5,000,000 

In  Treasury 2,000,000      7,000,000 

Preferred  Stock  Outstanding 3,000,000 

Total  Capital  Stock $8,000,000" 

2  Approved  Methods  for  the  Preparation  of  Balance  Sheet  Statements,  Washington,  Gov- 
ernment Printing  Office,  1918, 


Ch.  33]  FORMS  OF  STATEMENTS  1361 

§  349.    Subscriptions  to  Capital  Stock  on  the  Balance  Sheet 

The  amounts  receivable  on  subscriptions  to  capital  stock  are 
an  asset  and  should  be  shown  on  the  asset  side  of  the  balance 
sheet,  with  possibly  the  setting  up  of  a  deduction  similar  to 
an  allowance  for  bad  debts  in  case  the  payments  are  not  being 
made  as  due,  or  look  doubtful  for  other  reasons.  Such  an  asset 
as  this  would  be  placed  under  item  29  on  the  Federal  Reserve 
form. 

The  amount  of  capital  stock  which  is  reserved  to  be  issued 
to  the  subscribers  upon  payment  in  full  of  their  subscriptions, 
should  be  shown  under  the  capital  stock  grouping  on  the  balance 
sheet.  Assuming  $100,000  of  preferred  stock  so  reserved,  the 
preferred  stock  referred  to  in  the  preceding  section  would  appear 
as  follows: 

Preferred — Authorized $10,000,000 

Less:  Unissued $5,000,000 

In  Treasury 2,000,000        7,000,000 

Preferred  Stock  Outstanding $  3,000,000 

Plus:  Subscribed 100,000 

Preferred  Capital  Stock .^  Pf^LI^'fll. .      $3,100,000 

§  350.    No-Par  Stock  on  the  Balance  Sheet 

Stock  of  no  par  value  is  carried  on  the  balance  sheet  at  the 
value  at  which  it  appears  in  the  Capital  Stock  account.  The 
balance  sheet  should  also  show  (either  in  the  body  thereof  or  as  a 
footnote  thereto)  the  number  of  shares  outstanding,  thus 
enabling  the  book  value  of  each  unit  of  interest  to  be  readily 
found.  If  the  common  stock  in  the  foregoing  illustration  were 
of  no  par  value,  it  would  be  shown  on  the  balance  sheet  as 
follows : 

Capital  Stock: 
Common,  of  no  par  value,  50,000  shares  outstanding $5,000,000 

Another  method  would  be  as  follows: 


1362  CORPORATE  ACCOUNTING  [Bk.  III-. 

Capital  Stock: 

Common,  of  no  par  value  * $5,000,000 

*  50,000  shares  outstanding. 

§  351.    No-Par  Stock  of  a  Stated  Value 

When  no-par  stock  is  carried  at  a  stated  value,  that  value  is 
used  in  the  balance  sheet,  and  any  difference  between  the  stated 
value  and  the  amount  for  which  the  stock  was  actually  sold  is 
treated  as  discussed  in  a  preceding  chapter. » 

Form  C  shows  the  balance  sheet  as  at  December  31,  1920,  of 
the  Pierce-Arrow  Motor  Car  Company,  which  was  reincorporated 
on  October  i,  1916,  with  100,000  shares  of  8%  cumulative  pre- 
ferred stock,  value  $100  each,  and  250,000  shares  of  common 
stock  without  par  value.  The  preferred  stock  is  preferred  as  to 
assets  as  well  as  to  dividends,  is  redeemable  in  whole  or  in  part 
at  125  and  accrued  dividends,  and  is  convertible  at  the  option 
of  the  holder  into  common  stock,  share  for  share. 

The  two  kinds  of  stock  have  equal  voting  privileges.  By 
reference  to  the  balance  sheet  it  will  be  seen  that  the  company's 
common  stock  had  a  stated  value  of  $5  per  share  and  a  book 
value  of  $39.49  per  share,  including  capital  surplus  and  earned 
surplus,  so  that  the  conversion  privilege  does  not  seem  very 
attractive  to  the  holders  of  the  preferred. 

This  company  states  its  common  stock  at  $5  per  share 
(the  minimum  required  under  New  York  statutes)  in  addition 
to  which  it  has  a  capital  surplus  of  $4,081,411.90,  which  must  be 
considered  as  part  of  the  capital,  but  the  report  does  not  show 
how  much,  if  any,  of  it  belongs  to  the  preferred.  The  earned 
surplus  of  the  company  stood  at  $4,541,546.58  on  December  31, 
1920.  This  of  course  must  be  added  to  the  capital  values  in 
arriving  at  the  net  worth  of  the  company.  The  true  book  values 
of  the  common  and  preferred  shares  can  be  determined  only  after  ' 
learning  the  status  of  the  preferred  stock  as  to  accumulated 
earnings. 


»  Ch.  XI,  "Capital  Stock  Without  Par  Value.'! 


Ch.  33] 


FORMS  OF  STATEMENTS 


1363 


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1364  CORPORATE  ACCOUNTING  [Bk.  IH- 

It  will  be  seen  that  this  company  lists  its  capital  surplus  and 
its  earned  surplus  separately,  a  plan  which  should  always  be 
followed  by  corporations  carrying  unvalued  shares  of  stock 
at  a  stated  value.  This  shows  the  value  of  assets  turned  over 
to  the  company  in  excess  of  the  stated  value  per  share  of  common 
stock,  while  the  earned  surplus  represents  undivided  profits. 

§  352.    Surplus  on  the  Balance  Sheet 

The  showing  of  surplus  on  the  balance  sheet  presents  a 
number  of  interesting  features.  In  the  first  place  it  must  be 
remembered  that  the  Surplus  and  Capital  Stock  accounts 
together  make  up  the  net  worth  of  the  corporation.  The  most 
popular  form  of  balance  sheet  is  one  which  groups  these  net 
worth  items  in  such  a  way  as  to  show  a  total  of  the  net  worth 
items.  To  accomplish  this  result  the  capital  stock  and  surplus 
amounts  must  be  added  together  to  form  a  total  which,  added  to 
the  total  of  the  liabilities,  will  give  the  grand  total  of  the  credit 
side,  "Liabilities  and  Capital."  This  is  illustrated  on  the  balance 
sheets  shown  on  pages  1358-59.  Conversely,  if  there  is  a 
deficit,  it  will  be  subtracted  from  the  amount  of  capital  stock  to 
show  the  net  worth,  as  shown  in  item  34  of  the  Federal  Reserve 
balance  sheet. 

There  is  another  theory  which  is  used  in  the  preparation  of 
balance  sheets.  On  the  Federal  Reserve  balance  sheet  the 
assets  are  arranged  as  nearly  as  practicable  in  the  order  of  their 
availability,  and  the  liabilities  in  the  order  in  which  they  are 
payable,  with  the  net  worth  accounts  last.  Under  the  other 
plan,  exemplified  in  the  balance  sheet  shown  in  Form  D,  the 
permanent  or  fixed  assets  are  shown  first,  and  opposite  them  the 
sources  of  capital  (usually  capital  stock  and  funded  debt); 
the  order  of  the  other  assets  and  liabilities  being  very  much  as 
in  the  first  arrangement,  with  the  surplus  as  the  last  item  on  the 
credit  side*. 


Ch.  33]  FORMS  OF  STATEMENTS  136S 

While  this  method  is  well  established  in  practice,  especially 
for  the  balance  sheets  of  utility  corporations,  it  would  seem  that 
its  disadvantages  outweigh  its  advantages.  It  is  argued  that 
it  is  more  logical  to  present  first  the  capital  assets,  with  which  the 
business  is  carried  on,  in  juxtaposition  to  the  sources  of  capital, 
but  the  method  fails  in  entirely  accomplishing  this  because  the 
surplus,  which  is  shown  last,  is  usually  tied  up  also  in  the  capital 
assets.  It  has  the  added  disadvantage  of  not  showing  readily 
the  net  worth  of  the  corporation. 

While  the  second  method  may  have  some  advantages, 

...  it  is  perhaps  safe  to  assert  that  in  the  majority  of  cases  the 
former  is  preferable.  It  is  almost  always  used  in  the  case  of  finan- 
cial institutions.  If  the  balance  sheet  is  primarily  intended  to  be 
submitted  to  a  prospective  lender,  prominence  should  be  given  to 
the  comparison  of  current  assets  with  current  liabilities  by  placing 
them  at  the  top.  If  the  balance  sheet  is  intended  for  a  prospective 
purchaser,  the  net  worth  of  the  business  may  weU  be  stated  in  one 
amount,  thereby  conforming  to  the  first  arrangement.  In  the 
opinion  of  manj'  accountants,  the  growing  practice  of  issuing 
capital  stock  without  par  value  furnishes  an  additional  reason  for 
showing  in  the  balance  sheet  the  total  of  the  capital  stock  and 
surplus.* 

.  .  .  There  is  an  increasing  tendency  on  the  part  of  accountants 
to  make  a  marked  differentiation  in  the  display  of  liabilities  as  dis- 
tinct from  proprietorship  interest.  The  old-fashioned  balance- 
sheet  in  which  all  credit  amounts  were  tabulated  one  after  the  other 
up)on  the  right  hand  side  without  marked  grouping  or  classification 
has  given  way  to  the  modern  balance-sheet  wherein  the  attempt  is 
made  to  display  definitely  aU  those  totals  of  classification  which  are  ''i 
of  interest  to  the  business  world.  Liabilities  are  subdivided  so  as 
to  show  the  total  of  those  of  a  current  nature  as  distinct  from  those 
which  are  of  a  more  permanent  nature.  The  inclusion  of  capital 
stock  obligations  with  the  permanent  liabilities  is  giving  place  to 
the  method  wherein  all  proprietorship  measurements  are  grouped 
together,  cumulating  in  a  total  which  displays  in  one  amount  the 
net  excess  of  all  assets  over  liabilities.' 


*  Accountants'  Reports,  by  W.  H.  Bell,  p.  22. 

'  "Classification  of  Surplus,"  by  C.  B.  Couchman,  Journal  of  Accountancy,  Oct.  1921,  pp. 
368,  269. 


1366  CORPORATE  ACCOUNTING  [Bk.  III- 

FORM 

The  Blank 
Balance  Sheet, 

Assets 

Property,  Less  Depreciation — Schedule  i $   462,83447 

Good-Will,  Patents,  and  Trade-Marks 250,000.00 

Investment  in  Siibsidiary  Company:  * 

Capital  Stock — 1,000  Shares  of  $100  each $136,237.73 

Advances 50,000.00 


Total  Investment  in  Subsidiary  Company 186,237.73 

Sinking  Fund  for  Redemption  of  Bonds — Cash  and  Accrued 

Interest  (Bonds  Deducted  from  Liability,  per  contra) 4,962.94 

Current  Assets: 

Cash — Current  Funds $  97,526.06 

Cash  on  Deposit  to  Pay  Interest  and  Dividends. .         12,324.97 

Salesmen's  Working  Funds 3,422.95 

Trade  Notes  and  Acceptances  Receivable 143,212.57 

Accounts  Receivable: 

Trade  Debtors $261,404.06 

Less:  Reserves: 

Discounts $13,386.31 

Doubtful  Accounts .  .      10,326.42      23,712.73      237,691.33 


Accounts  Receivable — Officers  and  Employees.  .  .         34,778.67 

Marketable  Securities — Schedule  2 556,183.00 

Accrued  Interest  Receivable 7,981.07 

Inventories: 

Finished  Goods $205,042.36 

Work  in  Process 102,193.14 

Materials  and  Supplies 180,269.80      487,505.30 


Advances  on  Materials  Purchased 24,967.04 


Total  Current  Assets 1,605,592.96 

Deferred  Charges: 

Unamortized  Discount  on  Bonds $  24,516.29 

Prepaid  Insurance,  Interest,  and  Taxes 8,235.24 

Experimental  Expenses 16,294.08 

Total  Deferred  Charges , 49,045.61 


Total $2,558,673.71 

*  Should  be  named. 


•  By  permission  from  Accountants'  Reports,  b;'  W.  H.  Bell-  p.  97. 


Ch.  33]  FORMS  OF  STATEMENTS  I367 

D 

Company  * 
December  31,  1919 

Liabilities 

Preferred  Capital  Stock,  8%  Cumulative — Authorized,  3,000 

shares  of  $100  each;  Outstanding,  2,500  shares $    250,000.00 

Common  Capital  Stock — Authorized  and  Outstanding,  10,000 

shares  of  $100  each 1,000,000.00 

First  Mortgage  6%  Bonds,  Due  1934: 

Issued $500,000.00 

Less: 

In  Sinking  Fund $  50,000.00 

In   Treasury — Pledged    to    Secure 

Notes  Payable 175,000.00      225,000.0 


Outstanding 275,000.00 

Current  Liabilities:  ■,  * 

Notes  Payable— Loans VfVi . .  .KK^l'^^.  .V^P  $100,000.00 

Trade  Acceptances  Payable. '.....  .■      190,776.64 

Accounts  Payable 248,729.57 

Interest  and  Dividends  Payable 12,324.97 

Accrued  Accounts: 

Income  and  Excess  Profits  Taxes  (estimated) .  .         40,000.00 

Wages 13,069.17 

Interest 3,762.43 

Total  Current  Liabilities 608,662.78 

Deferred  Credit — Fire  Insurance  Suspense 5,491.64 

Reserves: 

Injuries  and  Damages $    8,250.27 

Contingencies 25,000.00 

Tptal  Reserves 33,250.27 

Surplus  from  Revaluation  of  Good-Will,  Patents,   and 
Trade-Marks 200,000.00 

Profit  and  Loss  Surplus: 

Balance,  January  i,  1919 $  85,743.68 

Surplus  for  the  year 220,525.34 

Total $306,269.02 

Less:  Dividends 1 20,000.00 


Balance,  December  31,  1919 186,269.02 

Total $2,558,673.71 


Note:    The  Company  has  contingent  liabilities  of  $109,326.73  on  account  of  notes 
and  acceptances  receivable  discounted. 


1368  CORPORATE  ACCOUNTING  [Bk.  III- 

§  353'    Reserves  on  the  Balance  Sheet 

We  have  seen'  that  reserves  are  of  two  kinds— operating  and 
non-operating  reserves— and  always  show  credit  balances.  Of 
these  the  operating  reserves  are  not  limited  in  use  to  corporate 
accounting,  and  cannot  be  discussed  here  except  to  say  that 
they  should  be  shown  on  the  balance  sheet  as  deductions  from 
asset  values,  as  in  the  case  of  reserves  for  depreciation  and 
reserves  for  bad  debts;  or  else  shown  as  accrued  liabilities,  as 
in  the  case  of  reserves  for  taxes.  It  may  be  repeated  that  there 
is  a  growing  objection  to  giving  the  name  "reserves"  to  these 
operating  reserves,  on  account  of  the  confusion  that  has  resulted 
therefrom.  Those  which  are  deductions  from  asset  values  are 
better  styled  "allowances,"  as  "Allowance  for  Depreciation" 
and  "Allowance  for  Bad  Debts,"  and  those  which  represent 
true  liabilities  are  preferably  spoken  of  simply  as  accruals,  as 
"Accrued  Taxes." 

In  regard  to  the  non-operating  reserves,  one  need  remember 
only  that  they  are  nothing  more  than  appropriations  of  surplus, 
in  order  to  see  that  they  belong  to  the  net  worth  group.  They 
represent  surplus  which  has  been  set  aside  for  some  specific 
purposes  and  is  therefore  not  available  for  dividends.  The 
balance  sheet  on  pages  1358-59  shows  such  an  appropriation  of 
surplus. 

' ' '  ''it  is  also  desirable  that  in  the  balance-sheet  the  accountant 
should  display  surplus  in  such  manner  that  the  amount  available 
for  dividends  may  be  readily  ascertainable.  All  surplus  which  has 
been  paid  in  or  earned  or  has  resulted  from  the  sale  of  capital  assets 
is  presumably  available  for  distribution  as  dividends  unless  it  has 
been  definitely  appropriated  for  some  other  purposes.  That  which 
is  not  available  would  include  any  balance  of  surplus  resulting  from 
appreciation  of  assets  and  all  items  of  surplus  which  had  been  im- 
pounded by  action  of  the  board  of  directors.* 

,     The  balance  sheet  on  pages  1366-67  shows  a  surplus  from  ap- 


p.  269. 


J  14- 

»  "Classification  of  Surplus,"  by  C.  B.   Couchman,  Journal  of  Accountancy,  Oct.   1921, 


Ch.  33l  FORMS  OF  STATEMENTS  1369 

preciation  in  such  a  way  as  to  indicate  clearly  that  it  is  not 
available  for  dividends. 

§  354.    Analysis  of  Surplus 

It  is  also  desirable  that  the  balance  sheet  shall  show  the 
changes  in  surplus  during  the  last  fiscal  period,  so  that  a  person 
having  the  balance  sheets  as  of  both  the  beginning  and  the  end 
of  the  year  and  seeing  the  difference  between  the  amounts  of 
surplus  at  those  two  dates  may  be  able  to  determine  the  reasons 
for  the  change.  Such  an  analysis  would  make  the  surplus 
section  of  the  balance  sheet  show  in  the  following  form : 

Surplus,  January  i,  1921 $50,247.23 

Less:  Dividend  declared  March  i,  1921 20,000.00 


,,,,,  $30,247.23 

Plus:  Profit  of  year  1921 I'vpr 12,962.38 

Surplus,  December  31,  1921 '. $43,209.61 

If  this  analysis  of  surplus  were,  however,  of  any  greater  length 
than  this,  it  would  be  better  to  make  a  separate  schedule  of  it 
in  some  such  form  as  that  which  follows : 

Analysis  of  Surplus 

Balance  of  Surplus,  December  31,  1921 $100,000 

Adjustments  applicable  to  prior  periods:  '  '^'  "^ 

Addition:  "'^^M'vN    ' 

Refund  of  Income  Tax  Overpaid $  1,000 

Deductions: 

Accounts  Payable  Not  Entered $200 

Items  Wrongly  Capitalized 400 

Total  Deductions 600 


Net  Increase IV.  T.'.'i . .'. 400 


True  Surplus,  December  31,  1921. ...,..,,..»,,,. ..vj,, $100,400 

Extraordinary  Profits  this  period.  .'.-i'T.  iV.h  .'jv. li/i«5I  .gi;. .    $17,000 

Net  Operating  Profit  this  period ,. 43,ooo         60,000 


Amount  available  for  appropriation $160,400 


13 70  CORPORATE  ACCOUNTING  [Bk.  HI- 

Appropriations  of  Surplus: 

Reserve  for  Sinking  Fund $10,000 

Dividends 20,000 

Total  Appropriations 30,000 

Surplus,  June  30,  1922 $130,400 


§  355-    Bonded  Liabilities  on  the  Balance  Sheet 

Bonds  outstanding,  of  course,  appear  among  the  liabilities 
on  the  balance  sheet.  Unsold  bonds  should  not  appear  as  an 
asset,  but  should  be  deducted  from  the  amount  authorized. 
In  order  that  the  sold  and  unsold  bonds  may  be  clearly  dis- 
tinguished, they  should  appear  in  the  balance  sheet  about  as 
follows : 

First  Mortgage  5%  Gold  Bonds: 

Total  Amount  Authorized : $1,000,000 

Less:  Unsold  Bonds 500,000 

Bonds  Issued  and  Outstanding $    500,000 

Bonds  repurchased  by  the  company  and  held  alive  in  the 
treasury  should  be  clearly  indicated  in  the  balance  sheet,  either 
as  a  subdivision  of  "Investments,"  or  as  "Treasury  Bonds,'" 
with  a  suitable  explanation  of  what  is  meant  thereby,  or  under 
such  other  caption  as  will  clearly  indicate  the  nature  of  the 
asset  without  possibility  of  misunderstanding.  Bonds  of  the 
company  purchased  by  the  trustees  of  the  sinking  fund,  insurance 
fund,  reserve  fund,  beneficial  fund,  or  by  any  subsidiary  or 
affiliated  organization,  board,  or  society,  should,  however, 
be  listed  in  the  assets  of  such  funds,  and  not  necessarily  as 
treasury  bonds.  While  bonds  so  purchased  are  sometimes 
hidden  among  the  general  investments  of  the  company,  this 
should  not  be  done. 

§  356.    The  Sinking  Fund  on  the  Balance  Sheet 

The  sinking  fund,  consisting  as  it  does  of  cash  and  securities, 
would  naturally  be  placed  among  the  assets  in  the  balance 


Ch.  33]  •  FORMS  OF  STATEMENTS  1371 

sheet;  but  since  the  sinking  fund  assets  are  not  free  for  use  as 
working  capital  but  have  been  handed  over  to  the  trustee 
practically  as  part  payment  on  the  bonded  debt,  there  is  some 
question  as  to  the  expediency  of  including  them  among  the 
balance  sheet  assets.  Many  companies  list  sinking  fund  assets 
among  the  corporate  assets,  while  others  show  them  as  deductions 
from  the  bonded  debt.  The  plan  adopted  depends  largely  on 
the  ideas  of  the  accounting  officer  or  of  the  corporation  officials. 
The  following  methods  of  listing  are  in  common  use : 

I.  Sinking  Fund  in  Hands  of  Trustee $157,130 

2  Trustee  of  Sinking  Fund,  being  amount  of  cash  and  securities  held  by 

the  Trustee  for  redemption  of  $1,000,000  5%  First  Mortgage  Bonds 

of  1936 157,130 

3  Sinking  Fund  Assets,  being  amount  in  hands  of  Trustee,  as  follows: 

Invested  in  Securities f  100,000 

Cash  in  Savings  Bank 57,130     157,130 

4.  Sinking  Fund  Assets.     (Cash  and  securities  amounting  to  $157,130  in 
hands  of  Trustee,  deducted  from  outstanding  bonds,  per  contra.) 

Under  the  last  plan  (4)  the  sinking  fund  assets  appear  only 
as  a  memorandum  among  the  assets,  while  the  amount  of  the 
funds  is  deducted  from  the  bonds  themselves  on  the  opposite 
side. 

§  357-     Good- Will  on  the  Federal  Reserve  Balance  Sheet 

Attention  must  be  called  to  the  rather  unusual  manner 
in  which  good-will  is  shown  on  the  approved  Federal  Reserve 
balance  sheet.  All  intangible  items  such  as  this  are  ordinarily 
shown  at  the  bottom  of  the  asset  side.  It  is  true  that  the 
banker,  in  examining  the  balance  sheet  as  a  basis  for  loans, 
appraises  the  various  assets  in  his  own  mind;  and  that  the  loan 
value  which  he  places  on  good-will  is  nothing. 

The  banker's  viewpoint  is  emphasized  in  the  handling  of  this 
item  on  the  Federal  Reserve  balance  sheet,  for  it  is  entirely 
omitted  from  the  assets.  Since  with  this  omission  the  debits 
and  credits  of  the  statement  would  not  balance,  the  book  value 
of  the  good-will  is  inserted  on  the  liability  side  as  a  deduction 


1372  CORPORATE  ACCOUNTING  [Bk.  HI- 

from  the  net  worth  before  that  is  added  to  the  liabilities.  The 
two  sides  will  thus  balance  in  that  the  book  value  of  the  good-will 
is  deducted  from  both,  being  omitted  on  the  debit  side,  where 
it  would  normally  be  found,  and  being  subtracted  from  the  total 
of  the  credits. 

§  358.    Other  Statements  bobnod  oiiJ  raoVf 

Other  statements  will  necessarily  be  prepared.  The^e  mky 
include  a  profit  and  loss  statement,  schedules  of  accounts  re- 
ceivable and  accounts  payable,  and  any  other  accounting  and 
statistical  data  which  may  be  desired.  Their  preparation, 
however,  involves  nothing  of  purely  corporate  interest,  as  they 
will  be  in  practically  the  same  form  for  corporations  as  for 
partnerships  and  individual  proprietorships. 


aoilaiib:^ 


CHAPTER  XXXIV 

CONSOLIDATED  STATEMENTS 

§  359-    Purposes  of  Consolidated  Balance  Sheet 

A  consolidated  balance  sheet  is  one  that  combines  the 
balance  sheets  of  several  different  concerns.  The  plan  of 
including  in  one  statement  the  items  of  a  main  company  and 
its  various  subsidiaries  is  now  in  general  use,  having  grown 
up  with  the  h61ding  company.  The  first  important  consolidated 
balance  sheet  published  was  probably  that  issued  by  the  United 
States  Steel  Corporation  in  1902.  This  company's  consolidated 
statements  still  constitute  excellent  examples,  combining  as 
they  do  the  statements  of  a  considerable  number  of  subsidiary 
companies. 

The  holding  company  and  each  of  its  subsidiaries  will  have 
its  own  statement,  but  it  is  frequently  necessary  or  desirable  to 
present  all  the  financial  details  in  one  balance  sheet,  in  order 
to  reflect  the  financial  position  of  the  whole  group  of  affiliated 
companies  as  one  undertaking.  The  assets  and  liabilities  of  the 
constituent  companies  are  therefore  included  with  those  of  the 
controlling  company,  after  eliminating  therefrom  the  inter- 
company stocks,  bonds,  and  accounts  which  indicate  the  relation 
of  one  company  to  another. 

§  360.    Need  of  Consolidated  Statements 

The  income  of  a  holding  company  consists,  besides  whatever 
profits  may  result  from  its  own  operations  if  it  is  also  an  operating 
company,  of  dividends  paid  by  the  companies  whose  stock  it 
owns.  The  earnings  of  these  companies  may  be  far  greater  or 
less  than  the  amount  of  dividends  paid;  in  the  latter  case  a 
surplus  will  be  accumulated  by  the  subsidiaries;  in  the  former 

1373 


1374  CORPORATE  ACCOUNTING  [Bk.  III- 

case  their  respective  capitals  may  be  impaired.  Under  such 
conditions  the  cost  of  the  stock  of  the  subsidiaries,  as  shown 
on  the  books  of  the  holding  company,  will  give  no  idea  as  to  the 
real  worth  of  the  subsidiaries  and  consequently  of  the  holding 
company.  It  should  be  readily  apparent  that  the  cost  of 
stocks  owned  by  a  holding  company,  so  often  purchased  (for 
book  purposes)  at  figures  which  may  represent  anything  but 
their  real  cash  value  at  the  time  of  purchase,  will  constitute  an 
entirely  inadequate  statement  of  the  assets  of  the  holding 
company. 

The  audit  of  the  books  of  a  holding  company,  therefore,  neces- 
sarily involves  the  audit  of  the  books  of  the  subsidiary,  so  that 
a  comparison  may  be  made  between  the  cost  of  the  stock  as 
shown  on  the  books  and  the  balance  sheet  of  the  holding  com- 
pany, with  the  net  worth  of  the  subsidiaries  as  shown  by  their 
balance  sheets.  The  simplest  form  of  presenting  the  results  of 
this  comparison  is  by  a  consolidated  balance  sheet. 

As  an  example  of  the  erroneous  figures  which  might  result 
from  a  failure  to  examine  the  books  of  the  subsidiaries  in  order 
to  show  the  true  value  of  their  stock  in  the  hands  of  the  holding 
company,  Ernest  Reckitt,  Certified  Public  Accountant,  relates 
the  following  experience : 

I  have  in  mind  a  case  where  I  was  called  in  to  make,  as  I  sup- 
posed, an  audit  of  the  books  not  only  of  the  "Holding  Company," 
but  also  of  the  subsidiary  companies,  and  was  amazed  to  find  that 
it  was  proposed  to  have  me  audit  only  the  "Holding  Company's" 
books.  Upon  explaining  that  I  could  give  no  certificate  on  such 
audit,  the  most  specious  arguments  were  advanced  and  the  pres- 
ident of  the  company  attempted  to  use  the  full  force  of  his  strong 
personality  to  persuade  me  to  defer  to  his  wishes,  which  naturally 
only  made  me  suspect  stiU  more  the  motives  which  actuated  him. 
Finally,  and  with  great  reluctance,  they  handed  me  the  books  of 
the  subsidiary  companies,  and  I  found  out  that  two  of  the  com- 
panies had  made  losses  aggregating  over  $200,000,  no  part  of  which 
losses  had  been  taken  care  of  on  the  books  of  the  "Holding  Com- 
pany," though  they  had  been  careful  to  bring  on  to  the  books  of  the 
"Holding  Company"  the  profits  made  by  other  subsidiary  com- 


Ch.  34]  CONSOLIDATED  STATEMENTS  1375 

panics.    One  year  later,  the  "Holding  Company"  and  most  of  the 
subsidiary  companies  were  in  bankruptcy,  as  they  deserved  to  be.^ 

§  361.    Effect  of  Statement  Consolidation  on  Inventories 

Perhaps  the  most  obvious  example  of  the  need  of  consolidated 
statements  is  found  in  the  case  of  companies  one  of  which  sells  its 
products  to  the  other.  Assume  the  case  of  a  candy  factory- 
owning  a  subsidiary  which  manufactures  paper  boxes,  seUing 
90%  of  its  output  to  the  parent  company.  If  just  before  the 
time  for  making  a  statement  the  subsidiary  "sells"  its  entire 
finished  goods  inventory  to  the  candy  factory  at  its  usual  margin 
of  profit  or  at  an  unusual  price,  the  transaction  will  be  represented 
on  the  books  of  the  one  company  by  an  account  receivable,  and 
on  the  books  of  the  other  by  an  equal  account  payable.  As  will 
be  seen  later,  these  will  both  be  eliminated  in  the  consolidated 
balance  sheet.  But  these  same  goods  will  appear  on  the  inventory 
of  the  candy  factory  at  a  greater  book  cost  than  the  real  cost  to 
the  combined  interests,  because  the  profit  charged  by  the 
subsidiary  has  been  included  in  the  inventory.  This  profit 
must  be  eliminated  if  we  are  to  get  down  to  accepted  principles 
in  the  valuation  of  inventories,  and  in  these  days  of  income  taxes 
only  a  corporation  which  is  very  careless  or  is  in  desperate 
straits  financially  will  be  willing  to  pay  a  tax  on  such  an  un- 
realized profit. 

§  362.    Contents  of  Consolidated  Balance  Sheet 

The  contents  of  a  consolidated  balance  sheet  are  practically 
the  same  as  of  that  of  a  single  company.  There  are,  however, 
certain  points  peculiar  to  such  statements  which  require  special 
attention.     They  are  as  follows: 

I.  Intercompany  obligations —existing  debts  among  the 
constitutent  companies  for  goods  sold,  for  advances  made 
to  one  another,  and  for  bond  interest  accrued,  or  declared 

•  Quoted  in  Auditing  Theory  and  Practice,  by  R.  H.  Montgomery  (ad  Ed.). 


1376  CORPORATE  ACCOUNTING  [Bk.III- 

dividends — being   offsetting   assets   and   liabilities,   should   be 
eliminated  from  the  combined  statement. 

2.  The  excess  above  cost  to  the  combined  interests  of  any 
valuation  of  inventories  based  on  prices  at  which  merchandise 
is  sold  by  one  company  to  another  is  eliminated. 

3.  Intercompany  holdings  of  capital  stock  are  eliminated. 

4.  Guaranties,  leases,  and  other  contracts  existing  between 
the  parent  company  and  subsidiaries,  are  shown  in  the  balance 
sheet  among  the  assets  and  liabilities  or  as  footnotes. 

5.  The  extent  of  ownership  in  the  subsidiary  companies' 
stock— whether  the  parent  company  owns  all,  a  controlling 
interest,  or  only  a  portion  thereof — and  the  extent  of  ownership 
by  the  underlying  companies  in  the  stock  of  the  parent  company 
or  of  the  other  companies,  should  be  clearly  stated,  either  in  the 
balance  sheet  or  in  a  supporting  schedule.  The  minority  interest 
in  surplus  profits  should  also  be  indicated. 

6.  The  parent  company's  ownership  of  bonds  of  the  sub- 
sidiary companies,  and  vice  versa,  should  be  shown. 

The  effect  of  these  steps  will  be  to  furnish  a  statement 
which  will  show  the  financial  standing  of  the  group  as  an  entity, 
and  at  the  same  time  the  relation  of  the  members  of  the  group 
to  each  other. 

§  363.    Preparation  of  Consolidated  Balance  Sheets 

The  preparation  of  a  consolidated  balance  sheet  requires 
first  the  preparation  of  a  fully  satisfactory  balance  sheet  of  each 
company.  All  corrections  and  other  adjustments  of  the  individ- 
ual statements  should  be  made  before  work  is  begun  on  the 
consolidation,  and  the  classification  of  similar  items  and  the 
terminology  used  should  be  the  same  on  all  the  statements. 

It  will  be  found  that  the  easiest  method  of  combining  the 
several  balance  sheets  is  by  entering  the  various  items  of  each 
on  analysis  paper.  The  names  of  the  companies  may  be  entered 
in  the  left-hand  margin  if  they  are  extremely  numerous,  the 


Ch.  34]  CONSOLIDATED  STATEMENTS  1377 

money  columns  being  headed  up  for  the  various  asset  and 
liability  items;  but  generally  the  reverse  method  will  be  more 
satisfactory,  i.e.,  entering  the  names  of  the  companies  at  the 
heads  of  the  money  columns  (using  one  column  for  each  com- 
pany), and  assigning  one  line  to  each  of  the  asset  and  liability 
items. 

The  next  column  (or  line)  after  the  enumeration  of  assets 
and  also  after  the  liabilities,  should  then  be  headed  "Total,"  and 
the  totals  of  each  account  for  all  companies  should  be  carried 
over  and  balanced,  the  grand  total  of  assets  equaling  the  grand 
total  of  liabilities. 

Two  columns  (or  lines)  may  then  be  provided  for  adjustments. 
As  these  are,  however,  usually  in  the  nature  of  eliminations 
(credits  to  assets  and  debits  to  liabilities)  rather  than  increases, 
some  accountants  provide  just  one  column  for  "Eliminations," 
entering  in  red  ink  any  adjustments  which  are  in  the  nature  of 
increases. 

§  364.    Elimination  of  Intercompany  Items 

Before  commencing  to  eliminate  intercompany  accounts, 
these  should  be  reconciled  between  the  various  sets  of  books 
to  make  certain  that  the  same  amount  is  shown  as  a  receivable 
on  the  part  of  one  company  as  is  shown  as  a  payable  on  the 
part  of  another.  Differences  may  exist  in  the  current  account 
between  two  of  the  companies  because  merchandise  shipped  and 
charged  by  one  company  has  not  yet  been  received  and  entered 
by  another,  6t  for  other  reasons.  In  the  case  just  mentioned 
the  adjusting  entry  on  the  work  sheet  would  debit  the  Inventory 
of  the  receiving  company  and  credit  its  Intercompany  Accounts 
Payable,  as  the  merchandise  should  of  course  be  included  in  the 
inventory  of  the  group. 

When  all  such  differences  have  been  adjusted  the  inter- 
company accounts  receivable  will  equal  the  intercompany 
accounts  payable,  and  all  should  be  eliminated  by  the  proper 
entries  on  the  work  sheet.    These  items  to  be  eliminated  will 


1378  CORPORATE  ACCOUNTING  [Bk.  III- 

include,  in  addition  to  debts  payable  by  the  holding  company 
or  one  of  the  subsidiaries,  to  another  of  the  subsidiaries  or  to  the 
holding  company  for  merchandise  sold  or  services  rendered, 
advances  of  money  from  one  to  another,  or  deposits  of  money  by 
one  of  the  companies  with  another,  bonds  of  one  of  the  com- 
panies held  by  another,  accrued  items,  and  declared  dividends. 
The  consolidated  balance  sheet  will  therefore  show  no  receiv- 
ables or  payables  except  those  due  from  and  to  outsiders. 

§  365.    Example  of  Work  Sheet 

The  manner  of  assembling  and  combining  the  items  of 
several  component  companies  into  a  consolidated  balance  sheet 
is  shown,  in  the  following  example.  Three  companies,  X,  Y, 
and  Z,  are  used  in  the  illustration,  the  first  being  purely  a 
holding  company,  and  the  other  two,  subsidiary  operating  com- 
panies. Intercompany  stockholdings  and  current  obligations 
that  require  careful  handling  are  included. 

Form  A,  on  the  following  page,  shows  how  the  accountant 
or  corporation  official  gathers  details  and  makes  deductions  on 
his  "working  papers,"  "working  sheets,"  or  "analysis  sheets," 
preparatory  to  his  final  exhibit.  The  assets  and  liabilities  are 
shown  separately  and  .  combined.  The  eliminations  of  inter- 
company items  in  arriving  at  the  net  results  are  also  shown. 
In  the  preparation  of  consolidated  balance  sheets,  the  state- 
ments of  the  several  companies  are  prepared  separately  and 
then  brought  together,  as  shown  in  this  form. 

Of  the  adjustments  shown,  those  already  referred  to  are 
the  elimination  of  $15,000  owing  by  Company  Y  to  Company  Z, 
and  of  $12,000  owing  by  Company  Z  to  Company  Y  (both  of 
which  are  deducted  from  "Cash  and  Sundry  Assets"  on  the 
asset  side) ;  the  removal  of  $60,000  of  advances  by  Company  X 
to  the  other  two  companies;  and  the  elimination  of  the  $30^000 
of  bonds  of  Company  Y,  held  by  Company  X. 
■»'"- 


Ch.  34] 


CONSOLIDATED  STATEMENTS 


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1380  CORPORATE  ACCOUNTING  [Bk.  IH- 

§  366.    Intercompany  Holdings  of  Capital  Stock 

The  other  eliminations  shown  are  those  of  intercompany 
holdings  of  capital  stocks.  In  the  present  simple  case  these 
are  all  carried  on  the  books  of  the  holding  companies  at  par, 
but  frequently  this  will  be  found  not  to  be  the  case.  This 
condition  results  from  the  purchase  of  the  stock  at  a  figure  other 
than  par,  and  necessarily  means  that  the  holding  company  has 
paid  a  premium  for  its  share  of  the  accumulated  surplus  of  the 
subsidiary  or  for  the  good-will  not  on  the  books,  or  has  perhaps 
received  the  stock  at  a  discount  on  account  of  the  existence  of  a 
deficit  or  the  lack  of  that  earning  power  which  constitutes  the 
value  of  good-will. 

Let  us  suppose  that  the  par  value  of  a  subsidiary's  stock  is 
$100,000,  all  of  which  has  been  purchased  by  the  holding  com- 
pany for  $1 75,000.  This  purchase  price  bought,  as  has  been  said, 
the  surplus  of  the  subsidiary  including  the  value  of  any  good-will 
not  on  the  books.  If  the  surplus  by  the  book  values  of  assets 
other  than  good-will  at  the  time  of  the  acquisition  of  the  stock 
was  $25,000,  the  sum  of  $50,000  must  have  been  paid  for  the 
good-will.    The  following  adjustment  will  therefore  be  necessary : 

Capital  Stock  of  Subsidiary $100,000.00 

Surplus 25,000.00 

Good-Will 50,000.00 

To  Investment  in  Stock  of  Subsidiary $175,000.00 

The  rule  is  admirably  expressed  as  follows: 

Where  the  book  value  of  the  subsidiary  company  in  a  balance- 
sheet  of  the  company  holding  that  stock  is  in  excess  of  the  par 
value  of  the  stock  plus  the  surplus  of  the  subsidiary  company  at  the 
date  of  acquisition  the  excess  should  be  charged  to  goodwill.  Where 
the  book  value  of  the  stock  of  a  subsidiary  company  in  a  balance- 
sheet  of  the  company  holding  that  stock  is  less  than  the  capital 
stock  plus  the  surplus  of  the  subsidiary  company  at  date  of  acquisi- 
tion, the  difference  should  be  credited  to  capital  surplus,  unless 
there  is  goodwill  of  a  greater  amount  either  on  the  accounts  of  the 
holding  company  or  of  the  subsidiary  company,  or  if  there  is  good- 
will of  a  greater  amount  arising  from  purchases  of  stocks  of  other 


Ch.  34]  CONSOLIDATED  STATEMENTS  1381 

subsidiary  companies.  This  treatment  is  based  on  the  assumption 
that  goodwill  is  shown  separately,  but  many  companies  in  their 
published  accounts  do  not  show  goodwill  separately  and  simply 
have  an  account  called  "cost  of  properties."  In  this  case  the  debits 
and  credits  would  be  made  to  this  account  instead  of  to  goodwill  or 
capital  surplus.* 

§  367.    Reason  for  Adjustment  of  Surplus 

The  reason  for  eliminating  in  the  consolidated  balance  sheet 
the  surplus  of  the  subsidiary  at  the  date  of  the  acquisition  of  its 
stock  by  the  holding  company,  instead  of  including  it  as  a  part 
of  the  consolidated  surplus,  is  that  the  surplus  of  the  subsidiary 
at  that  time  is  of  the  same  nature  as  its  capital  stock.  What 
the  purchaser  buys  is  all  or  a  proportionate  part  of  the  net  worth 
or  capital,  which  is  arbitrarily  divided  on  the  books  between  the 
two  accounts.  Capital  Stock  and  Surplus. 

A  business  cannot  accumulate  a  surplus  before  its  inception, 
neither  can  it  purchase  a  surplus  except  through  the  purchase 
of  the  capital  stock,  but  in  purchasing  all  of  the  capital  stock  it 
necessarily  purchases  all  of  the  surplus.  For  this  reason  divi- 
dends received  by  the  holding  company  out  of  surplus  accumu- 
lated by  the  subsidiary  prior  to  the  date  of  the  purchase  of  its 
stock,  should  be  credited  to  the  cost  of  the  investment  on  the 
books  of  the  holding  company  rather  than  to  income,  since  the 
undivided  surplus  constitutes  part  of  what  the  holding  company 
paid  for,  and  the  receipt  of  the  dividends  is  a  return  of  capital 
invested  rather  than  a  profit  earned.  The  Profit  and  Loss 
account  of  a  holding  company  should  therefore  reflect  only  the 
profits  earned  by  the  holding  company  after  its  organization 
plus  the  profits  of  subsidiaries  after  the  acquisition  of  their 
stock  by  the  holding  company. 

§  368.    Adjustment  of  Inventories 

If  any  one  of  a  group  of  companies  for  which  a  consolidated 
balance  sheet  is  being  prepared  has  in  its  inventory  merchandise 

•  "Consolidated  Accounts,"  by  G.  R.  Webster,  Journal  of  Accountancy,  Oct.  1919,  p.  263. 


1382  CORPORATE  ACCOUNTING  [Bk.  III- 

which  it  has  purchased  from  another  company  of  the  same  group, 
the  profit  made  by  the  vendor  company  in  the  sale  of  the  mer- 
chandise must  be  eliminated  from  the  inventory  valuation,  and 
the  merchandise  carried  in  the  consolidated  balance  sheet  at 
its  cost  to  the  group.  Careful  investigation  is  sometimes 
required  to  determine  the  amount  of  this  profit,  which  will  be 
eliminated  by  an  adjustment  debiting  Surplus  and  crediting 
Inventories.  Failure  to  make  this  adjustment  would  result  in 
the  combination's  showing  current  assets  at  an  improper  figure 
and  would  be  equivalent  to  the  carrying  of  inventories  by  any 
single  company  at  an  inflated  valuation. 

In  order  to  obviate  the  difficulty  of  securing  the  necessary 
figures  for  this  adjustment,  a  method  of  accounting  has  been 
developed  in  consolidated  companies  by  which  the  intercompany 
profit  is  shown  on  the  books  at  all  times.  This  profit  is  carried 
through  the  accounts  as  a  separate  item  from  the  original  cost 
until  the  finished  product  is  eventually  sold  outside  the  con- 
solidation. While  accomplishing  this  result  the  method  permits 
each  subsidiary  to  take  up  its  own  profits,  to  which  it  is  legally 
entitled.     The  following  example  outlines  the  method  in  brief: 

Company  A  produces  a  raw  material  and  sells  it  to  Company  B 
at  a  profit  of,  say,  10  per  cent;  Company  B  converts  this  raw 
material  into  a  partly  finished  product  and  ships  it  over  a  Railroad 
C,  owned  by  the  consolidation,  to  Company  D,  by  whom  it  is  fur- 
ther manufactured  and  finally  sold  to  outside  parties.  Company 
A  produces  material  to  the  cost  value  of  $100,000,  and  sells  $20,000 
of  this  to  outside  parties,  $60,000  to  Company  B,  and  has  the 
remaining  $20,000  in  stock.  Company  B  buys  material  from 
Company  A,  costing  $60,000,  for  $66,000;  spends  $34,000  in  further 
manufacture;  ships  $70,000  of  the  manufactured  product  over 
Railroad  C  to  Company  D;  sells  $20,000  to  outsiders,  and  has 
$10,000  in  stock.  Company  D  purchases  products  from  Company 
B,  costing  $70,000,  for  $77,000;  pays  $5,000  freight  to  RaUroad  C — 
which  costs  the  latter  $3,500;  expends  $18,000  in  completing  its 
manufacture;  sells  $80,000  of  the  finished  product  to  outsiders,  and 
has  the  remaining  $20,000  in  stock. 

The  books  of  Company  A  require  no  special  entries. 


Ch.  34]                          CONSOLIDATED  STATEMENTS  1383 

In  Company  B's  books  its  Manufacturing  account  will  stand  as 
follows: 

I.  C.  ist 

Profit         Cost  Total 

Cost  of  material $  6,000     $60,000  $  66,000 

Manufacturing  cost 34,000  34,000 

$  6,000     $94,000  $100,000 

•Cost  of  sales: 

To  outside  parties $  1,200     $18,800  $  20,000 

To  Company  D 4,200       65,800  70,000 

Balance  in  stock $     600     $  9,400  $  10,000 


In  company  D's  books  the  Manufacturing  account  will  be  dealt 
with  similarly,  as  follows: 

I.  C.  ist 

Profit  Cost  Total 

Cost  of  material  per  Company  B $11,200  $65,800  $77,000 

Freight ii5oo  3,500  5,000 

Manufacturing  cost 18,000  18,000 

$12,700  $87,300  $100,000 
Cost  of  sales: 

To  outside  parties 10,160  69,840  80,000 

Balance  in  stock $2,540  $17,460*  $20,000 


The  subsidiary  companies  will  take  up  in  their  Income  accounts 
the  whole  of  their  profits  on  their  sales,  and  will  declare  dividends 
in  the  usual  way.  Out  of  the  dividends  it  receives,  the  holding 
company  will  set  up  $600  in  respect  of  B's  profits,  and  $2,540  in 
respect  of  D's  profits,  or  a  total  of  $3,140,  which  will  be  credited  to 
an  inventory  reserve.  In  this  way,  all  stocks  on  hand  of  all  com- 
panies are,  on  the  consolidated  balance  sheet,  carried  at  net  cost 
within  the  consolidation,  and  the  consolidated  income  takes  up  no 
profit  except  on  sales  made  to  outside  parties.  If  any  of  the  pro- 
duct is  used  for  construction  work  within  the  orgajii:^ation,  the  net 
cost  only  is  used,  so  that  no  profit  of  subsidiary  companies  enters 
into  capital  expenditures.^ 


'  By    permission  from    Accounting   Practice  and   Procedure,   by  A.    Lowes   Dickinson, 
pp.  i8o-i83. 


CHAPTER  XXXV 

CONSOLIDATED  STATEMENTS  (Continued) 

§  369.    When  to  Use  Consolidated  Statements 

When  the  holding  company  owns  all  of  the  stock  of  a  sub- 
sidiary there  is  no  question  regarding  the  need  of  a  consolidated 
balance  sheet.  If  it  owns  51%  there  is  seldom  doubt  as  to  the 
advisability  of  the  consolidated  statement.  But  what  if  it  owns 
a  minority?  If  that  minority  holding  is  yet  sufficient  for 
effective  control,  few  perhaps  would  question  the  wisdom  of 
joining  the  statements. 

If  the  holding  company,  however,  is  not  able  to  exercise 
control  there  is  a  question  as  to  whether  the  statement  should 
be  joined.  The  rule  might  be  laid  down  that  if  the  stock  of 
the  other  company  forms  an  important  percentage  of  such  a 
holding  company's  assets,  no  balance  sheet  except  a  consolidated 
one  would  satisfactorily  present  the  holding  company's  condition, 
but  that  a  statement  for  the  other  company  would  be  adequate 
without  consideration  of  the  holding  company.  The  stock- 
holders of  the  subsidiary  have  no  interest  in  the  holding 
company  in  the  way  in  which  those  of  the  latter  have  in  the 
subsidiary  because  of  its  ownership  of  stock  in  the  subsidiary. 

No  definite  rule  can  be  promulgated.  This  fact  has  been 
recognized  by  the  Bureau  of  Internal  Revenue,  which  requires 
the  disclosure  of  affiliations  when  the  intercompany  stock 
ownership  is  in  excess  of  50%.  The  question  of  whether  or  not 
accounts  of  affiliated  companies  should  be  consolidated  is  to  be 
decided  on  the  merits  of  each  particular  case,  basing  that  decision" 
on  the  answer  to  the  question  as  to  which  form  of  statement 
will  more  fully  show  the  true  financial  condition  of  the  com- 
panies.    This  alone  can  be  the  final  test  in  doubtful  cases. 

1384 


Ch.  35]  CONSOLIDATED  STATEMENTS  1385 

§  370.    Basis  of  Consolidation 

There  are  two  methods  of  preparing  the  consoHdated  balance 
sheet  when  the  holding  company  does  not  own  all  of  the  stock 
of  the  subsidiary,  under  which  the  consolidated  statement 
shows:  (i)  Either  the  holding  company's  proportionate  share 
only  of  each  asset  and  liability  of  the  subsidiaries;  or  (2)  all 
the  assets  and  liabilities  of  the  subsidiaries,  bringing  over  on  the 
liability  side  of  the  consolidated  balance  sheet  the  outside 
interest  in  the  capital  stock  and  surplus  of  the  subsidiaries. 

The  second  is  the  customary  method,  and  it  should  be  readily 
apparent  that  it  is  the  better  method  of  showing  the  financial 
position  of  the  consolidated  companies.  The  inclusion  in  the 
consolidated  balance  sheet  of  80%  of  the  assets  and  80%  of  the 
liabilities  of  a  subsidiary  company  does  not  present  the  true 
condition.  It  seems  far  more  reasonable  to  show  all  the  assets 
and  all  the  liabilities  as  belonging  to  the  group,  which  as  a  group 
has  a  capital  liability  to  outsiders  for  the  par  value  of  their 
stock  and  for  the  share  of  the  surplus  represented  by  that  stock. 

Further,  if  a  holding  company  has  an  account  receivable  of 
$1,000  due  from  the  subsidiary,  and  if  there  is  shown  in  the 
consolidated  balance  sheet  that  percentage  of  the  assets  and 
liabilities  of  the  subsidiary  company  which  the  holding  company 
owns  of  the  subsidiary's  stock,  there  would  be  an  intercompany 
item  of  only  $800  (80%  of  the  stock  being  owned  by  the  holding 
company) ,  and  it  would  be  necessary  to  treat  the  additional  $200 
receivable  as  an  account  due  from  outsiders. 

A  consolidated  balance  sheet  prepared  in  this  way  shows  the 
holding  company's  own  assets,  liabilities,  capital  stock  and 
surplus,  and  its  proportion  of  the  assets,  liabilities,  and  surplus 
of  the  subsidiaries,  but  it  does  not  contain  all  the  information 
necessary  to  a  satisfactory  statement,  in  that  it  understates  the 
assets  controlled  by  the  consolidation  and  ignores  certain 
liabilities  which,  although  applicable  to  the  minority  interest, 
may  yet  have  to  be  financed  by  the  holding  company  in  order 
to  maintain  its  own  standing  and  organization. 


1386  CORPORATE  ACCOUNTING  [Bk.  ni- 

§  371.     Showing  Minority  Interest  as  a  Liability 

These  disadvantages  do  not  apply  to  the  second  method  of 
preparing  the  consoUdated  balance  sheet  when  the  holding 
company  does  not  own  all  of  the  stock  of  the  subsidiary,  under 
which  all  the  assets  and  habilities  of  the  affiliated  companies 
are  shown  (with  intercompany  items  eliminated),  the  outside 
interest  in  the  capital  stock  and  surplus  of  the  subsidiaries  being 
shown  as  a  liability. 

Taking  the  example  given  in  the  preceding  chapter  in  which 
the  intercompany  items  have  already  been  eliminated,  1  a  form  of 
balance  sheet  made  out  according  to  the  second  method  is  shown 
in  Form  B  which  follows.  A  comparison  of  the  two  forms  will 
show  exactly  how  the  latter  balance  sheet  has  been  prepared. 
The  source  of  the  various  figures  having  to  do  with  capital 
stock  will  be  readily  apparent.  The  manner  of  dividing  the 
surplus  is  shown  in  the  following  table.  The  figures  can  easily 
be  traced  back  to  the  balance  sheet  and  adjustments  in 
Form  A. 

Company  X  (the  holding  company)  has  a  surplus  of $  81,200.00 

Company  X  owns  $1 75,000  of  the  $300,000  stock  of  Company  Y  and  is 

therefore  entitled  to  175,000/300,000  of  its  surplus  of  $74,100 43,225.00 

Company  X  owns  all  of  the  capital  stock  of  Company  Z  and  is  therefore 

entitled  to  all  of  its  surplus  of 34,400.00 

The  surplus  owned  by  the  afl&liated  companies  is  therefore $158,825.00 

The  surplus  of  the  outside  interests  is  only  that  proportion 
of  the  surplus  of  Company  Y  which  the  outside  interests  own 
of  the  capital  stock  of  Company  Y,  or  125,000/300,000  of 
$74,100,  or  $30,875. 

The  outside  interests  have  an  interest  also  in  the  surplus  of 
Company  X  which  might  be  shown.  If  one-twentieth  of  Com- 
pany X's  surplus,  or  $4,060,  belongs  to  Company  Y,  then  the 
minority  interests  of  the  latter  company  own  five-twelfths  of 
this  surplus,  or  $1,691.67. 


I  See  Form  A,  page  I379. 


Ch..35l 


CONSOLIDATED  STATEMENTS 


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1388  CORPORATE  ACCOUNTING  [Bk.  III- 

§  372.    Combined  Balance  Sheet 

Form  C,  which  follows,  might  be  called  a  combined  balance 
sheet.  It  is  a  combination  of  the  assets  and  liabilities  of  several 
closely  affiliated  companies  without  any  cancellation  of  inter- 
company debits  and  credits.  The  items  are  arranged  very 
much  as  in  the  fourth  column  of  Form  A;  in  fact,  where  only  two 
or  three  companies  are  concerned,  the  combined  information 
might  be  presented  in  a  columnar  exhibit  comprising  the  first 
four  columns  of  Form  A  as  they  stand. 

Among  the  assets  are  included  $60,000  of  advances  to  sub- 
sidiary companies  and  $27,000  of  intercompany  debts,  the 
latter  included  with  the  sundry  assets.  These  are  likewise 
shown  as  offsetting  liabilities.  Taking  the  entire  matter  as  one 
concern,  it  will  be  seen  that  the  company  owes  $87,000  to  itself. 

Such  a  statement  as  this  is  not  favored  because  it  does  not 
show  readily  the  true  worth  of  the  group  or  its  quick  assets  and 
current  liabilities.  It  is  a  makeshift  at  the  best,  and  cannot 
truly  be  called  a  consolidated  balance  sheet.  The  word  "com- 
bined" seems  to  describe  it  best. 

Accountants  sometimes  consolidate  only  the  accounts  of  the 
subsidiary  companies,  the  balance  sheet  of  the  holding  company 
being  presented  separately  in  the  ordinary  or  unconsolidated 
form,  but  what  advantage  there  is  in  such  a  practice  is  hard  to 
see;  its  disadvantages  are  obvious. 

Form  C 

CONSOLmATED  GENERAL  BALANCE  ShEET 

OF  Company  X  and  Subsidiaries  Y  and  Z 
December  31,  1921 

(Presenting  all  accounts  and  intercompany  details  without 
cancellations) 

Assets 

Plant  and  Capital  Assets $   429,800 

Cash  and  Sundry  Assets 290,100 

Material,  Supplies,  and  Goods  in  Process 510,000 

Prepaid  and  Deferred  Charges 77.900 


Ch.  35]                        CONSOLIDATED  STATEMENTS       '  1389 

Advances  to  Subsidiary  Companies 60,000 

Investments  in  Stocks  and  Bonds  of  Affiliated  Companies* 430,000 

Total  Assets $1,797,800 


Liabilities 
Capital  Stock  Outstanding: 

Of  Company  X $500,000 

Of  Company  Y 300,000 

Of  Company  Z 200,000    $1,000,000 

Bonds  of  Company  Y 50,000 

Current  Liabilities 471,100 

Advances  and  Intercompany  Obligations 87,000 

Combined  Surplus 189,700 

Total  Liabilities $1,797,800 

*  The  investments  may  be  stated  separately  if  desired. 

§  373*    Additional  Illustrations  of  Consolidated  Balance  Sheets 

The  balance  sheet  of  the  Vulcan  Machine  Works  and  its 
subsidiaries  (Form  D) ,  which  follows,  is  that  of  a  manufacturing 
company,  and  shows  an  arrangement  of  details  slightly  different 
from  those  of  Forms  B  and  C.  It  will  be  noticed  that  the 
company's  bonds  to  the  value  of  $50,000  are  included  in  the  assets 
and  also  in  the  liabilities,  this  amount  being  owned  by  a  sub- 
sidiary. The  stockholdings  are  indicated  as  a  memorandum  on 
each  side,  while  the  stock  premium  is  included  in  the  assets, 
thus  indicating  that  the  stock  owned  is  worth  more  than  par. 
This  premium  might  be  charged  against  Surplus.  If  stock  is 
purchased  below  par,  the  discount  may  be  credited  to  Surplus, 
provided  the  stock  is  really  worth  face  value.  A  deficit  of  an 
underlying  company  should  be  shown  in  the  consolidated 
balance  sheet  as  a  deduction  from  Surplus. 


I390 


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1394  CORPORATE  ACCOUNTING  [Bk.  m- 

The  division  of  surplus  profits  between  the  holding  company 
and  outside  interests  must  obviously  depend  on  the  status  of 
the  preferred  stock.  The  holders  of  that  stock  may  or  may  not 
have  an  interest  in  excess  profits  over  and  above  the  dividend 
payments;  therefore  no  division  is  attempted  in  this  exhibit. 
Another  consolidated  balance  sheet,  shown  in  Form  E,  is  that 
of  the  Minnesota  Lumber  Company  which  owns  and  operates 
ten  retail  yards  and  four  subsidiary  companies.  In  connection 
with  this  statement  underlying  details  having  to  do  with  the 
separate  yards  of  subsidiary  companies  are  contained  in  support- 
ing schedules  not  reproduced  here.  Each  schedule  assembles 
all  of  the  items  of  a  similar  nature  on  hand  at  the  various  yards 
and  companies.  For  example,  Schedule  i  would  show  the 
cash  and  book  balances,  or  overdrafts,  at  the  various  yards  and 
companies  as  well  as  at  the  home  office.  Schedule  4  would 
in  like  manner  show  the  location  of  all  merchandise  inventories 
and  suppHes  of  the  various  yards  and  companies.  Otherwise 
the  balance  sheet  differs  but  slightly  from  the  other  forms  pre- 
sented in  this  chapter.  By  placing  the  capital  and  surplus 
profits  after  the  liabilities  instead  of  before,  it  is  possible  to  show 
the  "net  worth"  of  the  combined  companies. 

As  a  further  illustration  there  is  presented  on  pages 
1396-97  a  consolidated  balance  sheet  of  the  United  Equipment 
Company  and  the  Nelson  Car  Wheel  Company,  the  combination 
of  which  was  used  as  an  example  in  the  study  of  holding  com- 
panies.2  It  will  be  seen  that  this  consolidated  balance  sheet 
includes  only  the  two  stated  companies,  the  United  Equipment 
Company's  holdings  of  stock  in  other  companies  being  shown  in 
the  Investments  account.  It  is  obvious,  however,  that  this 
account  would  not  include  the  stock  of  companies  whose  state- 
ments are  included  in  the  consolidated  balance  sheet.  The 
investment  of  the  United  Equipment  Company  in  the  bonds 
of  the  subsidiary  is  deducted  from  the  Investments  account  and 

2  See  {  263. 


Ch.  3sl  CONSOLIDATED  STATEMENTS  1395 

added  to  the  amount  of  bonds  in  the  treasuries,  being  thus 
deducted  from  the  liabilities. 

§  374.    Consolidated  Income  Statement 

The  profit  and  loss  accounts  of  the  parent  company  and  its 
various  subsidiaries  may,  like  the  balance  sheets,  be  combined 
in  one  comprehensive  income  statement  or  statement  of  profit 
and  loss.  This  is  a  simpler  process,  however,  than  the  prepar- 
ation of  a  consolidated  balance  sheet,  since  there  is  no  minority 
interest  to  work  out. 

A  columnar  work  sheet  is  generally  used  in  combining  the 
various  items  of  income  and  expense,  as  already  illustrated 
under  the  balance  sheet. 

In  principle  the  consolidated  profit  and  loss  statement 
simply  groups  and  totals  similar  items  of  income  and  expense. 
There  are,  however,  certain  eliminations  to  be  made  which  are 
related  directly  to  the  asset  and  Hability  accounts  (other  than 
the  consolidated  surplus)  and  some  which  do  not  affect  the 
surplus.  Among  the  former  will  be  found  the  adjustment 
previously  discussed  whereby  any  profit  made  by  one  company 
in  the  group,  on  merchandise  sold  to  and  still  in  the  possession 
of  another,  must  be  eliminated  from  the  valuation  of  the  in- 
ventory, which  is  to  be  carried  at  cost  to  the  group  as  a  whole  and 
not  at  the  selling  price  of  the  company  which  transferred  it 
(which  is  its  cost  to  the  company  which  holds  it).^ 

§  375*    Elimination  of  Intercompany  Income  and  Expense  Items 

This  brings  us  to  the  fact  that,  for  purposes  of  the  con- 
solidated statement,  sales,  whether  of  products  or  of  services, 
from  one  company  in  a  consolidated  group  to  another  are  not 
to  be  considered  as  sales  any  more  than  are  shipments  of  mer- 
chandise from  one  branch  house  of  a  corporation  to  another, 
or  transfers  of  merchandise  or  material  from  one  department  to 

another.    In  the  consolidated  statement  such  sales  should  be  re- 

/ 

•See  I  361. 


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CORPORATE  ACCOUNTING 


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1398  CORPORATE  ACCOUNTING  [Bk.  III- 

moved  from  the  aggregate  sales  of  the  consolidation  and  from  the 
aggregate  cost  of  sales  of  the  consolidation.  It  will  be  evident 
that  there  will  be  no  change  on  account  of  this  adjustment 
in  the  profit  of  the  group  in  connection  with  merchandise  which 
has  been  sold  out  of  the  group,  because  when  the  sale  was  made 
from  one  company  within  the  group  to  another  the  selling  price 
of  the  former  became  a  part  of  the  debits  to  income  of  the  latter. 
On  merchandise  which  has  not  been  sold  out  of  the  group  there 
will  of  course  be  that  adjustment  of  profits  on  account  of  the 
changed  inventory  valuation  which  has  already  been  discussed 
in  relation  to  its  effect  on  the  balance  sheet. 

Payments  of  interest,  royalties,  and  other  expenses  from  one 
company  in  the  group  to  another  should  similarly  be  shown 
separately  in  the  consolidated  operating  statement  in  such  a  way 
that  they  will  offset  each  other  instead  of  being  included  in  both 
the  income  and  expense  of  the  consolidation.  This  adjustment 
will  not,  of  course,  affect  the  profit  of  the  group  as  a  whole, 
but  will  reduce  its  income  and  its  expenses  in  equal  amounts 
since  any  such  amounts  paid  and  received  entirely  within  the 
group  must  have  been  equal.  It  is  sometimes  necessary  to 
adjust  the  operating  statements  of  the  individual  companies  so 
that  accruals  and  prepayments  treated  differently  on  the 
books  of  the  several  corporations  may  be  handled  alike  in  order 
exactly  to  offset  each  other. 

These  suggestions  will  at  least  indicate  the  manner  in  which 
all  intercompany  transactions  should  be  handled,  the  fact  being 
kept  in  mind  that  the  object  of  the  consolidated  statement  is  to 
show  the  operations  of  the  entire  group  on  the  one  hand  with 
outside  interests  on  the  other.  All  transactions  occurring 
purely  within  the  group  are  to  be  taken  out,  so  that  the  sales 
accounts,  for  example,  are  to  show  only  sales  to  outsiders. 


CHAPTER  XXXVI 
PREPARATION  OF  FEDERAL  INCOME  TAX  RETURNS 

§  376.     Scope  of  This  Chapter 

The  income  tax  law  at  present  in  force  is  known  as  the 
Revenue  Act  of  1921.  Under  it  there  is  provided  a  tax  on  all 
net  ''gains,  profits,  and  income"  resulting  from  every  source. 
This  law  is  generally  believed  to  be  only  an  interim  act  which, 
while  it  carried  out  the  pledge  of  the  party  in  power  to  remove 
the  excess  profits  taxes  on  corporations,  has  not  evolved  a  fully 
satisfactory  substitute. 

The  questions  of  what  income  is  taxable,  how  its  amount 
is  determined,  and  what  rates  of  tax  apply  thereto,  open  up  a 
wide  field  to  which  many  volumes  have  been  devoted,  and  which 
cannot  be  touched  upon  here.  Any  brief  rules  which  might  be 
laid  down  would  be  subject  to  so  many  exceptions  that  they 
would  be  misleading  rather  than  informative.  This  chapter 
will  therefore  discuss  only  the  details  of  filling  out  the  form 
on  which  corporations  report  the  amount  of  their  income. 
This  report  form  is  called  the  "return." 

§  377.    Excess  Profits  Taxes  and  Invested  Capital 

For  all  fiscal  years  beginning  in  192 1  the  excess  profits 
taxes  apply  to  corporate  profits  so  far  as  those  profits  were 
earned  in  1921,  and  do  not  apply  to  any  profits  earned  in  1922 
or  thereafter.  As  a  consequence  of  this  fact  there  will  be  few 
original  returns  filed  hereafter  in  which  the  excess  profits  taxes 
need  be  considered.  Therefore,  in  a  work  of  this  kind,  which  is 
not  intended  to  be  a  study  of  income  taxation,  there  is  no 
need  of  a  discussion  of  those  schedules  of  the  income  tax  return 
which  have. to  do  with  invested  capital,  on  which  the  excess 

1399 


I400  CORPORATE  ACCOUNTING  [Bk.  111- 

profits  taxes  were  based.  These  schedules  are  the  ones  which 
have  given  taxpayers  the  most  trouble,  and  the  preparation  of 
corporate  returns  will  be  greatly  simplified  by  their  eHmination. 
It  must  be  admitted,  however,  that  other  features  which  have 
been  introduced  in  the  Revenue  Act  of  192 1  largely  offset  this 
benefit. 

§  378.    Services  of  Public  Accountants 

The  preparation  of  returns  under  the  1921  Act  is  so  simplified 
that  more  corporations  will  be  able  to  prepare  returns  satisfactory 
to  the  Bureau  of  Internal  Revenue  without  calling  in  outside 
help.  While  this  is  true,  it  does  not  seem  that  the  demand  for 
the  services  of  pubHc  accountants  versed  in  income  tax  matters 
can  be  greatly  decreased  without  disadvantage  to  the  taxpayers. 
Over  90%  of  the  problems  in  taxation  worked  out  by  public 
accountants  have  been  in  the  determination  of  what  constitutes 
net  taxable  income  rather  than  what  constitutes  invested  capital, 
and  these  problems  still  remain.  Corporations  generally  will 
therefore  continue  to  find  advantageous  the  employment  of 
competent  accountants  to  assist  them  in  showing  their  correct 
net  taxable  incomes,  as  they  will  thereby  avoid  overpayment  of 
tax  on  the  one  hand,  or  underpayment  with  consequent  future 
assessment  of  penalties  and  interest  on  the  other, 

§379.    Form  of  the  Return  ^^o.^^^^^... 

The  return  is  filed  on  Form  11 20  of  the  Bureau  of  Internal 
Revenue.  The  forms  to  be  used  for  taxable  years  beginning  in 
1922  have  not  yet  been  issued  by  the  Bureau,  so  that  for  the 
present  purpose  it  will  be  necessary  to  deal  with  the  form  in 
use,  omitting,  however,  the  calculation  of  the  invested  capital 
and  of  the  excess  profits  tax.  It  is  probable  that  the  form 
adopted  for  returns  of  years  subsequent  to  192 1  will  not  differ 
materially  from  the  present  Form  11 20,  except  in  the  omission  of 
these  obsolete  features  and  the  necessary  changes  in  the  method 
of  calculating  the  tax. 


Form  1120 

tT.3.  iNTUtN&L  RzTINnS 


THIS  RETURN  SHOULD 

BE  FILED  NOT  LATER 

THAN  THE  ISTH  DAY 

OF  THE  THIRD  MONTH 

rOLLOWINC  THE  CLOSE 

OF  THE  TAXABLE 

PERIOD 


corporahon  income  and  profits  tax  rehjrn 

FOR  CALENDAR  YEAR  1921 


Or  fof  pwiod  b«gutt 


,  1920,  and  «ndeJ ,  1921 


cuH  CHtcx  M.a  aaT.ori>ia> 


KINO  OF  BUSINESS.. 


^ 


'j&OlA*:><._: 


OAjUly 


IS  THIS  A  CONSOLIDATED  RETURN 


,?U). 


SCHEDULE  A-TAXABLE  NET  INCOME. 


1.  Groaa  Mies,  I«m  returns  tnd  sUowsnces  . 


CROSS  INCOME. 


S.  Less  cost  ol  goods  sold,  exclusive  o(  items  cklled  for  separately  below'  (from  Schedule  A2)- 


3.9-0  P-OO  -0-9. 


A?.?.3l..o|oo 


liSlMo 


,  Gross  iocoiae  from  operatioos  other  than  trading  or  manufacturing,  less  allovances  (from  Scjiedule  *^) 

.  Taxable  intei«ston  Liberty  Bonds,  etc.  (from  Schedule  **)  

.  Taxable  interest,  from  all  other  aoutcea  


.  Share  of  net  income  earned  by  peiaonal  service  corporatioi 
.  Dividends  on  stock  of  foreign  and  domestic  corpoiatiou 
.  Gross  income  from  all  other  sources  (not^  including  any  amount  i 

TouL  or  iTSMS  1  TO  10  


)  (from  SchaluiejuSlzl 


..3.l.ao<? 


W-^.. 


"} .imo 


DEDUCTIONS. 
.  Expenses  (except  amounts  reported  in  Item  2  above,  or  called  for  sepftntely  belov}  (from  Schedule  A12). 

.  Compensation  of  officers  (in  whatever  form  paid)  (from  Schedule  A13) 

.  Itepairs  (including  labor,  supplies,  etc.)  (from S/•*">^"^■*■*^^*)    j.r,,     ,.  

.  Interest  (see  page  2  of  Instructions,  paragraph  9) ,  ,  ■  ,.  . 

.  Taxes  (from  Schedule  A16) , „ 


..l).9.^2(?...«s 
ll.4.<?.?..l.o<?. 


'I 'a 

mo 


9i\%oo\p9_ 


JlSMloo 


17.  Bad  debts  (from  Schedule  A17)_ 


.  Exhaustion,  wear  and  tear  (including  obeoleecence)  (fio 
.  Depletion  (from  Schedule  A19) 


1  Schedule  A18).. 


I      2;Jo5o|oo 
!         I         I 


.  AiDOitizatioD  of  war  bdUtm  (from  Schedule  *'")  ,  ,    , 

Total  of  Itma  12  to  20 ^\ 

Itm  11  xnroi  Itm  21 

.  Irofit  or  lo«  05  nlfli  of  capital  UKto  and  mucellaneoua  iiive*tiB«iiti  (from  Schedule  A23) .... — 

,  Loeaei  by  fire,  stonn,  eto.    (From  Schedule  A24.)    (Extend  difference  between  or  sum  of  Items  23  and  24}.. 
.  Netinc-tmeexdufliveof  deductionsfof  dividends  (Item  2fl  minus  24,  extended)  -  ■ 


iE 


fiifio 


,  Dividends  deductible  under  Section  234Ca)  C  of  tho  Revenue  Act  of  1921,  (from  Schedule  A26) 

. Net  IwcoMl  (Item  25  mlous  Item  26)  (If  return  is  lor  a  period  less  than  twelve_mQnlhg,_see  pa^  1  of  Instructions,  paragraph  10) .. 


ns. 


2>?>.o. 


ii 


gap  po 


=lgT 


5l5P.Jp.O- 


iSo'pp. 


IDZ^ 


^.oJi3o. 


SCHEDULE  B-INVESTED  CAPITAL. 


1.  Capital,  flurploB,  and  undivided  profits  at  begimdag  of  taxable  period  (from  Schedule  E,  Item  1I)„ 

2.  Plus  adjustments  by  way  of  additions  (from  Schedule  F,  Item  4) 


4.  Less  adjustments  by  way  of  deductions  (from  Schedule  Q,  Item  7)..—., ..„..„„ 

(.  Beuaimdcb  .„ I... I — ■■.. . 

6.  riua  or  minus  chances  In  invested  capital  doriog  taxable  period  (net  Increase  or  Decrease  from  Schedule  II)  _ 


Total  (ob  REXAiKDxa). 


8.  Less  deduction  on  account  of  inadmiw'hle  a 
V.  Invwted  capital  for  taxable  period 


leU  (from  Scbadula  J)- 


SCHEDULE  C-EXCESS  PROFITS  CREDIT. 


1.  Eight  per  cent  of  Invested  capital  (or  taxable  period  (Itrat  9  tA  Schedule  B) 

2.  Exemption  (53,000)  (except  lor  a  foreign  corporation  or  a  corporation  satisfying  the  c 
>.  Exrew  Profits  Credit  (Item  1  plus  Item  2) - 


iitions  provided  tn  Section  2G2  of  the  Act)  , 


:cirx 


SCHEDULE  D-COMPUTATION  OF  TAXES. 


1.  BBAcam. 

(iTUI  3T,  BCSSDVU  A). 

%S3?,CS!!iT' 

1.  Baluicx  Bvwxot  to  Tax. 

lUTS. 

..A.,O^O.T^. 

1.  Net  income,  not  in  excess  of  20;«  at  invsH* 

, 

«o» 

«5 

1 

t.  Totals  computed  nadei  Section  a01( 
4.  Eusss  Fnau  Tax,  if  computed  und 

(.  Ket  'iscome  (Item  V,  Schedule  A)  . 

1 

■ 

*..... 

.... 

1.' 

I 

1     .     .1      - 

sr  Sections  303,  903, » 

IM(rt  or  837  Of  the  Revenue  Act  of  IMt  (see  pan  3  of  Instructions,  paragraph  H) —      

11.  Income  tax  (lOX  of  Item  10) 
U.  If  net  income  does  not  oxce 

1 

1 

ed  tlAXX.  enter  amount 

4 

in  excess  of  tS 

»nnn 

, 

, 

14.  LMii  tasom  and  prgdtl  tuM  psU  to  P 

"'•^sSS^SSitS*i 

fis*"""!.!.. 

10.  Balaacs(ltea5,lssslteM(,f,mll 

,orIlraae,i,aaif»). 

1. 

■ 

K. 

Balaaoe 

o«.*( 

!t«n 

UninosItemsKandlS) 

1.    





An  amendeJ  return  must  be  ptaintip  mariMd  ''AmencSed.* 


Checks  and  drafu  will  be  accepted  only  If  payable  at  par. 


I4OI 


piMI*  4  Of  lUtYin. 


SCHEDULE  L.— RECONCIUATION  OF  NET  INCOME  AND  ANALYSIS  OP  CHANGES  IN  SURPLUS. 


L  KM  iM«Bt  tm*  Seb*ABlt  A,  iMm  »  .. 


{•)  lB;«T«^t  tn  «bUffiUoos  at  t3»  Uattad  8Ut«  ud  lu  pMMSilou 

41fillOM   llMf«Ol -« _.. - 

(()  iBMnM  Ml  Vvm  X-oaa  Booli  ixwd  mdor  Vodtnt  Fwm  Lou 

<«)  DiTldfDiIi  on  *i<xk  offotMnrt  »>rTlt«  vorpontbni  out  of  tora- 
(/}  Otta»rUflB>ofMDUK»U*lBtQa«<t«b*d«UUo<lJ: 


I.  CbM|Hi<aliutnMrvMrof  bttddtbts,irit«nlT,f«bedalliA,lsiiotta 


4.  Cb*tiMtt>toWfiwrrMfaf«>BtlnjwUi,»te.Ctobod»tiU«a): 


I.  Tottl  of  iMiu  1  to  4,  tedntr* ... 

C  Tettfran  lUm  It .„... 

y.  NM  proai  tor  7Mr  u  sbcnrn  by 

miite  thirds  rilfiB  S  nlms  It' 

t,  Sarplai  ttd  nndlvldvd  pndu  a 


t.  Olb«rcr*<llf.tosiuptiu(to^dftttM): 


Ml  ToMl  ot  It«af  7  tot,  ti 


mc»M«pettel  (Ifm  10  mlnoi  Ifm  II) 


.2M 
120 


"fegrfcgol'oo 


5.i2L 


5^14. 


:2g 


rsc 


pop 


.00.. 


^[tE'M: 


}«)  DenMioni,  crMultlu,  uid  c^ntrllxitloai .._.... ______ 
I)  loooTM  at»f  proflU  Ikxoi  V*i4  to  tb*  Uutvd  blMM,ltl  pM- 

(0  Special  tinproi-eiocDt  iMos  tocdJif  to ^reaM  lbs  T«iiw  u'tti't 

(d)  Fumltun  tnd  nitUrMi'«t(UUM 


)  RApluamuta  »d  nmmta 
^  ImarsoM  pramlnmt  psU  -* 


'I  on  tbt  llto  o(  ur  efBar  or  emplByM 

U  dittctl*  or  ladlrMtlr  «  UMActarr 

I  InnUTM  or  ooMlmwd  to  purohaN  or 

„ ttrtMliOltlwUBltMl  8tMM,ttMll)tMMt 

Mb  ta  wholly  «naipt  (roa  tmtlaa,  ««»ptlot*fm 
to  purohtM  or  atrtr  Vtetorr  SK%  Kotos,  ortilnallr 
d  ior  by  the  ttznytr  — «_ 


lucumd  to 

■ubKribod  ior  by  the  ttznytr 

<l)  AddlUou  to  roMTTu  tat  M  debts  vtiirh  vy  not  IsclwM 

<()  Addlttoni 


utd  otbor  oontlikpDdat  (to  b«  dataOod): 


-iS 


jZ3.o..0ft< 


/70    n»!  DlTiatni»paiiiaiiai'ih»iiSMltji«iA'i 

y.yL  \  stock  or  thb  compiny,  ot  ottei  proponj);  g        ^ 

(<)Dat«paid.2!ldlUr.[^^    Cbaractcr 

W  Pato  pald.....^^. .-.«. .  ChkTMter 

<0  Data  p*M .— ^   Character 

(/)  DaU  paid „._„..    rhnf*ff>r  _^ 

Hbudabitila*arpliu(tob«d>ui>l):  ^  .s        ,       „ 


ZZB.QO.Oj.0.0. 


SCHEDULES  TO  BE  FXJRNISHED  IN  SUPPORT  OF  ITEMS  IN  SCHEDULE  A. 

Tb«  following  scbodulM  most  be  fumiahed,  and  those  prepared  oq  B«p:ir3te  shoeta  should  bo  firmly  attached  to  thia  return.    Enter  name  and  addren  of  coiporatioii  en  each  iheet. 


I  COST  or  GOODS  SOLD.  EXCLUSIVE  OP  ITEMS  CAXXED  TOR  SEPARATELY. 

If  onmxxl  IB  a  tnda  or  btultMcj  In  which  tha  prndiietloa .  patchase.  or  aale  o(  c 
an  iaeomMKododnt  lactor,  (a)  Mcora  bom  tb«  CoIlaetOT  at  Intental  UarcDiio  an 
i,C«itttcaioella*aalMr.ricmlUS.an<](b)f)Ulntbalar  - 


atatrbrtmttaa 

<n  KanlH 
<a>Co«o( 


oat  ot  nMdlMtnrini  or  otbtrwlM  prodiu 
ahowtnii  pnndpal  Itama  ot  eon,  t&a  nn 


<3)  ytolBTamory  at  b«elaatns  of  70U.. 


,.».jiao,-2.ia-..OQ-. 


8CHBDULB  A3i  CROSS  nrCOME  VROM 

rACTuRino. 

Sobmlt  a  a^aduta  dwwlac  th< 


'  th«  principal  Iti 


rACTuRino. 

^     SobmltaaA* ^ , -_ 

NlBc  fioupad  tn  ona  amouat.    (ror  Inwiranra  eompanlti  tea  pofa  3  o(  Instnjctioiu,  parafiaplu  3 

SCHEDULE  A4t  TAXABLB  IlfTXREST  OS  UBXRTT  BOIfDS.  ETC. 

Tbe  Intanat  on  tha  **J<p»««w  Ustad  hi  oohuoB  1  ottba  fellotrlnic  Uble  h  whoTIr  exmiipt  from  eorpontli 
taNMte,  Matla^HMptBOWOicwaprWtttltM  e^  to  tho  kxtsit  tliat  tha  accree»ta  prtodpal  amoasu  < 

"^  IB  MM  tbt  rtlJBlHwi  feiU  onMd  tbaM  MaaptlaBS,  tM  prtneipitl  amotmta  In  «xoaM  tboreof  -ilioiild  1 
Wfid  la  MiMM  <  m4  *■  taJSfcWwial  thwaaii  la  oalmnB  0.  ^rth«w  sectnlUu  wore  boncht  and  » 
^Ifthta  b  s  eoMtittlM  ntiB^  mA  «9oatka«aa9aalii«  t^  affllfatad  croup  U  eatltlad  to  the  raU  amou: 


(Aftnifate  rrlncipal  AtnoaDt). 

5.  Prioelpalatnoant 
In  rxceu  olecrnp- 

oil^^  2, 3,  and"*. 

fl.Ial*rartot> 
pilQclpal  ao't 

cxemptioni. 

2.130,000 

s.«m,ooo 

4.»S,000 

la}  Pim  Libert  T  Loaa  Second  Coti- 

*'*^83^^  Third, *iid°FSi5j; 

<c)  other  <>MI|auons  teiud  sinta 
Septamber  I.  IW7  (except Vkv 

<d>VkwrT    UbeftSI^I-oai.  ^Vek 
Not«.  aod  Treasury  Notea  -_ 

.Nous 

.Koirs.... 

.Now...... 

Total  T*i*wji  Twwtmwt .. 


SCBSOULI  AIOl  OKOS9  IllCCnfX  PR 

n^act  to  MlB  •!  caaMal  mmM  •(  Maaaoaa 

Bobmlt  s  acbadnla  iImvIbk  Cha  aoQKO.  ti: 

tMoubdBfcrai^adliiooaaaotmt.    TiMt 

SCHZDULX  AU:  ZXPEKSES  (eieapl  an 

bilox  (rouped  In  one  amoost.    (For  acbadi 
llsna,  pwacr^phi  >  to  7.  ) 

SCHEDULE  AtS:  COHPEItSATIOR  OP  OPPICESS. 


\  SOURCES  (not  Indpdhn  as;  ai&cmi 

tifthoprindpaUtam*  Inehtdad  herein  tb4 
■  should  baaoteredaa  Item  U),B<iiaduM  J) 

nSdw 
it  tha  prtodpal  Items  lot 
anJttad  tjlasuiaoca  ootapaatas  ai 


f,(2)di 


lea,  fS)  time  drroted  to  tnA  di 


SCHEDULE  At4:  REPAIRS  (hutodtaf  tabar,  nrpUea.  ereihettd.  and  ether  Banu    pioperlr  ehargee 

Submit  a  eebadule  ibewlBK  the  namra  aad  amount  of  tha  principal  Items  Included  hereto,  the  minor 
liHn;  [rniitml  In  nne  anwmni     (  For  claailflcatJoa  ot  fopatf  *  see  page  7  -"- — 

•CaXDUlE  Al«:  TAXES. 

tabmit  a  eebadule  sbowtnc  aapsntaly  tor  eadi  etaia  ot  tsiei  dedt 

P«d««t  beeiBa  and  proOt*  taxaa,  taxaa  which : ■"•  — •— 

iMiflta  ot  %  Mad  taPdtei  Ut  lanraasa  Ihayato-  -' 
•aMIoB  3M(o} I  ^thoEmeaa  Art «t  WL ) 


wed,  (a)  < 
Se>eUonZ! 


<Hbo>Maunt.   (SmB 


«  ttWMt  aiMnc  from  lalea  or  pfefctriaaal  acrrim  VtxA  Kara 


ki  lathis  schedule.    (S«o  p3i(e  3  ot  Instiuctlor  J,  paroenpt  10,  and  Section  2 


, - JUw.llo.^p;}. 

Pe£uitau£^yii^j^.)'MMw|.i2(<«ir..lji.i^. 


Kqaiiadpilfr 


Siim... 


■ir^gq.i.Qo7 


:  of  depradatlon  charted  off. 


_.2,ictO... 


IZMo- 


Ji..fc0P... 

.xq.s.i»6-. 


~sn<Qo. 


b  computed. 


a  attadi  a  sutemeat  showing  tl 


claimed  lor  tha  taxable  period  ai 
SCHEDULE  A19t  DEPLBTIOK. 

II  a  deduction  Is  claimed  on  account  of  depletion, seeora  from  theoollector  Form  D(mlnera]i),Forai:(eoa 
Form  r  (ndseananeeas  nonmetols).  Pans  O  (aflaadgaa),  or  Form  T  (timber).  All  In  and  file  wtth  return, 
complata  Taluatlon  data  has  been  tiled  with  otMadaanalia  in  prerioos  yt»n,  then  au  with  this  return  unions 
tlon  aaeaaHTF  U  fadog  nor  dayhwlpa  rtsadaft  tip  ta  data,  settine  forth  In  tull  statament  ot  all  trattsactloni  b« 
Inc  on  dadoMoat  or  addltlooa  to  Tahiaotphnleal  awets  wlih  esplaoatioa  ar  how  dMleilon  deduction  (er  ta 
aua psrtad bM ban decamlsed.  Iit«sao(nmb«ihl«sbouldbedoneb]rfllIin(lnForraT(tlmb«r). 
SCHEDULE  A20:  AHORTIZATIOIf  OT  WAR  PACILtTIES. 

Inciaaad«diuUaolicUmFdonaccDimtof  2nu>rtisitIan,aKhed(^^^  tnbmitted  eoBtalninr  tl 


111031). 


A  copy  01 


(See  Sectl<A  31 


SCHEDULE  All:  PROFIT  OS  LOSS  OH  SALES  OP  CAPTIAL  ASSETS  AMD  UISCBLLAIfBOUS 

rESTMBHTS. 

1  ease  ot  disposal  of  property,  resnltlnf  In  a  profit  or  Ion.  a  ^hadnjela  tha  tolto  wbif  form  most  b 


UCVESTMEHTS. 

In  ease  ot  disposal 


)rese&  asset.   (See  Seetiotts  Xa.  234(b)  * 


l.ElDd  of  property. 


'ltKdlltk&.... 


i..fc,.Qee. 


State  what  amount,  tf  any,  Indudod  la  oolnmn  S,  reprasanU  csod  will  „  t 

It  any  ottheosselt  vara  acquired  prior  to  March  l,m3,(tata  how  tbofUr  market  v 
determined.. .„ — — — 


I  substantiating  the  ttatls  u 


SCHEDULE  JM:  LOSSES  8T  PIRE,  STORM,  ETC. 

instfom  nres,  stonut,  shipwreck,  or  other  casualty,  or  from  then,  and  not  e 
othorwtie,  oxcept  that  eoniumS  should  show  "Insurance  and  salraee"  inst< 

6CQBDULS  A2S:  DIVIDEITDS  (dadudlhlo  under  Section  Z34(a)  6  ol  tha  P 


DISCOUHT  AHD  PREMIUM  OH  BOIfDS  S 


Intormatlon:  (e)  Class;  (b)  d 


n  each  Itsne  atid  Mie  ot  h 


Wfl  the  undeirifftMd,  prudent  and  troosarer  ef  the  corporation  for  which  this  letum  is  made,  beinp  sevorally  duly  iiworo.  each  for  hinweU  depowjs  and  B&ya  '"»»»»  J* 
rludiug  the  accompaoy&g  echedules  and  etat«roent«,  has  been  examined  by  him  aod  is  to  the  boat  ol  hia  lnowledge  and  baUef,  a  true  aod  complete  return  mad*  lo  gooa  mu».  l< 
ubia  period  as  itated,  punuant  to  the  Revenue  .\ct  of  1921  and  the  RegiuationB  issued  usder  authority  tberOi>f. 


Swora  to  aod  eubscribod  b«fon  me  thia  _ 


«  Rei  Ink 


1402 


Ch.  36]  FEDERAL  INCOME  TAX  RETURNS  1403 

§  380.    Preparing  the  Return 

The  easiest  way  to  prepare  the  corporation  income  tax 
return  is  to  work  from  the  Profit  and  Loss  account  to  the  return 
and  not  to  attempt  to  fill  out  the  return  in  the  order  in  which  the 
items  appear  on  the  form.  The  various  items  of  income  and 
expenses  will  be  shown  in  Schedule  A  on  page  i  and  Schedule  L 
on  page  4  of  the  return.  Both  these  pages  are  shown  in  the 
following  section.  If  the  book  closing  has  been  made  through  a 
work  sheet  in  the  form  ordinarily  used  by  an  accountant,  the 
items  in  the  *'Loss"  and  "Gain"  columns  of  that  work  sheet 
may  be  taken  as  they  come,  otherwise  the  various  amounts  closed 
into  Profit  and  Loss  will  be  taken  from  the  journal  entries. 

Let  us  consider  the  before-closing  trial  balance  and  work 
sheet  which  follow.  It  is  assumed  that  all  necessary  adjustments 
have  been  made  before  the  trial  balance  has  been  taken  off. 

§  381.    Showing  Items  of  Income 

It  is  usually  easiest  to  enter  first  the  items  of  income,  which 
will  be  found  as  credits  to  the  Profit  and  Loss  account  or  in  the 
"Gain"  column  of  the  work-sheet.  The  first  of  these  is  Net 
Sales,  $390,000.  It  is  to  be  entered  on  line  i  of  Schedule  A,  as 
shown  on  the  filled-in  form  which  follows.  Sub-Rental  Income 
of  $450  is  similarly  entered  on  line  6  of  Schedule  A. 

§  382.    The  Supporting  Schedules 

The  next  item,  Profit  on  Sale  of  Vacant  Lots,  $1,250,  belongs 
on  Une  23  of  Schedule  A,  where  it  will  be  noted  that  a  supporting 
schedule  known  as  Schedule  A23,  is  called  for.  A  form  for  this 
supporting  schedule  will  be  found  on  page  4  of  the  return. 
This  must  be  properly  filled  out  so  as  to  show  that  the  net 
profit  on  the  sale  has  been  computed  according  to  correct  prin- 
ciples. Because  we  shall  have  another  item  which  belongs 
in  this  supporting  schedule,^  we  do  not  now  enter  the  profit  on 
line  23  of  Schedule  A. 


>  See  deduction  for  loss  on  sale  of  Liberty  bonds,  discussed  in  {  393.' 


I404 


CORPORATE  ACCOUNTING 


IBk.  Ill 


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Ch.  36] 


FEDERAL  INCOME  TAX  RETURNS 


1405 


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I4O0  CORPORATE  ACCOUNTING  [Bk.  III- 

\ 

Other  supporting  schedules  and  the  method  of  j&Uing  them 
out  will  be  discussed  as  the  items  in  the  operating  statement 
are  reached. 

§  383.    Interest  Income 

The  next  item,  Interest  Income — Taxable,  $3,200,  will  be 
entered  directly  on  line  5  of  Schedule  A.  If  any  income  from 
investments  of  the  sinking  fund  had  been  credited  to  a  reserve 
account,  that  income  would  have  to  be  added  to  this  amount 
because  it  is  taxable.  Since,  however,  it  would  not  have  gone 
through  the  Profit  and  Loss  account,  it  would  have  to  be  entered 
as  item  13  (i-i)  of  Schedule  L  on  page  4  of  the  return,  where  the 
amount  of  taxable  income  as  shown  by  Schedule  A  is  reconciled 
with  the  Profit  and  Loss  account. 

The  corporation  has  received  during  the  year  $720  of  interest 
on  United  States  Liberty  bonds,  which  is  wholly  exempt  from 
income  tax,  but  might,  in  part  at  least,  be  subject  to  excess 
profits  tax.  As  the  excess  profits  tax  will  not  apply  hereafter, 
this  possibility  will  not  be  considered.  The  corporation  enters 
the  amount  of  the  income  from  this  source  on  line  2  (a)  of 
Schedule  L  on  page  4  of  the  return. 

§  384.    Schedule  Aio — Gross  Income  from  All  Other  Sources 

Proceeding  in  the  "Gain"  column  we  find  that  the  next 
item  is  Discount  on  Purchases,  $1,990.  This  is  of  course 
taxable,  and  is  entered  on  line  10  of  Schedule  A.  A  supporting 
schedule  is  required  if  any  amount  is  entered  on  this  line,  but  as 
we  shall  have  only  this  one  item  it  is  as  well  to  write  the  words 
"Discounts  on  Purchases"  on  the  line  instead  of  preparing  a 
schedule  for  the  single  item. 

§  385.    Unallowable  Deductions 

Starting  with  the  entries  in  the  "Loss"  column  of  the  work- 
sheet, which  are  the  debits  to  Profit  and  Loss,  we  find  first  two 


Ch.  36]  FEDERAL  INCOME  TAX  RETURNS  1407 

items  of  amounts  of  amortization,  of  Organization  Expense, 
$2,100,  and  Good-will,  $20,000.  Neither  of  these  is  deductible 
in  determining  the  amount  of  net  taxable  income.  They  are 
entered  on  lines  13  (j-i)  and  13  (j-2)  of  Schedule  L,  opposite 
the  non-taxable  income. 

§  386.     Schedule  A2 — Cost  of  Sales 

The  next  three  items  in  the  "Loss"  column  will  be  considered 
as  a  group.  Line  2  of  Schedule  A  calls  for  the  deduction  of  the 
cost  of  goods  sold  from  the  amount  of  sales,  carrying  only  the 
gross  profit  into  the  income  column,  and  refers  to  Schedule  A2 
on  page  4,  where  the  cost  of  goods  sold  is  worked  up.  Using  the 
figures  in  the  example  presented,  the  opening  inventory  of 
$86,000  is  entered  on  line  (3)  of  this  schedule,  and  the  purchases 
of  $210,000  are  shown  on  line  (i).  Freight  Inbound  is  usually 
considered  as  a  part  of  the  cost  of  sales,  and  in  such  case  would 
be  entered  on  line  (2)  with  the  notation  "Freight  Inbound" 
instead  of  supplying  a  separate  schedule  for  this  one  item. 

These  three  items  are  then  totaled  on  line  (4)  of  the  schedule, 
the  closing  inventory  of  $80,420  is  entered  on  line  (5),  and  the 
difference  between  the  amoimts  shovm  on  lines  (4)  and  (5)  is 
entered  on  line  (6). 

Before  leaving  Schedule  A2,  the  method  of  pricing  the 
inventories  should  be  entered  on  lines  (3)  and  (5).  It  will  be 
noted  in  the  instructions  printed  at  the  top  of  Schedule  A2 
that  only  two  bases  for  inventory  valuation  are  permitted  by 
the  regulations  promulgated  by  the  Commissioner  under  a 
section  of  the  law  authorizing  inventories  "upon  such  basis  as 
the  Commissioner,  with  the  approval  of  the  Secretary,  may 
prescribe  as  conforming  as  nearly  as  may  be  to  the  best  account- 
ing practice  in  the  trade  or  business  and  as  most  clearly  reflecting 
the  income."  2 


'  Sec.  203,  Revenue  Act  of  1921.  For  an  excellent  discussion  of  the  propriety  of  the  regu- 
lations see  Auditing  Theory  and  Practice,  by  R.  H.  Montgomery  (1922),  Chs.  VIII  and  IX. 
Another  point  of  view  is  presented  in  an  interesting  article  by  W.  A.  Paton  or.  "Inventory 
Valuation,"  appearing  in  Administration,  Mar.  1922,  pp.  291-302. 


i4o8  CORPORATE  ACCOUNTING  [Bk.  Ill- 

When  Schedule  A 2  has  been  completed,  the  amount  on  line 
(6),  which  is  the  cost  of  goods  sold,  is  carried  to  line  2  of  Schedule 
A  on  page  i ,  and  is  subtracted  from  the  amount  of  sales  already- 
entered  on  line  i ,  the  difference  or  gross  profit  being  carried  into 
the  next  column. 

§  387.    Cost  of  Sales  of  Manufacturing  Corporations 

The  cost  of  goods  sold  by  a  manufacturing  corporation 
includes,  of  course,  materials,  labor,  supplies,  and  all  the  items 
of  factory  burden.  The  total  of  all  expenses  which  are  allocated 
to  the  cost  of  manufacture  should  be  entered  -on  line  (2)  of 
Schedule  A2,  and  a  separate  typewritten  schedule  showing  the 
various  items  which  make  up  the  total  should  be  submitted  with 
the  return.  This  supporting  schedule  might  bear  the  title: 
"Schedule  A2  (2)— Cost  of  Manufacture."  Care  should  be 
taken  to  see  that  its  total  agrees  with  the  amount  entered  on 
line  (2)  of  Schedule  A2. 

§  388.    Form  1 126 — Certificate  of  Inventory 

There  is  required  to  be  filled  out,  sworn  to,  and  filed  with  the 
return,  another  form,  known  as  Form  11 26,  on  which  some 
one  official  makes  affidavit  as  to  the  persons  who  were  responsible 
for  the  taking  of  the  various  parts  of  the  inventory  and  each 
of  them  swears  to  the  accuracy  of  his  respective  part.  This 
form  is  shown  below. 

The  form  itself  shows  on  its  reverse  side  the  regulations 
in  regard  to  the  taking  of  inventories.  The  signer  of  the  principal 
certificate  swears  that  he  has  read  these,  and  that  the  inventory 
in  respect  to  which  the  certificate  was  filed  was  taken  in  accord- 
ance with  those  regulations.  He  shows  on  this  form  as  well  as  on 
the  income  tax  return,  the  basis  on  which  the  inventory  was 
priced.  The  signers  of  the  subsidiary  certificates,  who  are  the 
persons  directly  responsible  for  the  taking  of  the  inventory  swear 
that  they  also  have  read  the  instructions  and  that  the  inventory 
was  taken  in  accordance  therewith.     In  the  case  of  small  cor- 


CERTIFICATE  OP  INVENTORY 

(T«  bt  fiUd  with  Collector  of  InUmal  IUv«na«  witk  Incom*  Tax  Rcturo) 

FOR  CALENDAR  YEAR  1921 


Or  for  period  hian 

Namt 

Address 


,.,  19^ ,  arid  ertded 


W„ 


PRINCIPAL  CERTIFICATE 


I  eirear  (or  affirm)  that  the  dceisg  inventory  of  the  taxpayer  named  above,  amounting  to  S ,  was  taken  under  my 

direction,  and  that  to  the  beet  of  my  knowledge  and  belief  is  true  and  complete  in  every  respect;  that  the  method  of  pricing  the  raw 

material,  work  in  process,  and  finished  goods  was  at  •...„ __™. . ; 

that  I  have  carefully  read  all  of  the  instructions  on  the  reverse  side  of  this  form;  that  this  inventory  was  taken  in  accordance  therewith; 
and  that  the  following-named  persons  whose  separate  certificates  are  subscribed  hereon  or  attached  hereto  are  the  officers  and 
employees  under  whoso  personal  direction  the  -various  parta  of  this  inventory  were  taken : 


Nam. 


Title  or  potition. 


Part  ofimientonj  taien. 


Ammmt, 


Swom  to  and  subscribed  before  me  this  „ 


•  day  of. 


,19 


(3len*ti>re0 


(Signstnreof  officer  admliJsteriag  oath.) 


(Title.)  (Title.) 

was  used,  describe  ftUj,  state  why  used  and  date  on  vhich  Inventor/  < 


SUBSIDIARY  CERTIFICATE 

I  (or  ire),  the  undersigned  employees  of  the  taxpayer  named  above  swear  (or  affirm)  that  I  (or  we)  personally  directed  and  obaerved 
the  taking  of  the  parts  of  the  inventory  set  opposite  my  (or  our)  names,  and,  to  the  best  of  my  (or  our)  kaowlodge  and  belief,  is  true 
and  complete  in  every  respect;  that  I  (or  wc)havecarefully  read  the  Instructions  on  the  reverse  side  of  this  form  and  that  the  parts  of 
the  inventory  for  which  I  am  (or  we  are)  responsible  was  taJcen  iu  accordance  therewith. 


Signature, 


THtte  or  position. 


Part  o/ inventory  talen. 


Sworn  to  and  Eubaaibed  before  me  thia 


.  day  of . 


_,19_ 


(Slpuiin  of  oaotr  adnilsjstectiit  oMh.) 
1409 


INSTRUCTIONS. 


This  QsrtlflefttA  of  InTcinterf  must  b«  8u1)mltted  by  oil  toTp&yors  enTftfced  in  k 
trtd«  or  business  In  which  tn«  production,  purchaso.  or  sale  of  merchandise  of 
ftDT  kind  is  an  incoine>producing  (actor. 

Tb«  prinolpa]  oertiflcato  will  be  si^ed  by  the  ta.Tpayor  or  an  exncutlre  olTioer 
•ad  tlw  salwdiarr  certiflcato  by  omcers  and  employees  (such  as  department 
heads,  nqMrinUDdents,  etc)  designated  by  the  taxpayer  or  executivo  omcer. 
If  tbe  taxpayer  vbo  fills  In  the  principal  oertifloate  actually  directs  end  observes 
tba  taking  of  the  inventctfv,  the  SQbstdiary  certificate  need  not  be  filled  in. 

In  case  there  is  not  sufncient  spaoe  on  this  form  to  enter  the  namce  of  those 
directed  to  take  the  lnvontor>',  or  It  is  not  convenient  for  them  to  take  the  oath 
)obttly,  additional  copies  of  tbisformshould  be  used,  but  the  oath  of  the  principal 
ofnoer  need  only  be  made  on  the  first  sheet,  stating  thereon  tbe  number  of  sheets 
submitted. 

If  the  return  bas  alread  v  been  filed,  tbe  certUkate  should  bo  sent  to  tbe  conoctw 
of  tbe  district  hi  wbidi  tbe  return  was  filed. 

SECnoN  203  or  thx  Revkituz  Act  or  1921. 
That  ivfaaiMm  In  the  opinion  of  tbe  Commlssicmer  tbe  use  of  Inventories  is 
necenary  In  order  cleazly  to  determbia  the  income  of  any  taxpayer,  inventories 
shall  be  taken  by  sudi  taxptiyvt  upon  such  basis  as  the  Commissioner,  with  the 
aptnoral  of  tbeSeoretaiy,  may  pnscribe  as  oonfbnnins  as  neariy  as  may  be  to 
the  best  sooountlng  pnouce  in  tbe  trade  or  business  and  as  most  oeaily  reflecting 
the  Income. 

£xmACT3  FbOU  IIE0ULATI01T9  62. 

Akt.  1581.  NMd  <jt  Inventories.— In  order  to  reflect  tbe  net  Inoomo  correptlr, 
Inventories  at  the  beginning  and  end  of  each  year  are  necessary  in  every  ease  In 
vbidi  the  production,  purchase,  or  sale  of  merchandise  is  an  uicome-produdng 
factor.  Tbe  Inventory  should  indude  raw  materials  and  supplies  on  nand  that 
have  been  aocmlred  tor  sale,  ooostunptlon,  or  use  In  productive  processes,  together 
with  aU  flnitoed  or  pertly  finished  goocu.  Only  merchandise  title  to  which  is 
T«rted  in  the  tascpayer  should  be  included  in  the  Inventory.  Accordingly  the 
Edler  should  Include  In  bis  inventory  goods  under  contract  for  sale  but  not  yot 
segrutated  and  applied  to  tbe  contract  and  goods  out  upon  consignment,  but 
ahoiiu  exdnde  from  invent*^  goods  sold,  title  to  which  bos  passed  to  the  pur- 
<^iaser.  A  purchaser  should  Include  in  inventory  merchandise  purchased,  title 
to  whl^h  has  passed  to  him,  althoof^  such  merchandise  is  in  transit  or  for  other 
reasons  has  not  been  reduced  to  physical  possession,  but  should  not  include  goods 
ordered  for  future  delivery  transfer  of  tltla  to  which  has  not  yet  been  effected. 

Art.  15S2.  Valuation  of  inventories.— The  act  provides  two  tests  to  which 
each  inventory  must  conform:  (l)  It  must  conform  as  nearly  as  may  be  to  the 
best  accounting  prectioe  in  the  tz^e  or  business,  and  (2)  it  must  clearly  reflect 
the  income,  ftiollows,  therefore,  that  Inventory  rules  can  not  be  uniform  but 
must  give  efTeci  to  trade  customs  which  come  within  the  scope  of  the  best 
accounting  practice  in  the  particular  trade  or  business.  In  order  to  clearly 
reflect  Income,  the  inventory  practice  of  a  taxpayer  should  be  consistent  from 
year  to  year,  and  greater  wugnt  is  to  be  given  to  consistency  than  to  any  par- 
ticular method  ofinventorying  or  basis  of  TOluatlonsolongas  the  method  or  basis 
used  is  substantially  in  accord  with  these  regulations.  An  inventory  that  can 
be  used  under  the  l>est  accounting  practice  in  a  balance  sheet  shoeing  the  finan- 
cial position  of  the  taxpayer  can,  as  a  general  rule,  be  regarded  as  clearly  reflecting 
bis  income.  . 

The  basis  of  valuation  most  commonly  used  by  business  concerns  and  wblch 
meets  the  requirements  of  tbe  Revenue  Act  is  (a)  cost  or  (b)  cost  or  market. 
whichever  is  lower.  (For  inventories  by  dealers  in  securities,  see  article  1S85.) 
Any  goods  In  an  inventory  which  are  imsalable  at  normal  prices  or  unusable  in 
the  normal  way  because  of  damage,  imperfections,  shop  wear,  changes  of  style, 
odd  or  br^en  lots,  or  other  similar  causes.  Including  secondhand  goods  taken  in 
exchange,  ^ould  be  valued  at  bona  fide  selling  prices  less  cost  of  selling  whether 
basis  (a)or(&)isused,or  if  such  goods  consist  of  raw  materials  or  partly  finished 
goodshdd  for  use  or  consumption,  they  should  be  valued  upon  a  reasonable  basis, 
taking  into  consideration  the  usability  and  the  condition  of  the  goods,  but  in  no 
cosesnall such  value  be  less  than  tho scrap  value. 

Bona  fide  selling  xtT\oa  means  actual  oflorlngs  of  goods  during  a  period  ending 
not  later  than  30  days  after  Inventory  date. 

The  burden  of  prool  will  rest  upon  the  taxpayer  to  show  that  such  exceptional 
goods  as  are  valued  upon  such  selling  basis  come  within  the  dassificatious  indi- 
cated above,  and  he  shall  maintain  such  records  of  the  disposition  of  the  goods 
as  will  enable  a  verification  of  the  inventory  to  bo  made. 

In  respect  to  nonnal  goods  whichever  basis,  (a)  or  (6)  Is  adopted  must  be 
applied withreasonabloconsisteiicytotheentireinventory.  Taxpayers weregiven 
an  option  to  adopt  the  basis  of  eitnor  (o)  cost  or  (6)  cost  or  market^  whicUovyr  is 
lower,  fortheir  1«20  inventories,  and  the  basis  adopted  for  that  year  is  controlling, 
and  a  chuig©  can  now  be  made  only  after  permission  Is  secured  from  the  Com- 
xnissloner.  Goods  talcen  in  the  inventory  wMch  have  been  so  intermingled  that 
ttiey  can  not  be  identified  with  specific  mvoices  vdU  be  deemed  to  be  either  <a) 
tba  goods  most  recentlv  purchased  or  produced,  and  the  cost  thereof  will  be  ttie 
actoal  cost  of  the  goods  purchased  or  produced  during  the  period  in  which  the 
cnantity  of  goods  in  the  inventory  has  been  acquired,  or  (&)  where  the  taxpayer 
xoaint^ns  book  InventOTies  In  accordance  vith  a  sound  accoimtine  system  in 
which  the  respective  inventory  accounts  are  charged  with  the  actual  cost  of  the* 
goods  purchased  or  produced  and  credited  with  tne  value  of  goods  used,  trans- 
tared,  or  sold,  calculated  upon  the  basis  of  the  actual  cost  of  tbe  goods  acquired 
durtag  the  taxable  year  (including  the  Inventory  at  the  beginning  of  the  year) 
tbe  net  value  as  shown  by  such  inventory  accounts  vn.\l  be  deemed  to  bo  the 
cost  of  the  goods  on  hand.  The  balances  shown  by  such  book  inventories  should 
be  verified  by  physical  inventories  at  reasonable  intervals  and  adjusted  to 
conform  therewith. 

Inventories  should  be  recorded  in  a  legible  manner,  properly  computed  and 
summarized,  and  should  be  preserved  as  a  part  of  the  accounting  record  of  the 
taxpayer.  The  inventories  of  taxpayers  on  whatever  basis  taken  will  be  subject 
toinvestigatltm  by  tbe  CommissToner,  and  the  taxpayer  must  satisfy  the  Com- 
inissloner  of  tbe  correctness  of  tbe  jprices  adopted. 

The  foUonnlng  methods,  among  others,  are  sometimes  used  in  taking  or  valuing 
israntorlss,  but  are  not  in  accord  with  these  regulations,  viz: 

(a)  Dodootlng  from  tbe  Inventon^  a  reserve  for  price  changes,  or  an  estimated 

depredation  in  tbe  value  thereof. 

(b)  Takug  wodc  In  process,  or  other  parts  of  tbe  inventory,  at  a  nominal 

price  or  at  less  than  its  proper  value. 
(e)  Omitting  portions  of  the  stock  on  band. 
W  Uaint  a  constant  price  or  nominal  value  for  a  soK^Bed  normal  quantity  tit 

muerials  ot  goods  in  stock. 
(0  Including  stock  In  transit,  either  shipped  to  or  from  the  taxpayer,  tb« 

title  otwhich  Is  not  vested  in  the  taxpayer. 
Art.  1583.  Inventories  at  cost^^^t  means: 

(1)  In  the  case  of  nurchandiso  on  band  at  the  beginning  of  tbe  taxable  year, 
tbe  Inventory  price  of  such  goods. 

(2)  In  tbe  case  of  merchuidise  purchased  nnce  tbe  beginning  of  tbe  taxable 
year,  the  invoice  price  less  trade  or  other  discounts,  except  strictly  cash  dis- 
counts, approximating  a  fair  Interest  rate,  which  may  be  deducted  or  not  at  the 
option  ofihB  taxpayer,  provided  a  consistent  course  Is  foDowed.  To  this  net 
invoice  price  should  oe  added  transportation  or  other  necessary  charges  Incurred 
in  aoqu&ing  possession  of  the  .goods. 

(3)  In  tbe  case  of  meyhnndise  prodnood  by  tbe.taxpayer  since  the  beglnnhig 
el  toe  tazaUe  year,  (fi)  tbe  cost  of  raw  materials  and  su^pllsa  entering  Into  or 


consumed  In  connection  with  tbe  product,  (h)  expendlturu  f6r  direct  Isber, 
(c)  indirect  expenses  incident  to  ana  necessary  for  the  production  of  the  partifr 
ular  article,  including  In  such  indirect  expenses  a  reasonable  proportion  of  man- 
agement expenses,  but  not  including  any  cost  of  selling  or  return  ou  capital. 
whether  by  way  of  interest  or  profit. 

(4)  In  any  industry  in  which  the  usual  rules  for  computation  of  cost  of  pn>» 
ductlon  are  inapplicable,  costs  may  be  approximated  upon  such  basis  as  may  be 
reasonable  and  in  conformity  with  estaDllsbod  trade  practice  in  tho  particular 
industry.  Among  such  cases  are  (a)  farmers  and  raisers  of  live  stock  (see  article 
ISSR),  (o)  miners  and  manullcturers  who  by  a  single  process  or  uniform  series 
of  processes  dnive  a  product  of  two  or  more  kinds,  sizes,  or  grades,  the  unit  cost 
of  which  is  substannallv  ahke  (see  article  1687),  and  retail  merchants  who  use 
what  is  known  as  the  ''^retail  method  "  in  ascertaining  approximate  cost.  (See 
article  1588.) 

Art.  1584.  Inventories  at  market.— Under  ordinary  circumstances,  and  foe 
normal  goods  in  an  inventory,  "market"  means  the  current  bid  price  prevailing 
at  the  date  of  the  inventory  for  the  particular  merchandise  In  the  volume  In  whlcG 
usually  purchased  by  tho  taxpayer,  and  is  applicable  in  the  cases  (o)  of  goods 
purchased  and  on  hand,  and  (b)  of  basis  elements  of  cost  (matehids,  labor,  and 
burden)  in  goods  In  process  of  manufacture  and  In  finished  goods  on  bana;  ex- 
clusive, however,  of  goods  on  hand  or  in  process  of  manufacture  for  delivery 
upon  firm  sales  contracts  (i.  e..  those  not  legally  subject  to  cancellation  by  either 
party)  at  fixed  prices  entered  into  before  the  date  of  the  inventory,  whicn  goods 
must  be  Inventoried  at  cost.  Where  no  open  market  exists  or  whore  quotations 
are  nominal,  due  to  stagnwt  market  conditions,  the  taxpayer  must  use  such 
evidence  of  a  fair  market  mice  at  tbe  date  or  dates  nearest  Ihe  inventory  as  may 
be  available,  such  as  specifle  purchases  or  sales  by  the  taxpayer  ct  others  in  rea- 
sonable volume  and  nuule  in  good  f  aith,jOr  compensation  paid  for  cancellation  ctf 
contracts  for  purchase  conunltments.  Where  tl»  taxpayer  in  tho  regular  course 
of  business  has  of  ered  for  solo  such  merchandise  at  prices  lower  than  the  current 
price  as  above  defined,  the  Inventorv  may  be  valued  at  such  prices  less  proper 
allowance  for  selling  expense,  and  tne  correctness  of  such  prices  will  bo  deter* 
mined  by  reference  to  the  actual  sales  of  the  taTcpaver  for  a  reasonable  period 
before  and  after  the  date  of  the  inventory.  Prices  which  vary  materially  frott 
the  actual  prices  so  ascoitaincd  will  not  be  accepted  as  reflecting  the  market. 

Art.  15^  Inventories  by  dealers  In  securltles.^A  dealer  in  securities 
who  in  his  books  of  account  regularlv  inventories  unsold  securities  on  hand 
either  (a)  at  cost  or  (6)  at  cost  or  market,  whichever  is  lower,  or  (c)  at  market 
value,  may  make  his  return  upon  the  basis  upon  which  his  accounts  are  kept; 
provided  that  a  description  of  the  method  employed  shall  be  included  in  or 
attached  to  the  retium,  that  all  the  securities  must  be  Inventoried  by  the  same 
method,  and  that  such  method  must  be  adhered  to  in  subsequent  years,  unless 
another  be  authorized  by  the  Commissioner.  For  the  purpose  of  this  rule  ft 
dealer  In  securities  Is  a  merchant  of  securities,  whether  an  individual,  partner- 
ship, or  corporation,  with  an  established  place  of  business,  regularly  engaged  la 
the  ptuchase  of  securities  and  their  resale  to  customers;  that  is,  ono  who  as  ft 
merchant  buys  securities  and  sells  them  to  customers  with  a  view  to  the  gains 
and  profits  that  may  bo  derived  therefrom.  If  such  business  is  simply  a  branch 
of  the  activities  canned  on  by  such  person,  the  securities  Inveutoriod  as  here 
pro\*Ided  may  Include  only  thoso  held  for  purposes  of  resale  and  not  for  invest* 
mcnt.  Taxpayers  who  buy  and  sell  or  hold  sccuiitios  for  Investment  or  specu- 
lation, and  not  in  tho  course  of  an  established  business,  and  offloeis  of  corporis 
tlons  and  members  of  partnerships,  who  in  their  individual  capadtlea  buy  and 
sell  securities,  arc  not  dealers  in  securities  within  the  meaning  of  this  rule.  A 
dealer  In  securities  is  not  entitled  to  tho  benefits  of  section  206  with  reteenoe  te 
the  gain  from  tho  sale  of  securities. 

Art.  1580.  Inventories  of  live-stock  raisers  and  other  farmers.— (1) 
Farmers  may  change  tho  basis  of  their  rcttunsfrom  th^t  of  receipts  and  disburse- 
ments to  that  of  an  Inventory  basis,  which  necessitates  tho  use  of  opening  and 
closing  inventories  for  the  year  In  which  the  change  Is  made.  There  shoifld  be 
Included  In  tbe  opening  Inventory  all  farm  products  (including  live  stock),  pur* 
chased  or  ralsod,  which  were  on  huid  at  the  date  of  ttie  inventory,  but  inventories 
must  not  includis  real  estate,  buildings,  permanent  Improvements,  or  any  other 
assets  subject  todeprcciaticn. 

(3)  Because  of  the  d  ifflculty  of  ascertaining  actual  cost  of  live  stock  and  other 
iarm  products,  farmers  who  render  their  returns  upon  an  inventory  basis  may  at 
their  option  viijue  their  Inventories  for  the  current  taxable  year  accordmg  to  the 
"farm-price  toctbod"  which  provides  for  the  valuation  of  mventories  at  market 

ErIce  less  cost  of  marketing.  If  tho  use  of  the  "farm-price  method  "  of  valuing 
iventorlcsforanyta.vablc  year  Involvesachango  in  method  of  pricing  inventories 
from  that  employed  la  prior  years,  tho  opening  in\-entory  for  the  taxable  year 
in  which  the  clian^o  Is  mado  should  be  brought  in  at  the  same  value  as  the  closinji 
Inventory  for  the  preceding  taxable  year.  Ifsuch  valuation  of  the  openinginveu- 
tory  for  the  taxable  year  in  which  the  change  is  made  results  in  au  abnormally 
large  Incomo  for  that  year,  there  may  be  submitted  with  the  return  for  sucn 
.  taxable  year  an  adjustment  statement  for  the  preceding  year  based  on  tho  "  farm- 

Srice  method"  of  valuing  inventories;  up(»i  the  amount  of  which  adjustments 
le  tax.  If  any  be  due,  shall  be  assessed  and  {taid  at  tbe  rate  of  tax  in  efiect  for  such 
preceding  year. 

(3)  Where  rettims  bavo  been  made  In  which  the  taxable  net  Income  has  be6n 
computed  upon  incomplete  inventories,  the  abnormaUty  should  be  corrected  by 
submitting  with  the  return  for  the  current  taxable  year  a  statement  for  the  pro- 
ceding  year  in  which  such  adjustments  shall  be  maae  as  are  ncoessary  to  bring 
the  closing  inventorv  for  the  preceding  year  Into  agreement  with  the  opening 
complete  inventory  for  the  current  taxable  year.  It  necessary  to  reflect  the  in- 
come, similar  adjustments  may  be  made  as  at  the  beginning  of  the  preceding  year, 
and  toe  tax, if  any  boduo.shall  be  assessed  at  tbe  rate  of  tax  inofiectforsuch  year. 

AKT.  1587.  Inventories  ot  miners  and  manufacturers.— A  taxpayer 
engaged  in  mining  oi*  manufacturing  who  by  a  single  process  or  uniform  series  of 
processes  derives  a  product  of  two  or  more  kinds,  sizes,  or  grades,  the  umt  cost  ot 
which  Is  substantially  alike,  and  wholn  conformity  to  a  recognized  trade  practice 
allocates  an  amount  of  cost  to  each  kind,  size,  or  grade  of  product  wUch  in  the 
aggregate  will  absorb  the  total  cost  of  production,  may  use  such  allocated  cost. 


me  returii,  mat  inx;mm»m»uuim»n>*otifc.  nuu  um(.£>u^;ii  iijt;i.(iu<aiai,uuAi.McuLiv 

adhered  to  unless  a  change  is  aothorized  by  the  Commissioner.  Under  thu 
method  the  goods  in  the  Inventory  are  ordinarily  priced  at  tho  selling  prices  and 
the  total  retail  value  of  the  goods  In  each  department  or  of  each  class  of  goods  is 
reduced  to  approximate  cost  by  deducting  the  percentage  which  represents  tbe 
dlfle^ce  between  the  retail  selling  value  and  the  purchase  price.  Tnis  percent- 
age is  determined  by  departments  of  a  store  or  by  classes  of  goods,  and  should 
represent  as  accurately  as  may  be  the  amounts  added  to  the  cost  prices  of  the 
goods  to  cover  selling  and  other  expenses  of  doing  business  and  for  the  margin  of 

Erofit.  Incomputingtbepercentageabovementioned,  proper  adjustment  should 
9  made  (or  all  mark-ups  and  mark-downs. 

A  taxpayer  maintaining  more  than  one  department  In  his  store  or  dealing  in 
dassos  of  goods  carrying  different  percentages  of  gross  profit  should  not  use  a 
percentage  of  profit  based  upon  an  average  of  his  entire  business,  but  should 
compute  and  use  In  valuing  his  Inventory  the  proper  percentages  for  the  respe^ 
five  ospartmants  or  oIssibs  of  goods.  a— irsia 


I4IO 


Ch.  36]  FEDERAL  INCOME  TAX  RETURNS  141 1 

poratlons  the  officer  who  signs  the  principal  certificate  is,  of 
course,  often  the  man  who  is  also  responsible  for  the  taking 
of  the  inventory,  in  which  case  the  subsidiary  certificate  need 
not  be  filled  in.  The  instructions  on  the  reverse  of  the  form  are 
probably  clear. 

§  389.     Schedule  A12 — Expenses 

The  next  item  in  the  "Loss"  column  of  the  work-sheet  is 
Wages,  $26,600.  This  and  all  items  of  expense  for  which 
specific  spaces  are  not  provided  in  the  lower  half  of  Schedule  A 
will  be  included  in  the  total  to  be  entered  on  line  12  of  that 
schedule.  In  accumulating  this  total  the  method  least  likely  to 
result  in  errors  necessitating  a  checking  back,  is  to  head  up  a 
sheet  of  work-paper  with  the  title  "Schedule  A12 — Expenses," 
record  the  item  Wages,  $26,600,  afid  then  not  try  to  finish  the 
schedule  at  once  but  proceed  down  the  "Loss"  column  of  the 
work-sheet  or  the  journal  entry  debiting  Profit  and  Loss,  placing 
the  various  amounts  where  they  belong  as  they  are  reached. 
The  items  of  Delivery  Expenses,  Warehouse  Rent,  and  Ware- 
house Expense,  which  come  next,  will  all  be  entered  ori 
Schedule  A12. 

Bryant-Chase  Company 
Indianapolis,  Indiana 
1921 
Schedule  A12 — Expenses 

Wages $26,600 

Delivery  Expenses 2,300 

Warehouse  Rent 2,500 

Warehouse  Expense 460 

Discount  on  Sales 3.630  In 

Traveling  Expense 8,890 

OflSce  Exf>ense 4,600 

Advertising 16,000       "   •'■'^ 

Miscellaneous  Exf>ense 3,4°°     oH)  }o 

-,  J         Light  and  Heat 54° 

I         Insurance 600 

$69,520 


14 1 2  CORPORATE  ACCOUNTING  [Bk.  III- 

§  390.     Schedule  A18 — Depreciation 

The  next  item  is  Depreciation,  $12,610.  The  amount  is 
entered  on  line  18  of  Schedule  A,  and  the  facts  from  which  the 
depreciation  was  calculated  are  recorded  on  Schedule  A 18, 
page  4  of  the  return.  It  should  be  noted  that  the  cost  of  each 
asset,  divided  by  the  probable  life,  is  expected  to  be  the  amount  of 
depreciation  taken  on  that  asset  during  the  year.  If  increases 
have  been  made  in  the  asset  account  during  the  year,  as  for 
example  by  the  purchase  of  additional  machinery,  it  is  expected 
that  depreciation  will  be  taken  on  the  average  between  the  cost 
at  the  beginning  of  the  year  and  the  cost  at  the  end,  unless  depre- 
ciation can  be  readily  calculated  on  the  additions  for  the  period 
for  which  each  was  in  service.  There  is  nothing  in  the  law 
or  the  regulations  to  prevent  depreciation  at  proper  rates 
being  separately  calculated  on  each  individual  unit  of  equipment, 
as  is  often  done  when  a  property  record  is  kept. 

The  cost  total  on  Schedule  A18  is  expected  to  equal  the  bal- 
ance sheet  asset  valuation,  and  the  total  of  the  depreciation  taken 
in  the  current  year  and  in  previous  years  will  normally  equal  the 
amount  of  the  balance  in  the  Allowance  for  Depreciation  account. 
There  are,  however,  many  things  which  may  disturb  this  recon- 
ciliation. 

§  391.    Entry  of  Other  Expenses 

The  next  item  in  the  "Loss"  column.  Discount  on  Sales, 
$3,630,  will  be  entered  on  the  schedule  of  expenses  (A12)  which 
we  have  started. 

Officers'  Salaries,  $18,400,  will  be  entered  on  line  13  of  Sched- 
ule A,  and  a  schedule  of  these  salaries  will  be  typed  with  the 
heading  "Schedule  A13 — Compensation  of  Officers."  This  sched- 
ule will  show  for  each  officer  the  information  asked  for  on  page  4 
of  the  return. 

Traveling  Expense,  Office  Expense,  Advertising,  Miscellane- 
ous Expense,  and  Light  and  Heat,  will  all  be  listed  on  Schedule 
A12.     The  Miscellaneous  Expense  account  has  been  used  too 


Ch.  36]  FEDERAL  INCOME  TAX  RETURNS  1413 

freely  by  the  corporation  whose  return  we  are  preparing.  When 
the  office  audit  of  this  return  is  made,  it  is  likely  that  the  com- 
pany will  be  asked  to  furnish  an  analysis  of  the  items  making  up 
this  total.  As  this  request  may  not  come  until  some  years  later, 
difficulty  may  then  be  experienced  in  furnishing  the  details. 
Generally  speaking,  the  Miscellaneous  Expense  account  should 
be  used  so  sparingly  that  its  total  for  a  year  will  not  reach  $1,000, 
more  specific  accounts  being  opened  to  take  care  of  items  which 
would  otherwise  run  it  above  that  figure. 

Repairs,  $1,120,  will  be  entered  on  line  14  of  Schedule  A,  and 
a  separate  schedule  entitled  "Schedule  A14 — Repairs"  should  be 
prepared  showing  the  nature  and  amount  of  the  principal  items 
included  in  the  total.  Repairs  is  another  account  which  should 
not  be  allowed  to  become  a  burying  ground,  because  if  it  appears 
too  large  it  is  probable  that  the  Department  will  ask  to  have  it 
analyzed  in  order  to  make  sure  that  additions  to  capital  assets 
have  not  been  charged  off.  It  is  better  to  open  enough  accounts 
to  avoid  these  analyses  at  later  dates. 

Deductible  interest  will  be  entered  on  line  15  of  Schedule  A. 
Insurance  expense  goes  on  the  supporting  Schedule  A12. 

§  392.    Entry  of  Taxes,  Donations,  and  Bad  Debts 

Taxes  which  are  deductible^  are  entered  on  line  16  of  Sched- 
ule A,  and  a  supporting  schedule  entitled  "Schedule  A16 — 
Taxes"  should  be  prepared  showing  the  kind  and  amount  of  the 
various  taxes  claimed  as  a  deduction.  Federal  income  and 
profits  taxes  charged  against  Profit  and  Loss  of  the  year  should 
be  entered  as  item  13  (b)  of  Schedule  L  on  page  4;  if,  however, 
such  taxes  are  charged  to  Surplus,  their  amount  should  be  en- 
tered as  item  16  of  that  schedule. 

Donations  are  entered  as  item  13  (a)  of  Schedule  L,  donations 
by  a  corporation  not  being  deductible. 

The  deduction  for  bad  debts  charged  as  a  loss  during  the  year 


'  See  Sec.  234  (a-3)  of  the  Revenue  Act  of  1921. 


14 14  CORPORATE  ACCOUNTING  [Bk.  III- 

is  entered  on  line  17  of  Schedule  A,  and  the  information  asked 
for  in  that  connection  on  page  4  of  the  return  should  be  furnished 
in  a  separate  schedule  to  be  prepared  and  entitled  "Schedule  A17 
— Bad  Debts."  If  the  amounts  charged  off  represent  specific 
losses,  the  taxpayer  must  be  prepared  to  show  that  the  claim  of 
loss  is  justified ;  if  the  deduction  is  on  account  of  an  addition  to 
a  reserve  for  bad  debts  he  must  show  that  its  amount  is  reason- 
able. 

§  393*    Completion  of  Supporting  Schedules 

The  last  item  in  the  "Loss"  column  of  the  work-sheet  is  the 
amount  of  a  loss  sustained  on  the  sale  of  Liberty  bonds.  This 
must  be  entered  on  Schedule  A23  as  was  the  profit  on  the  sale  of 
vacant  lots.  The  loss  will  be  entered  in  red  ink.  The  net  gain 
on  the  sale  of  capital  assets  will  then  be  obtained  by  subtracting 
the  loss  from  the  profit  previously  entered,  and  will  be  carried 
over  to  line  23  of  Schedule  A,  and  also  (since  there  is  no  amount 
on  line  24)  to  the  last  column  on  line  24.  The  forms  to  be 
used  for  1922  and  subsequent  years  may  handle  differently 
the  gain  or  loss  on  sales  of  capital  assets. 

Schedule  A12  will  then  be  added  and  its  total  entered  on  line 
12  of  Schedule  A. 

Every  supporting  schedule  should  bear  the  name  and  the 
address  of  the  taxpayer,  at  least  to  the  extent  of  showing  the 
city  and  state.  It  should  also  show  the  year  to  which  it  applies, 
as  the  schedules  sometimes  become  detached  from  the  return. 
If  the  taxpayer  has  a  fiscal  year  other  than  the  calendar  year,  the 
schedule  should  show  just  when  such  fiscal  year  ends. 

When  the  return  is  finally  finished,  all  the  supporting  sched- 
ules, including  Form  11 26  (the  Certificate  of  Inventory)  should 
be  firmly  stapled  to  it  on  some  page  other  than  the  first.  As  long 
as  the  four-page  returns  are  in  use,  page  2  is  probably  the  best 
place.  If,  as  is  expected,  the  returns  for  1922  and  subsequent 
years  are  two-page  returns,  the  schedules  should  be  stapled  to 
the  back  of  the  return. 


Ch.  36]  FEDERAL  INCOME  TAX  RETURNS  1415 

§  394.    Completing  Schedule  A 

To  complete  Schedule  A,  the  total  of  items  i  to  10  inclusive 
should  be  placed  on  Une  11,  and  the  total  of  items  12  to  20  inclu- 
sive on  line  21.  The  difference  between  these  two  totals  should 
then  be  entered  on  line  22.  To  it  should  be  added  the  amount 
previously  entered  on  line  24,  and  the  sum  placed  on  line  25  and 
again  on  line  27. 

§  395.    Reconciliation  of  Income  and  Analysis  of  Surplus 

The  net  taxable  income  as  shown  on  line  27  of  Schedule  A  is 
then  entered  as  item  i  of  Schedule  L,  and  the  total  of  items  i  to 
4  inclusive  of  Schedule  L  is  recorded  on  line  5.  The  total  of  item 
13  is  recorded  on  line  14  and  also  on  line  6,  and  is  then  subtracted 
from  the  amount  shown  on  line  5,  the  difference  being  entered  on 
line  7.  If  the  work  has  been  done  correctly,  this  difference  will 
be  the  amount  which  has  been  credited  to  the  Profit  and  Loss 
account  during  the  year.  In  the  present  instance  the  amount 
on  line  6  is  larger  than  the  amount  on  line  5  and  the  difference, 
as  a  loss,  should  be  entered  on  line  7  in  red  ink. 

As  a  proof  that  the  increase  or  decrease  in  the  net  worth  of 
the  corporation  has  all  been  accounted  for,  Schedule  L  is  con- 
tinued as  an  analysis  of  the  changes  in  the  Surplus  account  dur- 
ing the  year.  The  Surplus  at  the  close  of  the  preceding  year,  as 
shown  by  the  balance  sheet  submitted  with  the  income  tax  re- 
turn, is  entered  as  item  8  of  Schedule  L,  and  is  added  to  the 
profit  (or  diminished  by  the  loss)  shown  on  fine  7,  the  sum  (or 
difference)  being  entered  as  item  10.  If  any  credits  of  non- 
taxable income  to  Surplus  on  account  of  the  return  of  amounts 
of  surplus  previously  appropriated,*  or  from  other  sources,  have 
been  made  during  the  year,  these  would  be  entered  as  item  9  and 
included  in  the  total  on  line  10. 

Debits  to  the  Surplus  account  during  the  year  on  account  of 
dividends,  additions  to  reserves  which  as  non-operating  reservess 

♦  See  Ch.  Ill,  "Reserve  Accounts." 

'  See  i  17.  For  handling  of  income  credited  directly  to  such  reserves  instead  of  passing 
through  the  Profit  and  Loss  account,  see  {  383. 


I4i6  CORPORATE  ACCOUNTING  [Bk.  Ill- 

are  not  deductible,  etc.,  are  entered  as  items  15  and  16  of  Sched- 
ule L.  Their  total  is  entered  as  item  17  and  also  as  item  11. 
The  difference  between  this  item  and  item  10  is  entered  on  line 
12,  and  must  be  the  amount  of  surplus  as  shown  by  the  balance 
sheet  as  of  the  closing  date  of  the  taxable  year  which  is  being 
reported. 

§  396.    Completion  of  the  Return 

To  complete  the  return  a  schedule  entitled  "Schedule  K — 
Balance  Sheets"  explained  on  page  3  of  the  return  (not  shown 
among  the  forms  of  this  chapter)  should  be  prepared  showing  in 
parallel  form  the  balance  sheets  of  the  corporation  at  the  begin- 
ning and  end  of  the  taxable  year.  The  balance  sheet  at  the  be- 
ginning should  agree  with  that  which  was  filed  as  the  balance 
sheet  at  the  end  of  the  preceding  taxable  year. 

All  the  information  specifically  called  for  under  the  heading 
"Questions"  on  page  3  of  the  return  (not  shown)  should  be  fur- 
nished, the  copy  for  filing  should  be  prepared,  the  schedules 
should  be  attached,  and  when  the  return  has  been  subscribed 
and  sworn  to  by  the  two  proper  officers  it  is  ready  to  be  filed, 
accompanied  by  a  check  for  at  least  one-fourth  of  the  tax  shown 
to  be  due. 

§  397.    Consolidated  Returns 

The  preparation  of  consolidated  returns  is  not  different  from 
that  of  other  corporate  returns,  but  attention  is  called  to  the 
fact  that  Form  11 22,  shown  below,  must  be  filed  for  each  of  the 
subsidiary  companies  whose  income  is  included  in  the  income 
reported  by  the  holding  company. 


I  lIB-UNmO  STATES  INTIRNAL  REVENUE  SERVICS 


INFORMATION  RETURN  OF  SUBSIDIARY  OR  AFFIUA^ID  CORPORATION 

WHOSE  NET  INCOME  AND  INVESTED  aPITAL  ARE  INaUDED  IN  RETURN  OF  A  PARENT  OR  PRINQPAL 
REPORTING  CORPORATION  FOR  PURPOSES  OF  INCOME  AND  PROFITS  TAXES 


II  Ktom  it  (or  nkiAr 
}UT  1921,  file  i(  on  or  be 
faro  Much  15,  1922,  with 
Iho  Collector  oi  Inlemal 
Rerenin  lor  the  Di>tricl  in 
which  the  Subiidiuy  or 
A0ili<ted  Corpontjoa  hu 
lit  principel  office. 

II  lor  I  period  other  thin 
«  calender  year,  the  return 
should  be  filed  on  or  belore 
the  15th  daj  of  the  third 
month  loUowiof  the  clot* 
«i  tuch  period. 


FOR  CALENDAR  YEAR  1921 


Or  (or  period  begun . 


,1920,  and  ended ,  1921 


(Name) 


(Street  and  suvtier  or  ninl  route) 
(Post  OlBce  and  State) 


(Date  Receired) 


1.  Date  incorporated. '. Under  laws  of  what  Stated.. 

2.  Eind  of  business 


8.  Par  value  of  capital  stock  outstanding  at  beginning  of  taxable  }>eriod: 

(o)  Common,  $ . ;  (jb)  preferred,  $ .„ 

4.  "Name  of  parent  corjioration , 

6.  Address  of  parent  corporation 

6.  Internal  revenue  district  in  which  consolidated  return  has  been  filed 

(Olve  dlstrtet,  or  dty  and  Stale) 

7.  The  department  prefers  that  the  entire  tax  shown  on  a  consolidated  return  be  paid  by  the  parent  or  principal 

reporting  corporation,  instead  of  being  apportioned  among  the  corporations  composing  the  affiliated  group, 

If  apportionment  is  made,  state  the  amoimt  of  income  and  profits  taxes  for  the  taxable  period  to  be  assessed 
against  the  subsidiary  or  affiliated  corporation  making  this-  return _ $ 

We,  the  undersigned,  president  and  treasurer  of  the  above-named  subsidiary  or  affiliated  corporation,  being 
severally  dilly  sworn,  each  for  himself  deposes  and  says  that  the  foregoing  return,  including  the  accompanying 
list  (if  any),  has  been  examined  by  him  and  is  to  the  best  of  his  knowledge  and  belief  a  true  and  complete  return 
of  information  made  in  good  faith  pursuant  to  the  Revenue  Act  of  1921  and  the  R^ulations  issued  thereunder. 

Sworn  to  and  subscribed  before  me  this 


.  day  of 


-,  1922. 


Prtaideni. 


(Slcnature  of  oUteer  admlnlaieflag  oetb) 


Trtaivrtr, 


1417 


I4l8  CORPORATE  ACCOUNTING  [Bk.  Ill- 

§  398.    Information  at  the  Source 

Attention  should  be  called  also  to  the  two  forms  given  below. 
These  must  be  sent  directly  to  the  Commissioner  of  Internal 
I^evenue  so  as  to  be  in  his  hands  not  later  than  March  fifteenth 
of  each  year.  These  forms  cover  the  transactions  of  the  calendar 
year,  irrespective  of  when  the  taxable  year  of  the  person  or  cor- 
poration filing  them  ends. 

They  are  known  as  Forms  1096  and  1099,  and  their  purpose 
is  to  inform  the  Commissioner  of  amounts  of  income  paid  to  and 
in  consequence  ordinarily  returnable  by  other  taxpayers.  Form 
1099  is  a  small  form  on  which  the  payer  reports  any  amounts  of 
"salaries,  wages,  rent,  interest,  or  other  fixed  or  determinable 
gains,  profits,  and  income"  in  excess  of  $1,000  to  any  individual, 
partnership,  corporation,  etc.,  during  the  preceding  calendar 
year,  using  one  blank  for  each  person  to  whom  such  payments 
were  made.  The  method  of  filHng  out  the  form  should  be  clear 
from  the  form  itself. 

Form  1099  is  in  substance  a  letter  of  transmittal  to  accom- 
pany the  smaller  report  forms.  It  is  to  be  headed  up  with  the 
name  of  the  taxpayer  making  the  statement  and  is  to  be  filled 
out  only  to  the  extent  of  showing  in  Block  B  the  number  of  re- 
port forms  1099  which  are  attached.  It  must  be  subscribed  and 
sworn  to  by  a  proper  person  before  forwarding  to  the  Commis- 
sioner.   Any  officer  of  a  corporation  may  make  the  affidavit. 

For  purposes  of  collecting  the  information  required  for  the 
proper  filling  out  of  these  forms,  a  card  such  as  that  reproduced 
below  has  been  found  very  useful.  Such  a  card  is  also  of  service 
in  the  matter  of  adjustment  of  workmen's  compensation,  etc. 
The  reverse  side  of  this  form  contains  a  similar  "record  of 
payments"  for  two  additional  years,  so  that  each  card  serves 
for  three  years. 


si.«-a 


tfii 


CO 


.a 
Q 
a 

o 


-a 

CO 


u 


5 

o 

p 

to 

I" 
a 


p;      .3 


-  o 


edj 


1419 


nKITXD  STATES  INTKHNAL  REVENUE  SESVICB 

ANNUAL  INFORMATION  RETURN 

OF  PAYMENTS  OF  INCOME,  ETC.,  REQUIRED  TO  BE  REPORTED  UNDER  REVENUE  ACT 

OF  1921 

FOR  CALENDAR  YEAR   1921 

(Raturn  for  Fiacal  Vmf  Can  Not  B«  JUempUi) 

FOR  INSTRUCTIONS  SEE  REVERSE  SIDE 


THIS  RETURN, 

AOCOMPAmEO  BY 

REPORTS  ON 

FORM  10S»,  MUST  BE 

FORWARDED  SO  AS 

TO  REACH  THE 
COMMISSIONER  OF 
INTERNAL  REVENUE. 
SORTING  SECTION, 
WASHINGTON,  D.  C. 
ON  OR  BEFORE 
MARCH  If,  im. 


(NuD«  of  p«noa  or  off  aniiaUoD  rtoderiog  this  return.) 


(StrMt  and  aumtwr  or  rural  route.) 


A 

B 

CHARACTER  OF  INCOME  PAID. 

NTTHBBR  OP 

REPORT 
FORMS  1099 
ATTACHED. 

iDterMt,  rant,  wlaries,  wages,  promiums,  annuities,  compensation,  remuneration,  emoliiments,  or  other 

(DO  HOT  WSTTK  IN  THIS  SPACB.) 

IMPORTANT  NOTICE 

Betarns  of  Information  are  required  to  be  rendered  on  the  basis  of  th«  calendar  year.  B«tanu  for  any  other  period 
«f  time  win  not  be  accepted. 

If  lilt  showing  names  and  addresses  of  payees  is  compiled  or  an  adding  madiine  tape  used  in  eteeutiBg  Fonns  1099.  It  should  be 
aabmitted  with  forms. 

The  name  of  the  individual,  corporation,  partnership,  etc.,  using  Form  1099  may  be  printed  or  stamped  on  each;  form,  if  so  deared. 

.  Betnms  '0(  individuals  on  this  form  must  be  signed  and  «wx>m,  to  by  the  individual  or  his.  duly  authorized  agent.  Returns  of 
coiporatioDS,  partnerships,  «tc.,  must  be  signed  and  sworn  to  by  an  officerof  the  oorpor&tion  or  member  offirm. 

I  Sweu  (or  affirm)  that  to  the  best  of  my  knowledge  and  belief  the  foregoing  return  and  the  accompanying  reports  constitute  a  true 
and  complete  statement  of  payments  of  the  aboTe^deacribed  clanes  of  income  made  by  the  person  or  organization  named  at  the  head 
of  this  return  during  the  calendar  year  1921. 


6wom  to  and  subscribed  before  me  this  . 


,  day 


(Sljiiatim.) 


(Stau  wtMther  UMUvidoal  ownar,  member  oi  firm, 


(Bcit«addreieotpetioDilgnlatlidlfl«iB>tfS>tt«tglWB»tb««j«lretnni.) 

rran  nrmui  must  bb  sioiibd  ako  sworm  to) 


1420 


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• 


BOOK  IV 
CORPORATE  FORMS 


7f  Acxm 


i 


Part  I — Forms  Relating  to  Organization 


CHAPTER  I 
CHARTER  FORMS 

The  following  charter  application,  i.e.,  a  complete  charter 
form  which  upon  due  allowance  by  the  state  officials  becomes  the 
actual  charter  of  the  company,  is  that  of  a  corpp,;"ation  organized 
under  the  laws  of  New  York.i  .^r^l.iii..' 

It  is  in'  the  ordinary  form.  It  provides  for  preferred  stock 
and  for  cumulative  voting. 

Form  I.    New  York  Charter 

Certificate  of  Incorporation 
of  the 
MIDVALE  REALTY  CORPORATION 


We,  the  undersigned,  all  being  of  full  age  and  two-thirds  being  citizens  of  the 
United  States  and  one  of  us  a  resident  of  the  State  of  New  York,  for  the  purpose 
of  forming  a  corporation  under  the  Business  Corporations  Law  of  the  State  of 
New  York,  do  hereby  certify  and  set  forth: 

First — The  name  of  said  corporation  fe^*  UHqr 

"MiDVALE  Realty  Corporation"  ' 

Second — The  purposes  for  which  said  corporation  is  to  be  formed  are  as  follows: 

(a)  To  take,  lease,  purchase  or  otherwise  acquire,  and  to  own,  use,  hold, 
sell,  convey,  exchange,  lease,  mortgage,  work,  improve,  develop,  cultivate, 
and  otherwise  handle,  deal  in,  and  dispose  of  real  estate,  real  property,  and 
any  interest  or  right  therein. 

(b)  To  take,  purchase,  or  otherwise  acquire,  and  to  own,  hold,  sell, 
convey,  exchange,  hire,  lease,  pledge,  mortgage,  and  otherwise  deal  in  and 


'  For  cost  of  incorporation,  see  Book  I,  Ch.  VIII,|"Cost  of  Incorporation";  for  general  dis- 
cussion of  charters,  see  Book  I,  Part  V,  "The  Charter." 

1425 


1426  CORPORATE  FORMS  [Bk.  IV- 

dispose  of  all  kinds  of  personal  property,  chattels,  chattels  real,  choses  in 
action,  notes,  bonds,  mortgages,  and  securities. 

(c)  To  convert  and  appropriate  any  land  that  may  be  acquired  or  be  law- 
fully controlled  by  this  corporation,  into  and  for  ways,  roads,  paths,  streets, 
controlled  by  this  corporation,  into  and  for  ways,  roads,  paths,  streets, 
alleys,  sidewalks,  parks,  gardens,  boulevards,  and  pleasure  grounds;  and 
generally  to  deal  with,  manage,  improve,'  and  administer  the  lands  owned 
and  controlled  by  the  corporation  or  entrusted  to  its  care. 

(d)  To  erect  or  to  have  erected,  to  construct  or  to  have  constructed, 
bouses,  works,  buildings,  storerooms,  factories,  tenements,  edifices  and 
structures  of  every  description;  and  to  rebuild,  enlarge,  improve,  and  alter 
existing  houses,  works,  buildings,  storerooms,  tenements,  edifices,  and 
structures  of  every  description;  and  to  buy,  sell,  own,  use,  manage,  and  lease 
the  same  or  similar  structures. 

(e)  To  warrant  the  title  to  lands  or  to  any  estate  or  interests  in  lands 
sold  by  said  corporation;  to  issue  notes,  bonds,  and  debentures  secured  by 
mortgage  or  deed  of  trust  upon  the  property  of  said  corporation  or  other- 
wise; and  to  sell  and  dispose  of  the  same  for  the  benefit  of  the  corporation 
or  for  any  lawful  purpose. 

(f)  To  make,  enter  into,  perform,  and  carry  out,  contracts  for  construct- 
ing, building,  altering,  improving,  repairing,  decorating,  maintaining, 
furnishing,  and  fitting  up  buildings,  tenements,  and  structures  of  every 
description;  and  to  advance  money  to,  and  to  enter  into  agreements  of  all 
kinds,  with  builders,  contractors,  property  owners,  and  others,  for  said 
purposes. 

(g)  To  collect  rents,  and  to  make  repairs,  and  to  transact,  on  commission 
or  otherwise,  the  general  business  of  a  real  estate  agent,  and,  generally,  the 
sale,  leasing,  control  and  management  of  lands,  buildings,  and  property  of 
all  kinds. 

(h)  To  purchase,  acquire,  hold,  and  dispose  of,  stocks,  bonds,  and  other 
evidences  of  indebtedness  of  corporations  wheresoever  organized,  and  to  pay 
for  the  same  in  cash  or  in  property  or  by  the  issuance  of  its  own  stock,  bonds, 
or  other  obligations,  to  exercise  in  respect  thereto  all  of  the  rights,  powers, 
and  privileges,  of  individual  owners  or  holders  thereof;  and  to  exercise  all 
voting  powers  thereon. 

(i)  To  purchase  or  otherwise  acquire  shares  of  its  own  capital  stock,  and 
to  hold  or  to  dispose  of  the  same  or  to  retire  the  same,  subject,  however,  to 
all  provisions  of  the  law  of  the  State  of  New  York. 

(j)  To  transact  any  or  all  of  its  business  outside  of  the  State  of  New 

'   '  York,  and  at  any  place  or  at  one  or  more  places  within  the  United  States 

of  America,  or  the  Dominion  of  Canada,  and  in  any  other  part  of  the  world, 

and  the  corporation  shall  have  all  the  power  to  accomplish  any  and  all  of  its 

objects  and  purposes  which  a  natural  person  would  have. 

Third — The  amount  of  capital  stock  of  said  corporation  is  One  Million  Dol- 
lars ($1,000,000). 

The  amount  of  capital  with  which  said  corporation  will  begin  business  is  One 
Thousand  Dollars  ($1,000). 

Fourth — The  total  number  of  shares  which  may  be  issued  by  the  corporation 
is  Ten  Thousand  (10,000)  Shares,  of  the  par  value  of  One  Hundred  Dollars  ($100) 
each. 

Of  said  capital  stock  Five  Thousand  (5,000)  Shares,  of  the  par  value  of  Five 
Hundred  Thousand  Dollars  ($500,000)  shall  be  cumulative  preferred  stock,  en- 
titled to  an  annual  dividend  of  six  per  cent  (6%)  from  the  profits  of  the  corpora- 
tion, payable  semiannually,  on  the  tenth  days  of  January  and  July  in  each  year, 
before  any  dividends  are  paid  upon  the  common  stock,  and  to  share  equally  with 


Ch.  i]  CHARTER  FORMS  1427 

the  common  stock  in  any  excess  paid  in  any  year  above  six  per  cent  (6%)  to  all 
the  stock,  and  in  the  event  of  liquidation  or  dissolution  from  any  cause  said  pre- 
ferred stock  shall  be  entitled  to  be  paid  in  full  from  the  assets  of  the  corporation 
before  anything  is  paid  to  the  common  stock.  The  holders  of  such  preferred  stock 
shall  not  be  entitled  to  vote  in  any  meeting  of  the  stockholders  or  election  of  direc- 
tors, unless  the  accumulated  dividends  due  and  unpaid  such  preferred  stock  at  the 
time  shall  equal  or  exceed  fifteen  per  cent  (15%)  of  the  par  value  of  said  stock. 

Of  said  capital  stock  Five  Thousand  (5,000)  Shares,  of  the  par  value  of  Five 
Hundred  Thousand  Dollars  ($500,000),  shall  be  common  stock  of  the  corporation. 

Fifth — The  principal  business  oflSce  of  said  corporation  is  to  be  located  in  the 
Borough  of  Manhattan  and  in  the  City,  County,  and  State  of  New  York. 

Sixthr—Tht  duration  of  said  corporation  is  to  be  perpetual. 

Seventh — The  number  of  directors  of  said  corporation  shall  be  five. 

Eighth — The  names  and  the  post-office  addresses  of  the  directors  of  said 
corporation  for  the  first  year  are  as  follows: 

{Names  and  addresses  of  directors  omitted.) 

Ninth — The  names  and  the  addresses  of  the  subscribers  to  this  certificate, 
and  the  number  of  shares  which  each  agrees  to  take  in  said  corporation  are  as 
follows: 

NAMES  ADDRESSES  SHARES 

John  B.  Clark  203  Broadway,  New  York  City  i 

Charles  F.  Holbrook  Mount  Vernon,  N.  Y.  i 

Douglas  Raymond  212  Madison  Ave.,  New  York  City  i 

Tenth — At  all  elections  of  directors  of  this  corporation  each  stockholder  shall 
be  entitled  to  as  many  votes  as  shall  equal  the  number  of  his  shares  of  stock, 
multiplied  by  the  number  of  directors  to  be  elected,  and  he  may  cast  all  of  such 
votes  for  a  single  director  or  may  distribute  them  among  the  number  to  be  voted 
for,  or  any  two  or  more  of  them,  as  he  may  see  fit. 

In  Witness  Whereof,  we  have  made  and  signed  this  certificate  in 
duplicate  this  13th  day  of  January,  one  thousand,  nine  hundred  and 
twenty-two. 

John  B.  Clark 
Charles  F.  Holbrook 
Douglas  Raymond 

State  of  New  York    1 
County  of  New  York/ 

Personally  appeared  before  me  this  13th  day  of  January,  1922,  John  B.  Clark, 
Charles  F.  Holbrook,  and  Douglas.  Raymond,  to  me  personally  known  to  be  the 
persons  described  in  and  who  executed  the  foregoing  certificate  and  severally 
acknowledged  that  they  executed  the  same  for  the  purposes  therein  set  forth. 

Henry  F.  Sherwood, 

Notary  Public  for 
("notarial!  New  York  County 

\        SEAL  / 


1428  CORPORATE  FORMS  [Bk.  IV- 

The  United  States  Steel  Corporation  was  first  organized  with 
a  capital  stock  of  $3,000.  This  very  modest  capitalization 
endured  for  less  than  six  weeks,  when  the  affairs  of  the  company 
having  reached  the  proper  point  for  a  permanent  organization, 
the  capitalization  was  raised  to  over  one  billion  dollars — at  that 
time  the  largest  industrial  capitalization  in  the  world.  The 
charter  which  follows  is  the  amended  charter  of  the  United 
States  Steel  Corporation. 

Form  2.    New  Jersey  Charter 

Amended  Certificate  of  Incorporation 

of 

'  UNITED  STATES  STEEL  CORPORATION 


We,  the  undersigned,  in  order  to  form  a  corporation  for  the  purposes  herein- 
after stated,  under  and  pursuant  to  the  provisions  of  the  Act  of  the  Legislature 
of  the  State  of  New  Jersey,  entitled  "An  Act  Concerning  Corporations  (Revision 
of  1896),"  and  the  acts  amendatory  thereof  and  supplementary  thereto,  do  hereby 
certify  as  follows : 

I — The  name  of  the  corporation  is 

"United  States  Steel  Corporation" 

II — The  location  of  its  principal  office  in  the  State  of  New  Jersey  is  at  No.  51 
Newark  street,  in  the  City  of  Hoboken,  County  of  Hudson.  The  name  of  the 
agent  therein  and  in  charge  thereof,  upon  whom  process  against  the  corporation 
may  be  served,  is  Hudson  Trust  Company.  Said  office  is  to  be  the  registered 
office  of  said  corporation. 

Ill — The  objects  for  which  the  corporation  is  formed  are: 

To  manufacture  iron,  steel,  manganese,  coke,  copper,  lumber,  and  other 

materials,  and  all  or  any  articles  consisting  or  partly  consisting  of  iron, 

steel,  copper,  wood,  or  other  materials,  and  all  or  any  products  thereof. 
To  acquire,  own,  lease,  occupy,  use  or  develop  any  lands  containing  coal 

or  iron,  manganese,  stone  or  other  ores,  or  oil,  and  any  woodlands,  or 

other  lands,  for  any  purpose  of  the  company. 
To  mine  or  otherwise  to  extract  or  remove  coal,  ores,  stone  and  other 

minerals  and  timber  from  any  lands  owned,  acquired,  leased  or  occupied 

by  the  company,  or  from  any  other  lands. 
To  buy  and  sell,  or  otherwise  to  deal  or  to  traffic  in  iron,  steel,  manganese, 

copper,  stone,  ores,  coal,  coke,  wood,  lumber  and  other  materials  and  any 

of  the  products  thereof,  and  any  articles  consisting  or  partly  consisting 

thereof. 
To  construct  bridges,  buildings,  machinery,  ships,  boats,  engines,  cars  and 

other  equipment,   railroads,   docks,   slips,   elevators,   water  works,  gas 


Ch.  i]  CHARTER  FORMS  1429 

works  and  electric  works,  viaducts,  aqueducts,  canals,  and  other  water- 
ways, and  any  other  means  of  transportation,  and  to  sell  the  same,  or 
otherwise  dispose  thereof,  or  to  maintain  and  operate  the  same,  except 
that  the  company  shall  not  maintain  or  operate  any  railroad  or  canal  in 
the  State  of  New  Jersey. 

To  apply  for,  obtain,  register,  purchase,  lease  or  otherwise  to  acquire,  and 
to  hold,  use,  own,  operate  and  introduce,  and  to  sell,  assign,  or  otherwise 
to  dispose  of,  any  trademarks,  trade  names,  patents,  inventions,  improve- 
ments and  processes  used  in  connection  with  or  secured  under  letters 
patent  of  the  United  States,  or  elsewhere,  or  otherwise;  and  to  use, 
exercise,  develop,  grant  licenses  in  respect  of,  or  otherwise  turn  to  account 
any  such  trademarks,  patents,  licenses,  processes  and  the  like,  or  any 
property  or  rights. 

To  engage  in  any  other  manufacturing,  mining,  construction  or  transpor- 
tation business  of  any  kind  or  character  whatsoever,  and  to  that  end  to 
acquire,  hold,  own  and  dispose  of  any  and  all  property,  assets,  stocks, 
bonds  and  rights  of  any  and  every  kind,  but  not  to  engage  in  any  business 
hereunder  which  shall  require  the  exercise  of  the  right  of  eminent  domain 
within  the  State  of  New  Jersey. 

To  acquire  by  purchase,  subscription  or  otherwise,  and  to  hold  or  to  dispose 
of  stocks,  Ixjnds,  or  any  other  obligations  of  any  corporation  formed  for, 
or  then  or  theretofore  engaged  in  or  pursuing  any  one  or  more  of  the  kinds 
of  business,  purposes,  objects  or  operations  above  indicated,  or  owning  or 
holding  any  property  of  any  kind  herein  mentioned,  or  of  any  corporation 
owning  or  holding  the  stocks  or  the  obligations  of  any  such  corporation. 

To  hold  for  investment,  or  otherwise  to  use,  sell  or  dispose  of,  any  stock, 
bonds  or  other  obligations  of  any  such  other  corporation;  to  aid  in  any 
manner  any  corporation  whose  stock,  bonds  or  other  obligations  are  held 
or  are  in  any  manner  guaranteed  by  the  company,  and  to  do  any  other 
acts  or  things  for  the  preservation,  protection,  improvement  or  enhance- 
ment of  the  value  of  any  such  stock,  bonds  or  other  obligations,  or  to  do 
any  acts  or  things  designed  for  any  such  purpose;  and,  while  owner  of 
any  such  stock,  bonds  or  other  obligations,  to  exercise  all  the  rights,  powers 
and  privileges  of  ownership  thereof,  and  to  exercise  any  and  all  voting 
power  thereon. 

The  business  or  purpose  of  the  company  is  from  time  to  time  to  do  any  one 
or  more  of  the  acts  and  things  herein  set  forth;  and  it  may  conduct  its 
business  in  other  States  and  in  the  Territories  and  in  foreign  countries, 
and  may  have  one  office  or  more  than  one  office,  and  keep  the  books  of  the 
company  outside  of  the  State  of  New  Jersey,  except  as  otherwise  may  be 
provided  by  law;  and  may  hold,  purchase,  mortgage  and  convey  real  and 
personal  property  either  in  or  out  of  the  State  of  New  Jersey. 

Without  in  any  particular  limiting  any  of  the  objects  and  powers  of  the 
corporation,  it  is  hereby  expressly  declared  and  provided  that  the  cor- 
poration shall  have  power  to  issue  bonds  and  other  obligations  in  payment 
for  property  purchased  or  acquired  by  it,  or  for  any  other  object  in  or 
about  its  business;  to  mortgage  or  pledge  any  stock,  bonds  or  other 
obligations,  or  any  property  which  may  be  acquired  by  it,  to  secure  any 
bonds  or  other  obligations  by  it  issued  or  incurred;  to  guarantee  any 
dividends  or  bonds  or  contracts  or  other  obligations;  to  make  and  per- 
form contracts  of  any  kind  and  description;  and  in  carrying  on  its  busi- 
ness, or  for  the  purpose  of  attaining  or  furthering  any  of  its  objects,  to  do 
any  and  all  other  acts  and  things,  and  to  exercise  any  and  all  other  powers 
which  a  copartnership  or  natural  person  could  do  and  exercise,  and  which 
now  or  hereafter  may  be  authorized  by  law. 

IV — The  total  authorized  capital  stock  of  the  corporation  is  eleven  hundred 


J430  CORPORATE  FORMS  [Bk.  IV- 

million  dollars  ($i,icx5,ooo,ooo),  divided  into  eleven  million  shares  of  the  par  value 
of  one  hundred  dollars  each.  Of  such  total  authorized  capital  stock  five  million 
five  hundred  thousand  shares,  amounting  to  five  hundred  and  fifty  million  dollars, 
shall  be  preferred  stock,  and  five  million  five  hundred  thousand  shares,  amounting 
to  five  hundred  and  fifty  million  dollars,  shall  be  common  stock. 

From  time  to  time  the  preferred  stock  and  the  common  stock  may  be  increased 
according  to  law,  and  may  be  issued  in  such  amounts  and  proportions  as  shall  be 
determined  by  the  Board  of  Directors  and  as  may  be  permitted  by  law. 

The  holders  of  the  preferred  stock  shall  be  entitled  to  receive,  when  and  as 
declared,  from  the  surplus  or  net  profits  of  the  corporation,  yearly  dividends  at  the 
rate  of  seven  per  centum  per  annum  and  no  more,  payable  quarterly  on  dates 
to  be  fixed  by  the  by-laws.  The  dividends  on  the  preferred  stock  shall  be  cumu- 
lative, and  shall  be  payable  before  any  dividends  on  the  common  stock  shall  be 
paid  or  set  apart;  so  that,  if  in  any  year  dividends  amounting  to  seven  per  cent 
shall  not  have  been  paid  thereon,  the  deficiency  shall  be  payable  before  any  divi- 
dends shall  be  paid  upon  or  set  apart  for  the  common  stock. 

Whenever  all  cumulative  dividends  on  the  preferred  stock  for  all  previous  years 
shall  have  been  declared  and  shall  have  become  payable,  and  the  accrued  quarterly 
installments  for  the  current  year  shall  have  been  declared,  and  the  company  shall 
have  paid  such  cumulative  dividends  for  previous  years  and  such  accrued  quarterly 
installments,  or  shall  have  set  aside  from  its  surplus  or  net  profits  a  sum  sufiicient 
for  the  payment  thereof,  the  Board  of  Directors  may  declare  dividends  on  the 
common  stock,  payable  then  or  thereafter,  out  of  any  remaining  surplus  or  net 
profits. 

In  the  event  of  any  liquidation  or  dissolution  or  winding  up  (whether  volun- 
tary or  involuntary)  of  the  corporation,  the  holders  of  the  preferred  stock  shall  be 
entitled  to  be  paid  in  full  both  the  par  amount  of  their  shares  and  the  unpaid  divi- 
dends accrued  thereon  before  any  amount  shall  be  paid  to  the  holders  of  the  common 
stock  and,  after  the  payment  to  the  holders  of  the  preferred  stock  of  its  par  value 
and  the  unpaid  accrued  dividends  thereon,  the  remaining  assets  and  funds  shall 
be  divided  and  paid  to  the  holders  of  the  common  stock  according  to  their  respective 
shares. 

V — The  names  and  post-ofl&ce  addresses  of  the  incorporators,  and  the  number 
of  shares  of  stock  for  which  severally  and  respectively  we  do  hereby  subscribe  (the 
aggregate  of  our  said  subscriptions,  being  three  thousand  dollars,  is  the  amount  of 
capital  stock  with  which  the  corporation  will  commence  business),  are  as  follows: 

NUMBER  OF  SHARES 
PREFERRED         COMMON 
NAME  POST-OFFICE  ADDRESS  STOCK  STOCK 

Charles  C.  Cluff  51  Newark  St.,  Hoboken,  N  J.  5  5 

William  J.  Curtis  51  Newark  St.,  Hoboken,  N.  J.  5  5 

Charles  MacVeagh  51  Newark  St.,  Hoboken,  N.  J.  5  5 

VI — The  duration  of  the  corporation  shall  be  perpetual. 

VII — The  number  of  Directors  of  the  company  shall  be  fixed  from  time  to  time 
by  the  by-laws;  but  the  number,  if  fixed  at  more  than  three,  shall  be  some  multiple 
of  three.  The  Directors  shall  be  classified  with  respect  to  the  time  for  which  they 
shall  severally  hold  office  by  dividing  them  into  three  classes,  each  consisting  of 
one-third  of  the  whole  number  of  the  Board  of  Directors.  The  Directors  of  the 
first  class  shall  be  elected  for  a  term  of  one  year;  the  Directors  of  the  second  class 
for  a  term  of  two  years,  and  the  Directors  of  the  third  class  for  a  term  of  three 
years;  and  at  each  annual  election  the  successors  of  the  class  of  Directors  whose 
terms  shall  expire  in  that  year  shall  be  elected  to  hold  office  for  the  term  of  three 
years,  so  that  the  term  of  office  of  one  class  of  Directors  shall  expire  in  each  year. 


Ch.  i]  CHARTER  FORMS         *  143 1 

The  number  of  Directors  may  be  increased  as  may  be  provided  in  the  by-laws. 
In  case  of  any  increase  of  the  number  of  the  Directors  the  additional  Directors 
shall  be  elected  as  may  be  provided  in  the  by-laws,  by  the  Directors  or  by  the 
stockholders  at  an  annual  or  special  meeting;  and  one-third  of  their  number  shall 
be  elected  for  the  then  unexpired  portion  of  the  term  of  the  Directors  of  the  first 
class,  one-third  of  their  number  for  the  unexpired  portion  of  the  term  of  the  Direc- 
tors of  the  second  class,  and  one-third  of  their  number  for  the  unexpired  portion 
of  the  term  of  Directors  of  the  third  class,  so  that  each  class  of  Directors  shall  be 
increased  equally 

In  case  of  any  vacancy  in  any  class  of  Directors  through  death,  resignation, 
disqualification  or  other  cause,  the  remaining  Directors,  by  affirmative  vote  of  a 
majority  of  the  Board  of  Directors,  may  elect  a  successor  to  hold  office  for  the  unex- 
pired portion  of  the  term  of  the  Director  whose  place  shall  be  vacant,  and  until  the 
election  of  a  successor. 

The  Board  of  Directors  shall  have  power  to  hold  their  meetings  outside  of  the 
State  of  New  Jersey,  at  such  places  as  from  time  to  time  may  be  designated  by  the 
by-laws  or  by  resolution  of  the  Board.  The  by-laws  may  prescribe  the  number 
of  Directors  necessary  to  constitute  a  quorum  of  the  Board  of  Directors,  which 
number  may  be  less  than  a  majority  of  the  whole  number  of  the  Directors. 

Unless  authorized  by  votes  given  in  person  or  by  proxy  by  stockholders  holding 
at  least  two-thirds  of  the  capital  stock  of  the  corporation,  which  is  represented  and 
voted  upon  in  person  or  by  proxy  at  a  meeting  specially  called  for  that  purpose  or 
at  an  annual  meeting,  the  Board  of  Directors  shall  not  mortgage  or  pledge  any  of 
its  real  property,  or  any  shares  of  the  capital  stock  of  any  other  corporation;  but 
this  prohibition  shall  not  be  construed  to  apply  to  the  execution  of  any  purchase- 
money  mortgage  or  any  other  purchase-money  lien.  As  authorized  by  the  Act  of 
the  Legislature  of  the  State  of  New  Jersey,  passed  March  22,  1901,  amending  the 
17th  section  of  the  Act  Concerning  Corporations  (Revision  of  1896),  any  action 
which  theretofore  required  the  consent  of  the  holders  of  two-thirds  of  the  stock  at 
any  meeting  after  notice  to  them  given,  or  required  their  consent  in  writing  to  be 
filed,  may  be  taken  upon  the  consent  of,  and  the  consent  given  and  filed  by  the 
holders  of  two-thirds  of  the  stock  of  each  class  represented  at  such  meeting  in  person 
or  by  proxy. 

Any  officers  elected  or  appointed  by  the  Board  of  Directors  may  be  removed  at 
any  time  by  the  affirmative  vote  of  a  majority  of  the  whole  Board  of  Directors. 
Any  other  officer  or  employee  of  the  company  may  be  removed  at  any  time  by  vote 
of  the  Board  of  Directors,  or  by  any  committee  or  superior  officer  upon  whom  such 
power  of  removal  may  be  conferred  by  the  by-laws  or  by  vote  of  the  Board  of 
Directors. 

The  Board  of  Directors,  by  the  affirmative  vote  of  a  majority  of  the  whole 
Board,  may  appoint  from  the  Directors  an  executive  committee,  of  which  a  ma- 
jority shall  constitute  a  quorum;  and  to  such  extent  as  shall  be  provided  in  the 
by-laws,  such  committee  shall  have  and  may  exercise  all  or  any  of  the  powers  of 
the  Board  of  Directors,  including  power  to  cause  the  seal  of  the  corporation  to  be 
affixed  to  all  papers  that  may  require  it. 

The  Board  of  Directors,  by  the  affirmative  vote  of  a  majority  of  the  whole 
Board,  may  appoint  any  other  standing  committees,  and  such  standing  committees 
shall  have  and  may  exercise  such  powers  as  shall  be  conferred  or  authorized  by  the 
by-laws. 

The  Board  of  Directors  may  appoint  not  only  other  officers  of  the  com- 
pany, but  also  one  or  more  Vice-Presidents,  one  or  more  Assistant  Treasurers, 
and  one  or  more  Assistant  Secretaries;  and  to  the  extent  provided  in  the  by-laws 
the  persons  so  appointed  respectively  shall  have  and  may  exercise  all  the  powers 
of  the  President,  of  the  Treasurer  and  of  the  Secretary,  respectively. 

The  Board  of  Directors  shall  have  power  from  time  to  time  to  fix  and  to 
det^noine  and  to  vary  the  amount  of  the  working  capital  of  the  company;    and  to 


1432  '       CORPORATE  FORMS  [Bk.  IV- 

direct  and  determine  the  use  and  disposition  of  any  surplus  or  net  profits  over  and 
above  the  capital  stock  paid  in;  and  in  its  discretion  the  Board  of  Directors  may 
use  and  apply  any  such  surplus  or  accumulated  profits  in  purchasing  or  acquiring 
its  bonds  or  other  obligations,  or  shares  of  its  own  capital  stock,  to  such  extent  and 
in  such  manner  and  upon  such  terms  as  the  Board  of  Directors  shall  deem  ex- 
pedient; but  shares  of  such  capital  stock  so  purchased  or  acquired  may  be  resold, 
unless  such  shares  shall  have  been  retired  for  the  purpose  of  decreasing  the 
company's  capital  stock,  as  provided  by  law. 

The  Board  of  Directors  from  time  to  time  shall  determine  whether  and  to 
what  extent,  and  at  what  times  and  places,  and  under  what  conditions  and  regula- 
tions, the  accounts  and  books  of  the  Corporation,  or  any  of  them,  shall  be  open  to 
the  inspection  of  the  stockholders,  and  no  stockholder  shall  have  any  right  to  inspect 
any  account  or  book  or  document  of  the  Corporation,  except  as  conferred  by 
statute  or  authorized  by  the  Board  of  Directors,  or  by  resolution  of  the  stock- 
holders. 

Subject  always  to  by-laws  made  by  the  stockholders,  the  Board  of  Directors 
may  make  by-laws,  and  from  time  to  time  may  alter,  amend  or  repeal  any  by-laws, 
but  any  by-laws  made  by  the  Board  of  Directors  may  be  altered  or  repealed  by  the 
stockholders  at  any  annual  meeting,  or  at  any  special  meeting,  provided  notice 
of  suCh  proposed  alteration  or  repeal  be  included  in  the  notice  of  the  meeting. 

In  Witness  Whereof,  we  have  hereunto  set  our  hands  and  seals  the 
23rd  day  of  February,  1901. 

Charles  C.  Cluff        [l.  s.] 
William  J.  Curtis        [l.  s.] 
Charles  MacVeagh    [l.  s.] 
Signed,  sealed  and  delivered  in 
the  presence  of 

Francis  Lynde  Stetson 
Victor  Morawetz 

State  op  New  Jersey  1        . 
County  of  Hudson     j 

Be  It  Remembered,  that  on  this  23rd  day  of  February,  1901,  before  the 
undersigned,  personally  appeared  Charles  C.  Cluflf,  William  J.  Curtis,  and  Charles 
MacVeagh,  who,  I  am  satisfied,  are  the  persons  named  in  and  who  executed  the 
foregoing  certificate;  and  I  having  first  made  known  to  them,  and  to  each  of 
them,  the  contents  thereof,  they  did  each  acknowledge  that  they  signed,  sealed 
and  delivered  the  same  as  their  voluntary  act  and  deed. 

Geo.  Holmes, 
Master  in  Chancery  of  New  Jersey 


The  following  charter  form  is  that  of  a  corporation  to  be 
organized  under  the  laws  of  Delaware,  but  intending  to  carry  on 
its  business  and  to  have  its  offices  and  plant  elsewhere.  It  is 
incorporated  in  Delaware  to  escape  the  high  cost  of  incorporation 
in  the  state  in  which  it  expects  to  conduct  its  business.  Some- 
times such  outside  organization  is  resorted  to  in  order  to  secure 
powers  not  obtainable  in  the  state  of  operation. 


Ch.  i]  CHARTER  FORMS  1433 

Form  3.    Delaware  Charter 


Certificate  of  Incorporation 

of  the 

HOLLIS  BAKERY 

First — The  name  of  this  corporation  is 

"HoLLis  Bakery" 

Second — The  location  of  its  principal  office  in  the  State  of  Delaware  is  to  be  in 
the  City  of  Wilmington,  County  of  New  Castle.  The  agent  in  charge  thereof  is 
James  L.  MacPherson. 

Third — The  objects  and  purposes  for  which  this  corporation  is  formed  are  to 
do  any  and  all  of  the  things  herein  set  forth,  as  fully  and  to  the  same  extent  as 
natural  persons  might  or  could  do,  and  in  any  part  of  the  world,  viz. : 

(a)  To  manufacture,  buy,  sell,  pack,  prepare,  and  generally  to  deal  in 
and  with  breads,  biscuits,  crackers,  cakes,  Italian  paste,  confectionery, 
cereals,  coffees,  teas,  dried  fruits,  and  foods  and  food  products,  and  ma- 
terials of  all  kinds,  either  raw  or  manufactured,  that  may  be  used  in  foods 
and  food  products,  or  for  the  packing,  adapting,  preparing,  or  preserving 
of  such  foods,  or  food  products;  and  generally  to  mix,  adapt,  refine,  pre- 
pare, preserve,  manufacture,  and  dispose  of  all  such  goods,  wares,  mer- 
chandise, and  materials,  either  in  original  packages  or  in  such  cans,  jars, 
boxes,  cartons,  or  other  containing  packages  as  may  be  found  necessary  or 
desirable. 

(b)  To  purchase,  lease,  or  otherwise  acquire  lands,  buildings,  tenements, 
and  factories,  in  Delaware  or  elsewhere,  for  the  plants,  offices,  workshops, 
warehouses,  laboratories,  and  manufactories  of  the  Company,  and  to  pur- 
chase, lease,  or  otherwise  acquire  tools,  implements,  engines,  machinery, 
apparatus,  fixtures,  and  conveniences  of  all  kinds,  for  the  manufacture, 
manipulation,  preparation,  preservation,  packing,  and  handling  of  the  ma- 
terials and  products  of  the  Company. 

(c)  To  apply  for,  obtain,  purchase,  lease,  or  otherwise  acquire,  and  to 
register,  hold,  own,  and  use  any  and  all  trade-marks,  trade  secrets,  processes, 
formulae,  inventions,  and  improvements  capable  of  being  used  in  con- 
nection with  the  work  of  the  Company,  whether  secured  under  letters  pa'tent 
in  the  United  States  or  elsewhere  or  otherwise;  and  to  use,  operate,  and 
manufacture  under  the  same,  and  to  sell,  assign,  grant  licenses  in  respect 
of  or  otherwise  dispose  of  and  turn  the  same  to  the  account  and  profit  of 
the  Company. 

(d)  To  do  any  and  all  things  set  forth  in  this  certificate  as  objects,  pur- 
poses, powers,  or  otherwise  to  the  same  extent  and  as  fully  as  natural  persons 
might  do,  and  in  any  part  of  the  world,  as  principals,  agents,  contractors, 
trustees,  or  otherwise,  and  either  alone  or  in  company  with  others. 

(e)  To  have  offices,  conduct  its  business,  and  promote  its  objects  within 
and  without  the  State  of  Delaware,  in  other  States,  the  District  of  Columbia, 
the  territories  and  colonial  dependencies  of  the  United  States,  and  in 
foreign  countries,  without  restriction  as  to  place  or  amount. 

Fourth — The  amount  of  the  total  authorized  capital  stock  of  this  corporation 
is  Five  Hundred  Thousand  Dollars  ($500,000),  divided  into  Five  Thousand  (5,00  ) 
Shares  of  the  par  value  of  One  Hundred  Dollars  ($100)  each. 


1434  Corporate  FORMS  (Bk.  rv- 

The  amount  of  capital  stock  with  which  this  corporation  will  commence 
business  is  the  sum  of  One  Thousand  Dollars  ($i,ooo). 

Fifth — The  names  and  places  of  residence  of  each  of  the  original  subscribers 
to  the  capital  stock,  and  the  number  of  shares  subscribed  for  by  each,  are  as  follows: 

NO.  OF 
NAMES  RESIDENCES  SHARES 

Henry  A.  Hollis  Cincinnati,  Ohio  3 

John  H.  Mason  <«  «  ^ 

Frank  Mencken  "  "  4 

Sixth — The  existence  of  this  corporation  is  to  be  perpetual. 

Seventh — The  private  property  of  the  stockholders  shall  not  be  subject  to  the 
payment  of  corporate  debts  to  any  extent  whatever. 

Eighth — In  furtherance,  and  not  in  limitation  of  the  powers  conferred  by 
statute,  the  Board  of  Directors  are  expressly  authorized: 

To  make,  alter,  amend,  and  repeal  the  by-laws;  to  fix  the  amount  to 
be  reserved  for  working  capital,  and  to  authorize  and  cause  to  be  executed 
mortgages  and  liens,  without  limit  as  to  amount,  upon  the  property  and 
franchises  of  this  corporation. 

With  the  consent  in  writing,  and  pursuant  to  a  vote  of  the  holders  of  a 
majority  of  the  capital  stock  issued  and  outstanding,  to  dispose  in  any 
manner  of  the  whole  property  of  this  corporation. 

To  determine  from  time  to  time  whether  and  to  what  extent  the  accounts 
and  books  of  this  corporation,  or  any  of  them,  shall  be  open  to  the  inspection 
of  the  stockholders;  and  no  stockholder  shall  have  any  right  of  inspecting 
any  account,  or  book,  or  document  of  this  corporation,  except  as  conferred 
by  law,  or  the  by-laws,  or  by  resolution  of  the  stockholders. 

The  stockholders  and  directors  shall  have  power  to  hold  their  meetings  and 
keep  the  books,  documents,  and  papers  of  the  corporation  outside  of  the  State 
of  Delaware,  at  such  places  as  may  be  from  time  to  time  designated  by  the  by-laws 
or  by  resolution  of  the  stockholders  or  directors,  except  as  otherwise  required  by  the 
laws  of  Delaware. 

It  is  the  intention  that  the  objects,  purposes,  and  powers  specified  in  the  third 
paragraph  hereof  shall,  except  where  otherwise  specified  in  said  paragraph,  be 
nowise  limited  or  restricted  by  reference  to  or  inference  from  the  terms  of  any 
other  clause  or  paragraph  in  this  certificate  of  incorporation,  but  that  the  objects, 
purposes,  and  powers  specified  in  the  third  paragraph  and  in  each  of  the  clauses  or 
paragraphs  of  this  charter  shall  be  regarded  as  independent  objects,  purposes, 
and  powers. 

We,  the  undersigned,  being  all  the  original  subscribers  to  the  capital  stock 
hereinbefore  named,  for  the  purpose  of  forming  a  corporation  under  the  laws  of  the 
State  of  Delaware,  do  make,  file,  and  record  this  certificate,  and  do  hereby  certify 
that  the  facts  herein  stated  are  true;  and  we  have  accordingly  hereunto  set  our 
respective  hands  and  seals,  this  sixteenth  day  of  January,  A.  D.  1922. 

Henry  A.  Hollis  [seal] 

John  H.  Mason  [seal] 

Frank  Mencken  [seal] 

In  presence  of 

James  Behrens 

Samuel  S.  Miller 


Ch.  i]  CHARTER  FORMS  143  5 

State  of  Delaware       \  cc  • 
County  of  New  CastleJ 

Be  It  Remembered,  that  on  this  sixteenth  day  of  January,  A.  D.  1922,  person- 
ally came  before  me,  Howard  Franklin,  a  Notary  Public  in  and  for  the  county  and 
state  aforesaid,  Henry  A.  Hollis,  John  H.  Mason,  and  Frank  Mencken,  parties  to 
the  foregoing  certificate  of  incorporation,  known  to  me  personally  to  be  such,  and 
severally  acknowledged  the  said  certificate  to  be  the  act  and  deed  of  the  signers 
respectively,  and  that  the  facts  therein  stated  are  truly  set  forth. 

Given  under  my  hand  and  seal  of  office  the  day  and  year  aforesaid. 

Howard  Franklin, 
Notary  Public 
("notarial  \ 

\       SEAL       / 


The  following  charter  of  the  General  Motors  Corporation  is 
unusual  in  its  very  brief,  direct  purposes  and  its  extended  state- 
ment of  connected,  collateral,  or  general  purposes. 

Form  4.    Delaware  Charter — No-Par- Value  Shares 


GENERAL  MOTORS  CORPORATION 

Certificate  of  Incorporation 

We,  the  undersigned,  in  order  to  form  a  corporation  for  the  purposes  herein- 
after stated,  under  and  pursuant  to  the  provisions  of  an  Act  of  the  Legislature  of 
the  State  of  Delaware,  entitled  "An  Act  Providing  a  General  Corporation  Law" 
(approved  March  10,  1899),  and- the  acts  amendatory  thereof  and  supplemental 
thereto,  do  hereby  certify  as  follows: 

First:    The  name  of  the  corporation  is 

General  Motors  Corporation 

Second:  The  principal  office  of  the  corporation  is  to' be' located  at  No.  7 
West  Tenth  Street,  in  the  City  of  Wilmington,  County  of  New  Castle,  State  of 
Delaware.  The  name  of  its  resident  agent  in  charge  thereof  is  the  Corporation 
Trust  Company  of  America,  whose  address  is  No.  7  West  Tenth  Street,  in  the 
City  of  Wilmington,  County  of  New  Castle,  State  of  Delaware. 

Third:  The  nature  of  the  business  of  the  corporation  and  the  objects  and 
purposes  proposed  to  be  transacted,  promoted,  or  carried  on  by  it,  are  as  follows, 
to-wit: 

(a)  To  manufacture,  buy,  sell  and  deal  in  automobiles,  trucks,  cars,  boats, 
flying  machines  and  other  vehicles,  their  parts  and  accessories,  and  kindred  articles, 
and  generally  to  conduct  an  automobile  business  in  all  its  branches. 

(b)  To  purchase  or  otherwise  acquire,  lease,  assign,  mortgage,  pledge  or  other- 
wise dispose  of  any  trade  names,  trade  marks,  concessions,  inventions,  formulae, 
improvements,  processes  of  any  nature  whatsoever,  copyrights,  and  letters  patent 
of  the  United  States  and  of  foreign  countries,  and  to  accept  and  grant  licenses 
thereunder. 


1436  CORPORATE  FORMS  [Bk.  IV- 

(c)  To  subscribe  or  cause  to  be  subscribed  for,  and  to  purchase  or  otherwise 
acquire,  hold  for  investment,  sell,  assign,  transfer,  mortgage,  pledge,  exchange, 
distribute  or  otherwise  dispose  of  the  whole  or  any  part  of  the  shares  of  the  capital 
stock,  bonds,  coupons,  mortgages,  deeds  of  trust,  debentures,  securities,  obligations, 
notes  and  other  evidences  of  indebtedness  of  any  corporation,  stock  company  or 
association,  now  or  hereafter  existing,  and  whether  created  by  or  under  the  laws 
of  the  State  of  Delaware,  or  otherwise;  and  while  owners  of  any  of  said  shares  of 
capital  stock  or  bonds  or  other  property  to  exercise  all  the  rights,  powers  and 
privileges  of  ownership  of  every  kind  and  description,  including  the  right  to  vote 
thereon,  with  power  to  designate  some  person  for  that  purpose  from  time  to  time 
to  the  same  extent  as  natural  persons  might  or  could  do. 

(d)  To  purchase,  hold,  sell  and  reissue  the  shares  of  its  own  capital  stock. 

(e)  To  buy,  lease,  or  otherwise  acquire,  so  far  as  may  be  permitted  by  law, 
the  whole  or  any  part  of  the  business,  good-will,  and  assets  of  any  person,  firm, 
association  or  corporation  (either  foreign  or  domestic)  engaged  in  a  business  of  the 
same  general  character  as  that  for  which  this  corporation  is  organized. 

(f)  To  endorse,  guarantee  and  secure  the  payment  and  satisfaction  of  bonds, 
coupons,  mortgages,  deeds  of  trust,  debentures,  securities,  obligations  and  evi- 
dences of  indebtedness,  and  also  to  guarantee  and  secure  the  payment  or  satis- 
faction of  interest  on  obligations  and  of  dividends  on  shares  of  the  capital  stock  of 
other  corporations;  also  to  assume  the  whole  or  any  part  of  the  liabilities,  existing 
or  prospective,  of  any  person,  corporation,  firm  or  association;  and  to  aid  in  any 
manner  any  other  person  or  corporation  with  which  it  has  business  dealings,  or 
whose  stocks,  bonds,  or  other  obligations  are  held  or  are  in  any  manner  guaranteed 
by  the  corporation,  and  to  do  any  other  acts  and  things  for  the  preservation,  pro- 
tection, improvement,  or  enhancement  of  the  value  of  such  stocks,  bonds,  or  other 
obligations. 

(g)  To  engage  in  any  other  manufacturing  or  mercantile  business  of  any  kind 
or  character  whatsoever,  and  to  that  end  to  acquire,  hold,  own  and  dispose  of  any 
and  all  property,  assets,  stocks,  bonds  and  rights  of  any  and  every  kind. 

(h)  Without  in  any  particular  limiting  any  of  the  objects'  and  powers  of  the 
corporation,  it  is  hereby  expressly  declared  and  provided  that  the  corporation  shall 
have  power  to  do  all  things  hereinbefore  enumerated,  and  also  to  issue  or  exchange 
stocks,  bonds  and  other  obligations  in  payment  for  property  purchased  or  acquired 
by  it,  or  for  any  other  object  in  or  about  its  business;  to  borrow  money  without 
limit;  to  mortgage  or  pledge  its  franchises,  real  or  personal  property,  income  and 
profits  accruing  to  it,  any  stocks,  bonds  or  other  obligations,  or  any  property  which 
may  be  acquired  by  it,  and  to  secure  any  bonds  or  other  obligations  by  it  issued  or 
incurred. 

(i)  To  carry  on  any  business  whatsoever  which  the  corporation  may  deem 
proper  or  convenient  in  connection  with  any  of  the  foregoing  purposes  or  otherwise, 
or  which  may  be  calculated,  directly  or  indirectly,  to  promote  the  interests  of  the 
corporation  or  to  enhance  the  value  of  its  property;  to  conduct  its  business  in  this 
State,  in  other  States,  in  the  District  of  Columbia,  in  the  Territories  and  Colonies 
of  the  United  States,  and  in  foreign  countries;  and  to  hold,  purchase,  mortgage 
and  convey  real  and  personal  property,  either  in  or  out  of  the  State  of  Delaware, 
and  to  have  and  to  exercise  all  the  powers  conferred  by  the  laws  of  Delaware  upon 
corporations  formed  under  the  act  pursuant  to  and  under  which  this  corporation  is 
formed. 

Fourth:  The  total  authorized  capital  stock  of  the  Corporation  is  as  follows: 
The  number  of  shares  of  stock  that  may  be  issued  shall  be  Fifty  Six  Million 
One  Hundred  Thousand  (56,100,000)  shares,  of  which  Two  Hundred  Thousand 
(200,000)  shares  shall  be  preferred  stock,  having  a  par  value  of  One  Hundred 
Dollars  ($100)  each.  Nine  Hundred  Thousand  (900,000)  shares  shall  be  debenture 
stock,  havinga  par  value  of  One  Hundred  Dollars  ($100)  each,  Five  Million  (5,000,- 


Ch.  i]  CHARTER  FORMS  1437 

ooo)  shares  shall  be  seven  per  cent.  (7%)  debenture  stock,  having  a  par  value 
of  One  Hundred  Dollars  ($100)  each,  and  Fifty  Million  (50,000,000)  shares  shall 
be_common  stock,  without  any  nominal  or  par  value. 

From  time  to  time  the  seven  per  cent.  (7%)  debenture  stock,  the  debenture 
stock,  the  preferred  stock  and  the  common  stock  may  be  increased  or  decreased 
according  to  law,  and  may  be  issued  in  such  amounts  and  proportions  as  shall  be 
determined  by  the  Board  of  Directors  and  as  may  be  permitted  by  law,  except  that 
no  seven  per  cent.  (7%)  debenture  stock  or  debenture  stock  shall  be  issued  unless 
the  net  assets  of  the  corporation  above  all  direct  liabilities,  as  shown  by  the  books 
of  the  corporation,  except  capital  stock  liability,  shall  amount,  after  the  issue  of 
said  seven  per  cent.  (7%)  debenture  stock  and  debenture  stock,  to  at  least  one  and 
one-half  times  the  par  value  of  all  seven  per  cent.  (7%)  debenture  stock  and  de- 
benture stock  issued  and  outstanding. 

The  holders  of  the  seven  per  cent.  (7%)  debenture  stock,  the  debenture  stock, 
and  the  preferred  stock  shall  be  entitled  pari  passu  to  receive,  when  and  as  declared, 
from  the  surplus  or  net  profits  of  the  corporation,  yearly  dividends  at  the  rate  of 
six  per  centum  (6%)  per  annum  on  the  debenture  stock  and  preferred  stock,  and 
seven  per  centum  (7%)  per  annum  on  the  seven  per  cent.  (7%)  debenture  stock, 
and  no  more,  payable  quarterly  on  dates  to  be  fixed  by  the  By-Laws,  which  divi- 
dends shall  run  from  the  date  of  the  issue  of  said  preferred  stock,  said  seven  per 
cent.  (7%)  debenture  stock  and  said  debenture  stock. 

The  dividends  on  the  preferred  stock,  the  seven  per  cent.  (7%)  debenture 
stock  and  the  debenture  stock  shall  be  cumulative  and  shall  be  payable  before  any 
dividend  on  the  common  stock  shall  be  paid  or  set  apart,  so  that,  if  in  any  year, 
dividends  amounting  to  six  per  centum  (6%)  on  the  preferred  stock  and  on  the 
debenture  stock,  and  amounting  to  seven  per  centum  (7%)  on  the  seven  per  cent. 
(7%)  debenture  stock  shall  not  have  been  paid  thereon,  the  deficiency  shall  be 
payable  before  any  dividend  shall  be  paid  upon,  or  set  apart  for  the  common  stock. 

Whenever  all  cumulative  dividends  on  the  preferred  stock,  the  seven  per  cent. 
(7%)  debenture  stock  and  the  debenture  stock  shall  have  been  paid,  and  a  sum 
sufficient  for  the  payment  of  the  next  ensuing  quarterly  dividend  on  the  preferred 
stock,  the  seven  per  cent.  (7%)  debenture  stock  and  the  debenture  stock  shall  have 
been  set  aside  from  the  surplus  or  the  net  profits,  the  Board  of  Directors  may 
declare  dividends  on  the  common  stock,  payable  then  or  thereafter,  out  of  any 
remaining  surplus  or  net  profits.  In  the  event  of  any  liquidation  or  dissolution, 
or  winding-up,  whether  voluntary  or  otherwise,  of  the  corporation,  the  holders 
of  the  preferred  stock,  the  seven  per  cent.  (7%)  debenture  stock,  and  the  debenture 
stock,  before  any  amount  shall  be  paid  to  the  holders  of  the  common  stock,  shall  be 
entitled  to  be  paid  pari  passu  in  full,  both  the  par  amount  of  their  shares  and  the 
unpaid  dividends  accrued  thereon;  and  after  such  payment  is  made,  the  remaining 
assets  and  funds  shall  be  divided  among  and  paid  to  the  holders  of  the  common 
stock  pro  rata  according  to  their  respective  shares. 

The  preferred  stock  at  the  option  of  the  Board  of  Directors  shall  be  subject 
to  redemption  in  whole  or  in  part  at  One  Hundred  Ten  Dojlars  ($110)  per  share 
and  accrued  dividends  thereon,  on  the  first  day  of  November,  1918,  or  on  any 
subsequent  dividend-paying  date  in  such  manner  as  the  Board  of  Directors  may 
determine. 

The  debenture  stock,  at  the  option  of  the  Board  of  Directors,  shall  be  subject 
to  redemption  in  whole  or  in  part  at  One  Hundred  Fifteen  Dollars  ($115)  per  share 
and  accrued  dividends  thereon,  on  the  first  day  of  November,  1919,  or  on  any 
subsequent  dividend-paying  date  in  such  manner  as  the  Board  of  Directors  may 
determine. 

The  seven  per  cent.  (7%)  debenture  stock,  at  the  option  of  the  Board  of 
Directors,  shall  be  subject  to  redemption  in  whole  or  in  part  at  One  Hundred 
Twenty  Dollars  ($120)  per  share  and  accrued  dividends  thereon,  on  the  first  daj'  of 
November,  1920,  or  on  any  subsequent  dividend-paying  date  in  such  manner  as 
the  Board  of  Directors  may  determine. 


1438  CORPORATE  FORMS  [Bk.  IV- 

The  holders  of  the  preferred  stock,  the  seven  per  cent.  (7%)  debenture  stock 
and  the  debenture  stock  shall  not  have  any  voting  power  whatsoever,  except  upon 
the  question  of  selling,  conveying,  transferring  or  otherwise  disposing  of  the  prop- 
erty and  assets  of  the  corporation  as  an  entirety,  provided,  however: 

(a)  In  the  event  that  the  corporation  shall  fail  to  pay  any  dividend  upon  the 
preferred  stock  when  it  regularly  becomes  due,  and  such  dividend  shall  remain  in 
arrears  for  a  period  of  six  (6)  months,  the  holders  of  the  preferred  stock  shall  have 
the  right  to  vote  onfall  matters  in  like  manner  as  the  holders  of  the  common  stock, 
during  the  year  next  ensuing,  and  during  each  year  thereafter  during  the  continu- 
ance of  said  default  until  the  corporation  shall  have  paid  all  accrued  dividends 
upon  the  preferred  stock; 

(b)  In  the  event  that  the  corporation  shall  fail  to  pay  any  dividend  on  the 
seven  per  cent.  (7%)  debenture  stock  or  on  the  debenture  stock  when  it  regularly 
becomes  due,  and  such  default  shall  continue  for  a  period  of  six  (6)  months,  the 
holders  of  the  seven  per  cent.  (7%)  debenture  stock  and  of  the  debenture  stock 
shall  have  the  sole  and  exclusive  right  of  voting  on  all  questions  whatsoever, 
to  the  exclusion  of  the  holders  of  the  common  and  preferred  stock,  during  the 
continuance  of  such  default  until  the  corporation  shall  have  paid  all  accrued  divi- 
dends on  the  debenture  stock  and  on  the  seven  per  cent  (7%)  debenture  stock;  or 

(c)  In  the  event  that  the  earnings  of  the  corporation  during  any  calendar  year 
shall  amount  to  less  than  nine  per  cent.  (9%)  on  the  par  value  of  the  seven  per  cent 
(7%)  debenture  stock  and  the  debenture  stock  issued  and  outstanding  during  said 
year,  the  holder  of  each  share  of  the  seven  per  cent.  (7%)  debenture  stock  and  the 
debenture  -stock  shall  have  an  equal  right  to  vote  on  all  questions  with  the  holder 
of  each  share  of  the  common  stock,  which  right  to  vote  shall  continue  during  the 
continuance  of  said  default  until  such  time  as  the  net  earnings  during  some  future 
calendar  year  shall  equal  nine  per  cent.  (9%)  on  the  par  value  of  the  seven  per  cent. 
(7%)  debenture  stock  and  the  debenture  stock  issued  and  outstanding  in  such  year. 

The  holders  of  the  common  stock  shall  have  the  right  to  vote  on  all  questions 
to  the  exclusion  of  all  other  stockholders,  except  as  herein  otherwise  provided. 

^Any  preferred  stock,  seven  per  cent.  (7%)  debenture  stock,  debenture  stock, 
or  common  stock,  authorized  hereunder  or  under  any  amendment  hereof,  in  the 
discretion  of  the  Board  of  Directors  may  be  issued  except  as  herein  otherwise  pro- 
vided in  payment  for  property  or  services,  or  as  bonuses  to  employees  of  the  corpora- 
tion or  employes  of  subsidiary  companies,  or  for  other  assets  or  securities,  including 
cash,  necessary  or  desirable  to  be  purchased  or  acquired  from  time  to  time  for  the 
corporation,  or  as  a  dividend  upon  the  common  stock  payable  in  preferred  seven 
per  cent.  (7%)  debenture,  or  common  stock  of  the  corporation. 

No  holders  of  stock  of  the  corporation  of  whatever  class  shall  have  any 
preferential  right  of  subscription  to  any  shares  of  any  class  of  stock  of  the  corpora- 
tion issued  or  sold,  or  to  be  issued  or  sold,  or  to  any  obligations  convertible  into 
stock  of  the  corporation,  nor  any  right  of  subscription  to  any  thereof,  other  than 
such,  if  any,  as  the  Board  of  Directors  in  its  discretion,  may  determine,  and  any 
shares  or  convertible  obligations  which  the  Board  of  Directors  may  determine  to 
offer  for  subscription  to  the  holders  of  stock  may,  in  its  discretion,  be  offered  to  the 
holders  of  preferred  stock  and/or  seven  per  cent.  (7%)  debenture  stock,  and  /or 
debenture  stock,  and/ or  common  stock,  to  the  exclusion  of  any  other  class  or  classes 
of  stock  then  existing,  provided  however,  that  no  additional  common  stock  or 
obUgations  convertible  into  common  stock  shall  be  issued  or  sold  for  cash,  except 
after  first  having  been  offered  for  subscription  to  the  holders  of  the  then  outstanding 
common  stock  according  to  their  respective  shares. 

Unless  the  holders  of  at  least  three-fourths  in  amount  of  the  seven  per  cent. 
(7%)  debenture  stock  and  debenture  stock  then  outstanding  shall  consent  thereto 
either  in  writing  or  at  a  special  meeting,  the  Board  of  Directors  shall  not  mortgage 
or  pledge  or  place  any  specific  lien  upon  the  whole  or  any  part  of  the  property  of 
the  corporation,  but  this  prohibition  shall  not  be  construed  to  apply  to  the  execution 


Ck.  ij  CHARTER  FORMS  I439 

of  any  purchase  money  mortgage  or  any  other  purchase  money  lien,  nor  to  the 
assumption  of  any  mortgage  or  other  lien  upon  property  purchased  nor  to  the 
renewal  or  renewals  thereof  or  to  substitutions  therefor,  in  whole  or  in  part,  nor 
shall  it  prevent  the  directors  at  any  time  from  pledging  securities  belonging  to  the 
corporation  for  the  purpose  of  securing  cash  to  be  used  in  the  ordinary  course  of 
the  business  of  the  corjjoration,  provided  such  cash  advances  are  procured  upon 
obligations  of  the  corporation  which  shall  mature  not  more  than  three  years  from 
the  date  thereof;  nor  shall  any  amendment  to  any  provision  contained  in  this 
certificate  of  incorporation  in  reference  to  the  rights  and  the  security  of  the  holders 
of  the  seven  per  cent.  (7%)  debenture  stock  and/or  the  debenture  stock  be  au- 
thorized, unless  such  amendment  is  consented  to  by  the  holders  of  three-fourths  of 
the  seven  per  cent.  (7%)  debenture  stock  and/or  the  debenture  stock  then  issued 
and  outstanding. 

The  preferred  stock  and  the  debenture  stock  may  be  exchanged  in  the  manner 
and  at  the  times  prescribed  by  the  Board  of  Directors,  on  the  basis  of  one  share  of 
preferred  or  debenture  stock  and  One  Hundred  Dollars  ($ioo)  cash  for  two  (2) 
shares  of  seven  per  cent.  (7%)  debenture  stock. 

The  common  stock  may  be  issued  by  the  Corporation  from  time  to  time  for 
such  consideration,  not  less  than  Ten  Dollars  ($10)  a  share,  paid  for  wholly  or 
partly  by  cash,  by  labor  done,  by  personal  property  or  by  real  property  or  leases 
thereof,  or  as  dividends  from  the  surplus  or  net  profits  at  such  price,  as  may  be 
fixed  from  time  to  time  by  the  Board  of  Directors.  Each  share  of  the  common 
capital  stock  of  the  Corporation  now  outstanding,  of  the  par  value  of  One  Hundred 
Dollars  ($100)  each,  shall  be  exchanged  for  ten  (10)  shares  of  common  stock  of  no 
par  value,  in  such  manner  as  may  be  prescribed  by  the  Board  of  Directors. 

The  amount  of  capital  stock  with  which  the  Corporation  will  commence 
business  is  the  sum  of  One  Thousand  Five  Hundred  Dollars  ($1,500)  being  fifteen 
shares  of  the  common  capital  stock  of  the  Corporation  of  the  par  value  of  One 
Hundred  Dollars  ($100)  each. 

Fifth:  The  names  and  places  of  residence  of  each  of  the  original  subscribers 
to  the  capital  stock  and  the  number  of  shares  subscribed  for  by  each  are  as  follows: 

NUMBER  OF 
NAME  RESIDENCE  SHARES 

COMMON  STOCK 

Herbert  E.  Latter  Wilmington,  Delaware  5 

Norman  P.  Coffin  Wilmington,  Delaware  5 

Clement  M.  Egner  Elkton,  Maryland  5 

Sixth:    The  corporation  is  to  have  perpetual  existence. 

Seventh:  The  private  property  of  the  stockholders  shall  not  be  subject  to 
the  payment  of  corporate  debts  to  any  extent  whatever. 

Eighth:  The  number  of  Directors  of  the  corporation,  not  less  than  three, 
shall  be  fixed  from  time  to  time  by  the  By-laws  and  the  number  may  be  altered 
as  therein  provided.  In  case  of  any  increase  in  the  number  of  Directors,  the 
additional  Directors  shall  be  elected  as  provided  by  the  By-laws,  by  the  Directors, 
or  by  the  stockholders  at  an  annual  or  special  meeting.  In  case  of  any  vacancy  in 
the  Board  of  Directors,  the  remaining  Directors,  by  afiirmative  vote  of  a  majority 
thereof,  may  elect  a  successor  to  hold  oflice  for  the  unexpired  portion  of  the  term  of 
the  Director  whose  place  is  vacant  and  until  his  successor  shall  be  duly  elected  and 
qualified. 

In  further^ince,  and  not  in  limitation  of  the  powers  conferred  by  law,  the  Board 
of  Directors  are  expressly  authorized: 

(a)  To  make,  alter,  amend  and  repeal  the  By-laws  of  the  corporation. 


I440  CORPORATE  FORMS  /Bk.  IV- 

(b)  To  remove  at  any  time  any  officer  elected  or  appointed  by  the  Board  of 
Directors  but  only  by  the  affirmative  vote  of  a  majority  of  the  whole  Board  of 
Directors.  Any  other  officer  or  employe  of  the  corporation  may  be  removed  at  any 
time  by  a  vote  of  the  Board  of  Directors,  or  by  any  committee  or  superior  officer 
UfK)n  whom  such  power  of  removal  may  be  conferred  by  the  By-laws  or  by  the 
vote  of  the  Board  of  Directors, 

(c)  To  designate,  by  resolution  passed  by  a  majority  of  the  whole  Board,  two 
or  more  of  their  number  to  const/'tute  an  executive  committee,  who,  to  the  extent 
provided  in  said  resolution  or  in  the  By-laws  of  the  corporation,  shall  have  and 
exercise  the  powers  of  the  Board  of  Directors  in  the  management  of  the  business  and 
affairs  of  the  corporation,  and  shall  have  power  to  authorize  the  seal  of  the  cor- 
poration to  be  affixed  to  all  papers  which  may  require  it.  A  majority  of  such 
committee  shall  constitute  a  quorum  for  the  transaction  of  business. 

To  designate  any  other  standing  committees  by  the  affirmative  vote  of  a  ma- 
jority of  the  whole  Board,  and  such  standing  committees  shall  have  and  may 
exercise  such  powers  as  shall  be  conferred  or  authorized  by  the  By-laws,  including 
_  the  power  to  cause  the  seal  of  the  corporation  to  be  affixed  to  any  papers  which  may 
require  it. 

(d)  From  time  to  time  to  fix  and  to  vary  the  sum  to  be  reserved  over  and 
above  its  capital  stock  paid  in  before  declaring  any  dividends;  to  direct  and  deter- 
mine the  use  and  disposition  of  any  surplus  or  net  profits  over  and  above  the  capital 
stock  paid  in;  to  fix  the  time  of  declaring  and  paying  any  dividend,  and,  unless 
otherwise  provided  in  this  Certificate  or  in  the  By-laws,  to  determine  the  amount 
of  any  dividend.  All  sums  reserved  as  working  capital  or  otherwise  may  be  applied 
from  time  to  time  to  the  acquisition  or  purchase  of  its  bonds  or  other  obligations 
or  shares  of  its  own  capital  stock  or  other  property  to  such  extent  and  in  such  man- 
ner and  upon  such  terms  as  the  Board  of  Directors  shall  deem  expedient  and 
neither  the  stocks,  bonds  or  other  property  so  acquired  shall  be  regarded  as  ac- 
cumulated profits  for  the  purpose  of  declaring  or  paying  dividends  unless  otherwise 
determined  by  the  Board  of  Directors,  but  shares  of  such  capital  stock  so  purchased 
or  acquired  may  be  resold,  unless  such  shares  shall  have  been  retired  for  the  pur- 
pose of  decreasing  the  Company's  capital  stock  as  provided  by  law. 

(e)  From  time  to  time  to  determine  whether  and  to  what  extent,  and  at  what 
time  and  places  and  under  what  conditions  and  regulations  the  accounts  and  books 
of  the  corporation  (other  than  the  stock  ledger),  or  any  of  them,  shall  be  open  to 
the  inspection  of  the  stockholders;  and  no  stockholder  shall  have  any  right  to 
inspect  any  account  or  book  or  document  of  the  corporation,  except  as  conferred  by 
statute  or  authorized  by  the  Board  of  Directors  or  by  a  resolution  of  the  stock- 
holders. 

(f)  With  the  written  assent  of  the  holders  of  two-thirds  of  its  issued  and  out- 
standing stock  of  all  classes,  without  a  meeting,  or  pursuant  to  the  affirmative  vote 
in  person  or  by  proxy  of  the  holders  of  two-thirds  of  its  issued  and  outstanding 
stock  of  all  classes,  at  any  meeting,  either  annual  or  special,  called  as  provided  in 
the  By-laws,  the  Board  of  Directors  may  sell,  convey,  assign,  transfer  or  otherwise 
dispose  of,  any  part  or  all  of  the  property,  assets,  rights  and  privileges  of  the  cor- 
poration as  an  entirety,  for  the  stock,  bonds,  obligations  or  other  securities  of 
another  corporation  of  this  or  of  any  other  State,  Territory,  Colony  or  foreign 
country,  or  for  cash,  or  partly  cash,  credit,  or  property,  or  for  such  other  considera- 
tion as  the  Board  of  Directors,  in  their  absolute  and  uncontrolled  discretion,  may 
determine. 

(g)  The  corporation  may  by  its  By-laws  confer  upon  the  Directors  powers 
and  authorities  additional  to  the  foregoing  and  to  those  expressly  conferred  upon 
therti  by  statute. 

Ninth:  Both  the  stockholders  and  the  Directors  of  the  corporation  may  hold 
their  meetings  and  the  corporation  may  have  an  office  or  offices  in  such  place  or 
places  outside  of  the  State  of  Delaware  as  the  By-laws  may  provide,  and  the  cor- 


Ch.  i]  CHARTER  FORMS  1441 

poration  may  keep  its  books  outside  of  the  State  of  Delaware  except  as  otherwise 
provided  by  law. 

Tenth:  The  corporation  reserves  the  right  to  amend,  alter,  change  or  repeal 
any  provision  contained  in  this  Certificate  of  Incorporation  in  the  manner,  now  or 
hereafter  prescribed  by  statute,  and  all  rights  conferred  on  stockholders  herein  are 
granted  subject  to  this  reservation. 

In  Witness  Whereof  we  have  hereunto  set  our  hands  and  seals  this  13th 
day  of  October  1916 

Herbert  E.  Latter     [seal] 
Norman  P.  Coffin       [seal] 
Clement  M.  Egner     [seal] 
In  the  presence  of: 

William  J.  Maloney  , 

State  of  Delaware  "I 
County  of  New  Castle/      ^" 

Be  it  remembered  that  on  this  13th  day  of  October,  A.  D.  1916,  personally 
came  before  me  William  J.  Maloney,  a  Notary  Public  in  and  for  the  County  and 
State  aforesaid,  Herbert  E.  Latter,  Norman  P.  Coffin  and  Clement  M.  Egner, 
parties  to  the  foregoing  Certificate  of  Incorporation,  known  to  me  personally  to  be 
such  and  simultaneously  acknowledged  the  said  certilicate  to  be  the  act  and  deed 
of  the  signers  respectively  and  that  the  facts  therein  stated  are  truly  set  forth. 

Given  under  my  hand  and  seal  of  office  the  day  and  year  aforesaid. 

William  J.  Maloney, 
Notary  Public 
[seal] 


CHAPTER  II 

SPECIAL  CHARTER  CLAUSES 

The  lines  of  business  directly  covered  by  the  special  charter 
clauses  of  the  present  chapter  are  representative.  Where  any 
desired  business  is  not  included,  it  will  in  most  cases  be  possible 
to  find  among  those  given,  some  related,  or  similar  purpose 
clauses  that  can  be  adapted  to  meet  the  particular  requirements. 

The  clauses  of  Forms  5  to  53  cover  the  specific  purposes  of 
particular  businesses.  It  is  usual,  as  will  be  seen  by  reference 
to  the  charters  of  the  preceding  chapter,  to  include  in  the  charter 
of  the  ordinary  business  corporation  other  clauses  giving  general 
powers  in  addition  to  the  specific  purposes.  Such  clauses  will 
be  found  in  Forms  54  to  64.  As  a  corporation  always  has  power 
to  do  such  legitimate  things  as  are  necessary  to  effect  the  pur- 
poses of  its  creation,  these  additional  clauses  are  not  as  a  rule 
strictly  necessary,  but  are  added  for  the  sake  of  completeness 
and  to  remove  any  possible  doubt  as  to  the  extent  of  the  cor- 
porate powers. 

The  direct  purpose  clauses,  Forms  5  to  53,  are  arranged  alpha- 
betically. 

Form  5.     Advertising 


To  carry  on  the  general  business  of  advertising  and  to  act  as  advertising  agents: 

(a)  To  undertake  and  carry  into  effect  contracts  with  individuals,  firms,  and 
corporations  for  advertising  and  publicity  in  all  its  varieties. 

(b)  To  deal  and  contract  for  advertisements  and  advertising  in  papers,  periodi- 
cals and  by  mail,  signs,  bill-boards,  and  posters  in  all  forms  and  in  all  places. 

(c)  To  print,  publish,  and  circulate  all  forms  of  advertising  and  publicity 
material. 

(d)  To  print,  publish,  and  deal  in  all  kinds  of  papers,  publications,  and  articles 
or  things  useful  to  or  in  connection  with  advertising  and  publicity. 


144? 


CK  2l  SPECIAL  CHARTER  CLAUSES  1443 

Form  6.    Amusement  Devices 

(a)  To  make,  install,  and  operate  certain  devices,  mechanisms,  and  apparatus 
for  amusement,  recreation,  entertainment,  and  exhibition,  invented  or  devised  by- 
Ward  L.  Donaldson. 

(b)  To  make,  lease,  purchase,  and  otherwise  acquire,  and  to  use,  operate, 
sell,  and  license  to  use,  all  manner  of  devices,  apparatus,  and  constructions  for  the 
purpose  of  amusement,  recreation,  entertainment,  and  exhibition. 

(c)  lb  purchase,  lease,  exchange,  and  otherwise  acquire  any  and  all  rights, 
permits,  privileges,  franchises,  and  concessions  suitable  or  convenient  for  the 
purposes  of  the  Company. 

Form  7.     Automobiles 

To  assemble,  manufacture,  sell,  and  deal  in,  and  to  import  and  export,  motor 
cars,  automobiles,  and  motor  vehicles  of  all  kinds  and  descriptions  whatsoever,  and 
to  carry  on  any  trade  or  business  incidental  thereto  or  connected  therewith. 

To  manufacture,  buy,  sell,  and  deal  in  all  kinds  of  motors,  engines,' mechanisms, 
and  devices  operated  by  steam,  electricity,  internal  combustion,  and  other  forces 
or  applications  of  power. 

Form  8.    Automobiles  and  Garage 

To  manufacture,  deal  in,  sell,  operate,  and  let  for  hire  automobiles,  motor 
cycles,  and  motor  vehicles  and  supplies  and  fittings  therefor  of  every  kind,  nature, 
and  description. 

To  erect,  lease,  or  otherwise  acquire,  and  to  maintain  and  operate,  a  garage  or 
garages  for  the  storing,  caring  for,  and  repairing  of  automobiles  and  motor  vehicles 
of  every  kind,  nature,  and  description. 

To  make  and  sell  parts,  supplies,  batteries,  and  accessories  useful  with  and  in 
connection  with  the  use  of  motor  cars  and  vehicles;  to  store,  clean,  and  repair 
automobiles  and  motor  vehicles,  and  to  replace  their  parts,  and  to  do  all  other 
things  incidental  to  the  business  of  conducting  a  garage  and  repair  shop,  or  profit- 
able in  connection  therewith. 


Form  9.    Bonds  and  Securities 


(a)  To  buy,  sell,  exchange,  pledge,  mortgage,  and  generally  deal  in  and  with 
government,  municipal,  and  industrial  bonds,  stocks,  and  other  securities,  and  in 
and  with  bonds  and  mortgages  or  other  evidences  of  indebtedness  or  ownership  of 
•any  individual,  firm,  or  corporation,  and  in  and  with  stocks,  debentures,  trust 
receipts,  and  other  securities  of  corporations,  both  domestic  and  foreign;  and  while 
the  owner  thereof  to  exercise  the  rights  and  privileges  of  ownership,  including  the 
right  to  vote  thereon,  and  to  issue  in  exchange  therefor  its  own  stock,  bonds,  and  other 
obligations,  and  generally  to  carry  on  the  business  of  stock  and  bond  brokers;  but 
nothing  herein  shall  be  construed  as  an  attempt  to  secure  powers  not  properly 
obtainable  by  corporations  organized  under  the  Business  Corporation  Law  of  the 
State  of  New  YorL 


1444  CORPORATE  FORMS  [Bk.  IV- 

(b)  To  deposit  in  trust  with  any  person,  firm,  or  corporation  or  corporations, 
any  or  all  of  said  bonds,  stocks,  or  other  securities,  and  issue  against  such  securities 
collateral  trust  gold  notes  in  any  denomination  that  may  be  deemed  desirable  by 
the  directors  of  the  company. 

(c)  To  buy,  sell,  rent,  lease,  or  otherwise  acquire,  to  hold,  own,  use,  improve, 
mortgage,  sell,  exchange,  lease,  or  otherwise  dispose  of  real  property,  improved  or 
unimproved. 

(d)  To  register  and  certify,  or  to  guarantee,  the  genuineness  or  authenticity 
of,  or  the  payment  of  the  principal  or  interest  of  any  bonds,  notes  or  debentures 
of  any  person,  firm,  corporation,  or  association  so  far  as  the  same  may  be  permitted 
by  corporations  organized  under  the  act  under  which  this  company  is  incorporated. 

(e)  To  borrow  money  with  or  without  pledge  of  or  mortgage  on  all  or  any  of 
its  property,  real  or  personal,  as  security,  and  to  loan  and  advance  money  upon 
mortgages  on  personal  and  real  property  or  on  either  of  them. 

(See  also  Form  51) 

Form  10.    Brick  Machinery 

(a)  To  secure  for  the  State  of  New  York  rights  to  manufacture,  use,  operate^ 
sell,  lease,  and  otherwise  dispose  of  the  brick-pressing  mechanism  and  machinery 
invented  and  patented  by  James  D.  Warner. 

(b)  To  make,  manufacture,  buy,  sell,  and  generally  to  deal  in  and  with  brick, 
tile,  and  all  other  sand,  lime,  clay,  cement,  earthen,  mineral,  and  composition 
wares,  materials,  and  manufactures. 

(c)  To  purchase,  lease,  or  otherwise  acquire  lands,  kilns,  depots,  buildings, 
warehouses,  factories,  rights,  inventions,  machinery,  and  plants  in  the  State  of 
New  York  and  elsewhere,  for  the  purpose  of  conducting  and  carrying  on  such 
manufactures  and  business. 

(d)  To  erect  or  have  erected,  to  construct  or  have  constructed,  houses,  works, 
buildings,  storerooms,  tenements,  edifices,  and  structures  of  every  description,  and 
to  rebuild,  enlarge,  improve  and  alter  existing  houses,  works,  buildings,  storerooms, 
tenements,  edifices,  and  structures  of  every  description. 

(e)  To  buy,  sell,  exchange,  dig,  mine,  excavate,  prepare,  manufacture,  and 
generally  to  deal  in  and  with  all  raw  and  manufactured  substances,  minerals,  and 
materials,  necessary  or  convenient  for  the  uses,  manufactures,  and  operations  of 
the  corporation,  and  to  sell,  exchange,  and  otherwise  dispose  of  and  turn  to  account 

•  all  products  and  manufactures  resulting  from  the  same. 


Form  II.    Building  Materials 

(a)  To  manufacture,  buy,  sell,  and  generally  to  deal  in  and  with  cement, 
lime,  plaster,  and  artificial  stone;  and  to  erect  or  purchase  or  lease  kilns,  store 
houses,  factories,  warehouses,  and  other  structures  necessary  for  the  conduct  of 
said  business,  and  for  the  manufacture  and  storing  of  such  materials  and  for  other 
structural  materials,  supplies,  and  the  implements  and  tools  useful  in  connection 
therewith. 

(b)  To  acquire,  own,  hold,  lease,  maintain,  establish,  and  operate  quarries, 
brickyards,  lime-kilns,  cement  and  plaster  mills,  and  furnaces,  factories,  and  estab- 
lishments for  the  manufacture,  preparation,  production,  and  adaption  of  all  kinds 


Ch.  2]  SPECIAL  CHARTER  CLAUSES  1445 

of  structural  material  and  supplies,  and  for  the  manufacture  and  repair  of  any  and 
all  machinery,  tools,  implements,  vehicles,  elevators,  apparatus,  and  appliances 
used  in  or  necessary  in  the  prosecution  of  the  said  work,  business,  and  undertaking 
of  the  corporation. 


Form  12.     Cloaks  and  Garments  ' '' 

'  (a)  To  manufacture  cloaks,  kimonos,  dressing  sacques,  negligees,  gowns, 
robes,  waists,  skirts,  and  all  kinds  of  garments  and  wearing  apparel  for  men, 
women,  and  children. 

(b)  To  conduct  and  carry  on  the  business  of  cutting  out,  making,  and  prepar- 
ing clothing  and  wearing  apparel  of  all  kinds,  and  of  all  other  articles  which  may  be 
conveniently  or  advantageously  handled  in  connection  with  the  aforesaid  business. 

(c)  To  buy,  sell,  import,  export,  and  deal  in  and  with  woolen,  cotton,  sillc, 
and  other  textile  fabrics,  and  in  any  and  all  other  materials  useful  or  necessary  in 
the  manufacture  of  clothing  and  wearing  apparel. 


Form  13.     Contracting  and  Building 

iU..— — - - — - - 

(a)  To  make,  enter  into,  perform,  and  carry  out  contracts  for  building,  erect- 
ing, improving,  constructing,  altering,  repairing,  decorating,  finishing  and  furnish- 
ing houses,  buildings,  warehouses,  storerooms,  edifices,  works,  tenements,  and 
structures  of  every  kind  and  description;  to  carry  on  in  all  their  respective  branches 
the  business  of  builders,  contractors,  decorators,  and  such  other  trades  and  busi- 
nesses as  pertain  to  or  are  connected  with  the  general  business  of  building  and 
construction. 

(b)  To  take  over,  acquire,  purchase,  own,  sell,  lease,  hire,  hold,  control, 
manage,  maintain,  and  operate  quarries,  brickyards,  lime-kilns,  refineries,  asphalt, 
cement  and  plaster  mills,  lumber  yards,  timber  lands,  saw  mills,  glass,  metal  and 
woodworking  plants,  pulp  and  paper  mills,  furnaces,  factories,  and  establishments 
for  the  manufacture,  preparation,  and  production  of  building  supplies,  material, 
furnishings,  decorations,  and  furniture;  and  to  buy,  sell,  and  generally  deal  in  and 
with  all  such  articles  and  materials. 

(c)  To  act  as  agents,  factors,  brokers,  commission  merchants,  carriers,  con- 
tractors, builders,  architects,  decorators,  surveyors,  engineers,  appraisers,  lessees, 
managers  of  estate,  or  otherwise  in  entering  into,  undertaking,  performing,  and 
carrying  out  and  conducting  any  and  all  things  set  forth  in  this  certificate  as  objects, 
purposes,  or  powers  that  it  may  do  for  itself;  and  to  exercise  its  powers  to  the  same 
extent  that  natural  persons  might  do,  and  in  any  part  of  the  world  to  the  full  extent 
permitted  to  corporations  organized  under  the  Business  Corporations  Law  of  the 
State  of  New  York. 


Form  14.    Cotton  and  Textile  Fabrics 

(a)  To'carry  on  the  business  of  buying,  selling,  storing,  ginning,  baling,  com- 
pressing, shipping,  and  otherwise  dealing  in  and  with  cotton  of  all  kinds;  and  of 
making,  producing,  refining,  adapting,  preparing,  buying,  selling,  storing,  and 
otherwise  dealing  in  and  with  cotton-seed  oils  and  other  oils;  and  of  buying,  selling 
storing,  and  otherwise  dealing  in  and  with  cotton-seed;  and  in  making,  adapting, 

W  10  i'.VO'y^JiiltlU/hD   'li:>  II-    vt.ui    iiJlii" 


1446  '■'''  'CORPORATE  FORMS  [Bk.  IV- 

preparing,  bu3nng,  selling,  storing,  and  otherwise  dealing  in  and  with  all  products 
and  by-products  of  cotton  and  cotton-seed,  and  in  utilizing  the  same  to  the  profit 
and  advantage  of  the  corporation. 

(b)  To  grow,  purchase,  deal  in  and  with,  manufacture,  prepare  for  market, 
and  market,  cotton,  flax,  hemp,  wool,  silk,  and  other  fibrous  materials  of  all  kinds; 
to  manufacture,  deal  in  and  with  all  the  products  and  by-products  of  said  materials 
and  all  articles  or  products  or  by-products  consisting  in  part  of  such  materials,  or 
any  products  or  by-products  thereof;  to  bleach,  dye,  print,  and  otherwise  manipu- 
late and  treat  in  such  manner  as  may  be  desired,  and  spin,  comb,  weave,  and  pre- 
pare for  market,  either  wholly  or  in  part,  and  market  and  deal  in  any  of  such 
materials,  products,  by-products  or  articles;  and  to  do  all  things  and  engage  in 
any  and  all  kinds  of  business  and  in  all  parts  of  the  world  which  in  the  opinion  of 
the  corporation  may  be  necessary,  ancillary,  incidental,  profitable,  or  proper  to 
or  in  connection  with  said  business  or  any  portion  thereof. 

(c)  To  buy,  sell,  manufacture,  operate,  and  generally  deal  in  and  with  any 
and  all  devices,  machinery,  and  apparatus  for  ginning,  baling,  compressing,  pre- 
paring, or  otherwise  manufacturing  or  treating  cotton,  flax,  hemp,  wool,  silk,  and 
other  fibrous  or  other  materials;  and  to  do  all  business  connected  with  and  collateral 
thereto,  including  the  selling,  shipping,  and  warehousing  of  the  products. 

(d)  To  erect,  construct,  and  equip  cotton  storage  warehouses  and  general 
warehouses,  and  to  purchase  and  lease  the  same,  or  rights  to  or  interests  therein, 
and  to  conduct  the  business  of  storage  and  warehousing,  and  all  the  business  neces- 
sarily or  impliedly  incidental  thereto  or  profitable  in  connection  therewith,  and 
to  further  carry  on  the  business  of  general  warehousing  in  all  its  several  branches; 
to  construct,  purchase,  or  otherwise  acquire,  and  to  operate  and  maintain,  all  or 
any  means  of  conveyance  for  the  transportation  by  land  or  by  water  of  any  and  all 
products,  goods,  or  manufactured  articles  of  the  corporation;  to  issue  negotiable 
certificates,  debentures,  warrants,  and  other  evidences  of  indebtedness  upon  com- 
modities stored  in  the  corporation's  warehouses  and  to  persons  warehousing  goods 
with  the  corporation;  and  to  make  advances  or  loans  of  its  own  funds  or  as  the 
agent  for  others  upon  the  security  of  such  goods  or  otherwise;  to  manufacture,  sell, 
and  trade  in  all  materials,  apparatus,  and  appliances  usually  dealt  in  by  ware- 
housemen; and  generally  to  carry  on  and  undertake  any  business  undertaking, 
transaction,  or  operation  commonly  carried  on  or  undertaken  by  warehousemen,  or 
any  business  which  may,  in  the  opinion  of  the  corporation,  be  necessary,  ancillary, 
incidental,  profitable,  or  proper  to  or  in  the  carrying  on  of  said  business  or  any  part 
thereof,  without  any  restrictions  whatsoever. 

(See  also  Form  53.) 

Form  15.    Dairy  and  Farm  Products 

(a)  To  buy,  sell,  and  generally  deal  in  and  with  milk;  to  condense,  preserve 
and  evaporate  the  same,  and  to  manufacture  butter,  cheese,  and  other  milk  prod- 
ucts; to  sell  and  handle  fresh  milk,  eggs,  butter,  and  all  kinds  of  farm  and  dairy 
products;  and  to  deal  generally  in  and  with  food  products  of  every  kind  and  de- 
scription, including  cereals  and  cereal  products,  meats,  fish,  vegetables,  fruit  of 
all  kinds  or  preserved  goods,  and  all  kinds  and  descriptions  of  food  preparations. 

(b)  To  lease,  build,  purchase,  or  otherwise  acquire  storehouses,  packing  houses, 
and  canning  factories  for  handling  and  storing  milk,  butter,  cheese,  eggs,  vegetables, 
poultry,  and  all  other  food,  farm  and  dairy  products,  and  to  sell  or  otherwise  dis- 
pose of  the  product  of  such  packing  houses  and  factories. 

(c)  To  conduct  and  carry  on  any  other  business,  manufacturing  or  otherwise, 
which  may  seem  advantageous  or  useful  in  connection  with  the  general  business 


Ch.  2]  SPECIAL  CHARTER  CLAUSES  I447 

of  the  Company,  and  to  manufacture,  market,  or  prepare  for  market,  any  goods  or 
commodities  which  the  Company  may  use  in  connection  with  its  business. 

(d)  To  protect  the  products  of  the  company  by  trade-marks,  trade-names,  or 
any  distinguishing  name  or  title,  and  to  acquire  and  take  over  any  trade-marks, 
patent  rights,  processes,  formulae,  and  apparatus  useful  or  convenient  in  the 
conduct  of  the  said  business  of  the  corporation. 


Form  16.    Department  Store 

(a)  To  establish,  conduct,  and  carry  on  the  general  business  of  a  department 
store  and  mail  order  business;  and  in  connection  therewith  to  carry  on  all  or  any 
of  the  trades  and  businesses  of  dry-goods  merchants,  cloth  manufacturers,  furriers, 
haberdashers,  hosiers,  milliners,  dress-makers,  cloak-makers,  mantua-makers, 
tailors,  hatters,  clothiers,  furnishers,  outfitters,  glovers,  lace  manufacturers,  feather- 
dressers,  boot  and  shoemakers,  saddlers,  harness-makers,  cabinet-makers,  uphol- 
sterers, jewelers,  gold  and  silversmiths,  watch  and  clock-makers,  booksellers, 
restaurant  keepers,  tobacconists,  cigar  makers,  confectioners,  barbers,  hair- 
dressers, photographers,  printers,  publishers,  engravers,  stationers,  decorators, 
chemists,  druggists. 

(b)  Generally  to  buy,  sell,  import,  export,  manufacture,  and  deal  in  and  with 
textile  fabrics,  leather  goods,  household  and  ofl&ce  furniture,  ironmongery,  hard- 
ware, tools,  implements,  machinerj-,  china,  glassware,  crockery,  pottery  and 
utensils,  notions,  fancy  goods,  soaps,  perfumery,  drugs,  medicines,  chemicals  and 
toilet  articles,  precious  stones,  jewelr>-,  ornaments,  watches,  clocks,  plated  goods, 
foods,  groceries,  meats,  fish,  vegetables,  fruits,  provisions,  supplies,  dairy  products, 
candies,  confections,  books,  periodicals,  pictures,  works  of  art,  bicycles,  motor 
cycles,  automobiles,  motor  boats,  sporting  goods,  photographic  supplies,  domestic, 
trained  and  fancy  animals  and  birds,  and  all  kinds  and  descriptions  of  goods,  wares, 
and  commodities. 

(c)  To  advertise  by  all  legitimate  methods;  to  carry  on  the  business  of  print- 
ing, publishing,  engraving,  bookbinding,  designing,  and  producing  and  reproducing 
printing,  writing,  drawing,  and  impressions  of  all  kinds;  to  buy,  sell,  manufacture, 
and  deal  generally  in  and  with  paper,  envelopes,  books,  periodicals,  magazines  and 
advertising,  printed  and  duplicated  materials  of  all  kinds,  and  with  all  supplies, 
stationery,  and  materials  useful  in  connection  with  the  business  of  advertising, 
printing,  and  publishing. 

(d)  To  apply  for,  obtain,  purchase,  lease,  or  otherwise  acquire,  and  to  register, 
hold,  own,  use,  operate,  and  manufacture  under,  and  to  sell,  assign,  grant  licenses 
in  respect  of,  or  otherwise  dispose  of  and  turn  to  account  and  profit,  any  and  all 
trade-marks,  improvements,  processes,  formulae,  trade  secrets,  rights,  franchises, 
licenses,  inventions,  contrivances,  devices,  appliances,  brands,  labels,  patterns, 
and  models,  whether  secured  under  letters  patent  in  the  United  States  or  in  any 
foreign  country,  or  otherwise  or  in  any  other  manner. 

- ~ " tn-ynrtsTT 

Form  17.    Drugs 


linj;    t mill 


(a)  To  prepare,  compound,  manufacture,  buy,  sell,  import,  export,  and  gen- 
erally deal  in  and  with  drugs,  medicines,  chemicals,  periumeries,  soaps,  toilet 
articles,  druggists'  sundries,  wines,  liquors,  mineral  and  soda  waters,  proprietary 
articles,  electrical  and  surgical  apparatus,  physicians'  and  hospital  supplies,  and  all 
kinds  of  pharmaceutical,  chemical,  ahd  medicinal  preparations,  compounds,  and 
materials. 


1448  CORPORATE  FORMS  [Bk.  IV- 

(b)  To  conduct  and  carry  on  in  all  its  branches  the  business  of  chemists, 
druggists,  and  manufacturers  and  dealers  in  medical,  chemical,  pharmaceutical 
and  other  compounds,  preparations,  and  materials,  and  in  all  supplies,  mechanisms, 
apparatus,  and  implements  used  in  such  business  or  in  connection  therewith. 

(c)  To  prepare,  manufacture,  and  sell  the  facial  preparation  known  as  "Rose 
Cr6me,"  and  generally  to  buy,  sell,  manufacture,  prepare,  and  deal  in  and  with 
fine  perfumeries,  toilet  preparations,  and  all  such  drugs,  unguents,  chemicals,  and 
other  materials  as  may  be  used  or  handled  in  connection  therewith. 

(d)  To  buy,  sell,  combine,  prepare,  manufacture,  and  generally  to  deal  in 
and  with  all  manner  of  chemicals,  chemical  products,  drugs,  and  compounds  and 
preparations  thereof;    and  to  patent,  register,  or  otherwise  protect  the  same. 


Form  18.    Dry-Goods 

To  buy,  sell,  import,  export,  and  to  deal  generally  in  and  with  all  kinds  of 
textile  goods,  wares  and  merchandise;  and  to  prepare,  manufacture  and  deal  in 
all  kinds  of  dry-goods,  cloths,  and  textile  fabrics  and  garments  and  other  manu- 
factures of  the  same;  and  to  conduct  and  carry  on  the  general  wholesale  and  retail 
dry -goods  and  white  goods  business  in  all  its  branches;  and  to  conduct  and  carry 
on  any  form  of  manufacturing  or  mercantile  enterprise  necessary  or  incidental  to 
the  general  busines  of  the  Company. 

(This  may  be  added  to  as  desired  from  Form  16.) 

Form  19.     Electrical  Supply  Company 

(a)  To  manufacture,  prepare,  construct,  erect,  install,  and  build  electrical 
devices,  motors,  dynamos,  batteries,  meters,  supplies,  apparatus,  machinery, 
improvements,  appliances,  and  plants  of  all  descriptions;  and  to  buy,  sell,  import, 
export,  and  generally  deal  in  and  with  the  same,  and  all  tools,  stock,  supplies,  and 
material  useful  in  connection  therewith. 

(b)  To  carry  on  the  business  of  electrical  and  mechanical  engineers;  to  design, 
construct,  enlarge,  repair,  improve,  and  manufacture  all  kinds  of  plants,  engines, 
and  machines;  generally  to  work  and  operate  as  tool-makers,  brass  founders,  metal 
workers,  millwrights,  machinists,  iron  and  steel  converters,  smiths,  builders,  metal- 
lurgists; to  buy,  sell,  repair,  manufacture,  and  deal  in  machinery,  implements, 
rolling  stock,  and  hardware  of  all  kinds;  and  to  build,  construct,  and  repair  rail- 
roads, water,  gas,  and  electric  works,  bridges,  viaducts,  piers,  and  works  and 
structures  of  all  kinds. 


Form  20.    Engineering — Mechanical 

(a)  To  conduct  and  carry  on  the  business  of  mechanical  engineers,  and  to 
design  and  construct  plants,  engines,  machines,  tools,  and  apparatus  of  all  kinds. 

(b)  To  manufacture,  buy,  sell,  and  generally  deal  in  tools,  implements,  and 
machinery  and  hardware  of  all  kinds. 

(c)  To  operate  and  do  business  as  tool-makers,  brass  founders,  metal-workers, 
millwrights,  machinists,  smiths,  builders,  and  mechanical  engineers. 


(Add  to  as  desired  from  Forms  29,  30,  36  and  38.) 


Ch.  2]  SPECIAL  CHARTER  CLAUSES  1449 

Form  21.     Express  and  Delivery  ; 

(a)  To  collect,  receive,  distribute,  and  deliver  goods,  merchandise,  parcels, 
packages,  baggage,  and  express  matter,  and  to  do  a  general  cartage  and  delivery 
business  in  the  City  of  Greater  New  York  and  elsewhere;  to  contract  with  express 
or  railroad  or  other  companies  for  the  collection,  transportation,  or  distribution  of 
goods,  merchandise,  freight  and  express  matter  in  said  city  and  elsewhere,  and  to 
perform  all  such  contracts. 

(b)  To  buy,  sell,  manufacture,  and  otherwise  acquire,  and  to  use,  repair, 
store,  operate,  lease,  let  out,  and  otherwise  employ  and  utilize  cars,  trucks,  wagons 
and  other  vehicles  and  conveyances  designed  for  the  carriage  and  transportation 
of  goods,  freight,  and  merchandise  of  all  kinds. 

(c)  To  do  a  general  trucking  and  expressing  business;  to  receive,  handle,  ship, 
forward,  and  transport  goods,  wares,  merchandise,  and  freight  of  all  kinds. 

Form  22.     Films  and  Motion  Pictures 


•'  (a)  To  make,  design,  prepare,  stage,  and  arrange  for  all  manner  of  plays, 
dramas,  and  exhibitions,  suitable  for  reproduction  as  photo-plays,  motion  pictures, 
or  film  reproductions  of  any  kind. 

(b)  To  make,  prepare,  deal  in,  and  lease  or  sell  photo-plays  and  motion  picture' 
films,  and  to  prepare  and  take  pictures,  photographs,  plates,  and  films,  and  to  deal 
in,  lease,  or  sell  the  same. 

(c)  To  purchase,  secure  on  royalty,  or  otherwise  acquire,  scenarios,  plans  for 
photo-plays,  manuscripts  for  plays,  and  representations,  and  to  employ  actors,  and 
other  persons  skilled  in  staging  and  reproducing  such  photo-plays  and  motion 
pictures,  and  to  do  all  things  necessary  or  convenient  in  taking,  making,  develop- 
ing, and  exhibiting  photo-plays  and  moving  pictures  and  film  representations. 

(d)  To  make,  buy,  lease,  or  otherwise  acquire  all  kinds  of  photographic  and 
moving  picture  devices,  cameras,  apparatus,  and  machinery,  and  to  own,  main- 
tain, and  operate  the  same,  and  to  conduct  and  carry  on  the  business  of  making, 
selling,  and  leasing  films  for  all  kinds  of  photo-plays  and  moving  pictures. 

(e)  To  buy,  sell,  lease,  and  operate  halls,  theaters,  opera  houses,  and  all  lo- 
cations and  edifices  suitable  for  the  exhibition  of  motion  pictures  and  photo-plays, 
and  in  all  such  halls,  rooms,  and  spaces  to  use  and  operate  and  conduct  exhibitions 
of  moving  pictures,  or  to  give  concerts,  plays,  exhibitions,  and  other  public  enter- 
tainments of  all  kinds. 


Form  23.     Furniture 

(a)  To  manufacture,  buy,  sell,  export,  import,  exchange,  and  generally  deal 
in  and  with  all  kinds  of  house,  store,  office,  and  other  furniture,  carpets,  curtains, 
fixtures,  and  furnishing  goods. 

(b)  To  engage  generally  in  the  business  of  furnishing,  decorating,  improving, 
and  altering  rooms,  houses,  stores,  offices,  and  all  kinds  of  halls,  buildings,  and 
apartments. 

(c)  To  purchase,  lease,  or  otherwise  acquire  and  hold  lands,  buildings,  tene- 
ments, and  factories  for  the  offices,  workshops,  and  storerooms  of  the  Company, 
and  to  lease,  mortgage,  and  convey  such  real  estate  in  such  manner  as  may  appear 
for  the  best  interests  of  the  Company. 


I450  CORPORATE  FORMS  [Bk.  IV- 

Form  24.     Gas  and  Electric  Fixtures 

(a)  To  manufacture,  buy,  sell,  import,  export,  and  generally  deal  in  and  with 
gas  and  electrical  fixtures,  lamps,  lamp  shades,  globes,  pendants,  chandeliers, 
lambrequins,  and  gas  and  electrical  attachments  of  all  kinds. 

(b)  To  buy,  sell,  import,  export,  prepare,  and  utilize  glass,  wood,  metal, 
cloths,  silks,  leathers,  and  other  materials  for  the  manufacture  of  such  gas,  lamp, 
and  electrical  fixtures,  and  to  do  all  things  necessary  or  convenient  in  connection 
with  such  utilization. 

(This  may  be  added  to  from  Forms  26  and  3$.) 

Form  25.    Hardware 

(a)  To  buy,  sell,  import,  export,  and  generally  deal  in  and  with  all  kinds  of 
tools,  hardware,  and  machinery;  to  establish,  maintain,  and  operate  shops  and 
factories  for  the  manufacture  and  construction  of  all  kinds  of  tools,  hardware, 
machines,  and  mechanical  construction. 

(b)  To  buy,  sell,  and  generally  to  deal  in  iron,  steel,  manganese,  copper, 
zinc,  brass,  and  other  metals,  and  in  any  and  all  articles  made  of  or  partly  con- 
sisting of  metal,  wood,  and  other  materials,  and  to  engage  in  the  repair  and  manu- 
facture of  all  goods,  wares,  and  commodities  dealt  in  by  the  corporation. 


Form  26.    Heating  Apparatus 

(a)  To  manufacture  gas,  oil,  and  electric  stoves,  heating  apparatus,  cooking 
apparatus,  lighting  apparatus,  and  all  devices  for  the  utilization  of  gas,  oil,  and 
electricity  and  other  agencies  for  cooking,  lighting,  and  heating,  together  with  all 
parts,  fixtures,  instruments,  mechanisms,  attachments,  and  machinery,  incident 
to,  or  appertaining  to,  or  to  be  used  in  connection  with  gas,  oil,  electricity,  or  other 
agencies  used  for  the  purposes  of  the  business  of  this  Company. 

(b)  To  apply  for,  obtain,  purchase,  or  otherwise  acquire,  and  to  register, 
patent,  or  otherwise  secure,  any  and  all  trade-marks,  inventions,  devices,  improve- 
ments, and  appliances,  patented  or  otherwise,  relating  to,  or  applicable  to,  the  use 
of  gas,  oil,  electricity,  or  other  agencies  for  cooking,  heating,  or  lighting,  or  capable 
of  being  used  in  connection  therewith;  to  own,  bold,  use,  operate,  manufacture 
under,  introduce,  sell,  assign,  or  otherwise  dispose  of  the  same;  and  to  do  all  other 
things  as  may  be  necessary  or  desirable  to^cquire,  use,  dispose  of,  and  turn  to 
account,  any  and  all  such  patents,  licenses,  trade-marks,  improvements,  devices, 
and  appliances. 

(c)  To  carry  on  the  trade  or  business  of  buying,  selling,  renting,  leasing, 
producing,  preparing,  adapting,  manufacturing,  and  othervnse  dealing  in  any  and 
all  kinds  of  gas,  oil,  and  electrical  devices,  fixtures,  mechanisms,  machines,  novel- 
ties, and  supplies,  and  hardware  of  all  kinds  and  descriptions,  and  of  all  materials, 
raw  and  manufactured,  useful  or  desirable  in  connection  with  or  relating  to  such 
trade  or  business;  and  to  carry  on  any  other  manufacturing  or  mercantile  business 
that  can  be  advantageously  conducted  in  connection  with  the  said  business. 


Ch.  2]  SPECIAL  CHARTER  CLAUSES  1455 

Form  27.     Hotel 

(a)  To  plan,  design,  and  construct  buildings  for  hotel  purposes  or  to  buy,  sell, 
and  acquire  the  same;  to  conduct  and  carry  on  such  hotel  or  hotels  for  the  accom- 
modation of  the  public;  and  to  rent  private  rooms,  suites,  and  all  accommodation 
necessary  for  that  purpose. 

(b)  To  conduct  and  carry  on  the  business  of  buying  and  selling  cigars  and 
tobacco,  of  providing  meals  and  food  for  the  general  public,  and  to  buy  all  things 
necessary  in  connection  therewith. 

(c)  To  purchase,  lease,  or  otherwise  acquire  lands,  buildings,  and  real  estate 
for  hotel  use;  and  to  lease,  mortgage,  and  convey  such  real  estate  in  such  manner 
as  may  appear  to  the  best  interests  of  the  corporation. 

Form  28.     Ice  Company 

(a)  To  manufacture,  buy,  sell,  store,  and  generally  deal  in  and  with  ice  and 
refrigerating  materials  and  supplies,  and  to  transact  all  legitimate  business  inci- 
dental thereto  or  in  anywise  connected  therewith. 

(b)  To  carry  on  the  business  of  refrigerating,  cold  storage,  and  general  ware- 
housing, and  all  the  business  necessarily  or  impliedly  incidental  thereto;  to  man- 
ufacture, sell,  and  trade  in  all  goods  usually  dealt  in  by  warehousemen;  to  con- 
struct, hire,  purchase,  operate,  and  maintain  all  or  any  conveyances  for  the  trans- 
portation in  cold  storage  or  otherwise  by  land  or  water  of  any  or  all  products,  goods, 
or  manufactured  articles;  and  to  do  all  things  incidental  to  the  business  of  cold 
storage  and  warehousing. 

(See  also  Form  49.) 

Form  29.    Inventions  and  Patents 

To  apply  for,  purchase,  or  otherwise  acquire,  and  to  hold,  own,  use,  operate, 
and  to  sell,  assign,  or  otherwise  to  dispose  of,  to  grant  licenses  in  respect  of  or 
otherwise  turn  to  account,  any  and  all  inventions,  improvements,  and  processes 
used  in  connection  with,  or  secured  under  letters  patent  of  the  United  States  or 
elsewhere,  or  otherwise;  and,  with  a  view  to  the  working  and  development  of  the 
same,  to  carry  on  any  business  whether  manufacturing  or  otherwise,  which  may 
be  calculated  directly  or  indirectly  to  effect  these  objects. 

Form  30.    Inventions  and  Patents 


To  acquire  the  United  States  rights  for  the  system  of  automatic  signals  devised 
by  Henry  H.  Hardy  of  South  Orange,  New  Jersey,  together  with  the  inventions, 
processes,  apparatus  and  devices  included  thereunder  or  connected  therewith; 
to  take  over  such  United  States  letters  patent  as  may  already  have  been  issued 
for  such  inventions  and  improvements  thereon;  to  procure  United  States  letters 
patent  for  such  other  inventions  and  improvements  as  are  not  already  so  pro- 
tected; to  hold  all  such  letters  patent,  and  to  operate  and  manufacture  thereunder 
or  to  grant  licenses  in  respect  thereof,  or  to  sell  and  assign  the  said  patents,  in 
whole  or  in  part;  or  to  dispose  otherwise  of  and  turn  to  account  any  or  all  of  the 


1452  CORPORATE  FORMS  [Bk.  IV^ 

same  in  such  manner  as  may  in  the  judgment  of  its  Board  of  Directors  be  for  the 
best  interests  of  the  Company. 


Form  31.     Jewelry 

(a)  To  manufacture,  buy,  sell,  import,  and  generally  deal  in  and  with  gold 
and  silverware,  watches,  jewelry,  precious  stones,  opera  glasses,  chains,  umbrellas, 
silver  and  plated  ware,  gold  and  silver  ornaments,  and  all  goods,  wares,  and  mer- 
chandise usually  dealt  in  by  watch  makers  and  jewelers. 

(b)  To  manufacture,  repair,  regulate,  and  put  in  order  watches,  clocks, 
jewelry,  and  gold  and  silver  ware  of  all  kinds;  and  to  plate,  polish,  and  perform  all 
operations  necessary  in  connection  with  the  handling  of  jewelers'  goods,  wares,  and 
supplies. 


Form  32.    Leather 

(a)  To  manufacture,  produce,  and  otherwise  prepare,  and  to  buy  and  other- 
wise acquire,  sell,  store,  transport,  distribute,  dispose  of,  and  deal  in  and  with  (i) 
leather,  lumber,  belting,  and  any  and  all  other  merchandise  and  "commodities  of 
whatsoever  nature  and  character;  and  (2)  any  and  all  materials,  machinery, 
appliances,  products,  and  supplies  proper  or  adapted  to  be  used  in  or  in  connection 
with  or  incidental  to  the  manufacture,  production,  or  preparation  of  any  of  the 
articles,  merchandise,  and  corrmiodities  aforesaid;  and  also  (3)  any  and  all  com- 
modities and  things  which  result  from  or  are  by-products  of  the  manufacture, 
production,  or  preparation  of  leather,  lumber,  belting,  or  other  merchandise  or 
articles,  or  in  the  manufacture,  production,  or  preparation  of  which  any  of  the 
said  articles  may  be  a  factor  or  an  ingredient,  or  of  which  the  same  may  be  a  com- 
pxjnent  part. 

(b)  To  engage  in  any  other  manufacturing,  warehousing,  trading,  or  selling 
business  of  any  kind  or  character  whatsoever. 

(c)  To  acquire,  dispose  of,  lease,  and  utilize,  in  the  manner  and  to  the  extent 
permitted  by  law,  lands,  timber,  bark,  tanneries,  mills,  warehouses,  plants,  and 
other  buildings  and  structures,  machinery,  supplies,  and  any  and  all  articles  and 
property,  including  good-will,  which  the  corporation  may  deem  to  be  necessary  or 
convenient  to  the  attainment  or  furtherance  of  any  of  its  objects. 


Form  33.    Lighting  and  Heating 

(a)  To  manufacture,  buy,  sell,  and  lease  gas,  oil,  and  electric  devices,  mechan- 
isms, and  apparatus,  for  the  production  of  light,  heat,  and  power,  and  of  all  such 
piping,  conductors,  and  accessories  as  are  usual  in  connection  therewith. 

(b)  To  manufacture,  buy,  sell,  and  deal  in  all  kinds  of  goods,  wares,  tools, 
fixtures,  and  appliances  that  may  be  useful  in  the  production  or  utilization  of  light, 
heat,  and  power  from  any  source. 

(c)  To  construct,  equip,  and  install  engines,  power  plants,  machines,  appara- 
tus, and  appliances  for  the  manufacture,  production,  generation,  and  supplying  of 
gas,  light,  heat,  power,  electricity,  or  other  motive  power;  and  to  maintain,  repair, 
improve,  control,  and  operate  the  same. 


Ch.  2]  SPECIAL  CHARTER  CLAUSES  1453 

Form  34.    Locks 

(a)  To  acquire  the  inventions  and  improvements  of  Owen  T.  Hartwell  relating 
to  locks  and  locking  devices;  to  manufacture  under  the  same;  and  to  sell  and  dis- 
pose of  the  locks  and  devices  so  manufactured. 

(b)  To  manufacture,  buy,  sell,  import,  export,  and  generally  deal  in  and  with 
locks,  fastenings,  and  attachments  used  in  connection  therewith. 

(c)  To  apply  for,  obtain,  purchase,  or  otherwise  acquire,  and  to  register,  hold, 
own,  and  sell  or  otherwise  dispose  of,  trade-marks,  improvements,  inventions, 
processes,  formulae,  trade  secrets,  and  apparatus  of  all  kinds,  whether  secured 
under  letters  patent  of  the  United  States  or  any  foreign  country,  or  in  any  other 
manner. 


Form  35.    Lumber 

(a)  To  purchase  or  otherwise  acquire,  and  to  hold,  lease,  and  sell  timber, 
mineral,  and  other  lands  and  the  products  thereof;  to  build,  construct,  and  operate 
shops,  sawmills,  and  factories  for  the  handling  of  all  timber  and  lumber  and  for 
planing,  dressing,  and  preparing  the  various  products  of  such  lands  for  market; 
to  buy,  sell,  import,  export,  and  generally  deal  and  trade  in  wood,  lumber,  logs, 
and  timber  and  brick,  stone,  lime,  and  other  building  materials. 

(b)  To  conduct  and  transact  its  said  business  in  any  of  the  states,  territories, 
colonies,  or  dependencies  of  the  United  States,  and  in  any  and  all  foreign  countries, 
to  have  one  or  more  offices  therein,  and  therein  to  conduct  its  said  business* 


Form  36.    Manufacturing  (General) 

(a)  To  design,  manufacture,  construct,  repair,  and  to  buy,  sell,  and  deal  in 
all  tools,  parts,  machines,  mechanisms,  apparatus,  and  all  goods,  articles,  and 
commodities,  dealt  in  or  sold  by  retailers,  wholesalers,  and  exporters  in  the  United 
States  of  America  and  its  territories  or  colonies. 

(b)  To  purchase,  lease,  or  otherwise  acquire  lands  and  buildings  suitable  for 
its  purposes,  and  to  erect,  build,  and  maintain  all  such  plants,  buildings,  and  ware- 
houses, engines  and  machinery,  and  offices  as  it  may  require  to  manufacture,  store, 
and  sell  its  wares  and  commodities. 

(c)  To  purchase  or  otherwise  acquire  such  patents,  licenses,  patent  rights, 
processes,  and  improvements,  and  to  operate  under,  or  sell,  lease,  and  grant 
licenses  in  respect  of,  as  may  from  time  to  time  be  for  the  best  interests  of  the 
corporation. 


Form  37.    Meat  and  Cattle 

(a)  To  buy,  sell,  import,  export,  and  deal  in  and  with  meat,  live  cattle,  pigs, 
and  sheep  at  wholesale  or  retail,  in  the  United  States  or  elsewhere,  and  to  carry  on 
the  said  trade  or  business  of  dealing  in  meats  and  meat  products  in  all  its  branches; 
to  erect  and  build  abattoirs,  cold  storage  warehouses,  sheds,  slaughter  houses, 
packing  houses,  and  other  structures  necessary  or  convenient  for  the  purposes  of 
the  company. 


1454  CORPORATE  FORMS  [Bk.  IV- 

(b)  To  slaughter  cattle,  pigs,  and  sheep;  to  preserve  meat  and  products  there- 
of; to  buy,  sell,  and  generally  deal  in  hides,  fats,  tallow,  grease,  and  animal  products. 


Form  38.    Metal-Working 

(a)  To  work  and  operate  as  welders,  tool-makers,  brass  founders,  metal- 
workers, machinists,  smiths,  model-makers,  and  metallurgists. 

(b)  To  design,  construct,  enlarge,  repair,  improve,  and  manufacture  all  kinds 
of  tools,  parts,  motors,  machines,  engines,  devices,  mechanisms,  and  inventions. 

(c)  To  buy,  sell,  lease,  alter,  repair,  store,  use,  operate,  manufacture,  and  deal 
in  and  with  tools,  motors,  engines,  machines,  dynamos,  appliances,  and  apparatus 
relating  to  or  useful  in  connection  with  motor  vehicles  or  motor  machinery. 


Form  39.     Mining 


(a)  To  buy,  lease,  or  otherwise  acquire  mines,  mining  rights,  quarries,  and 
mineral  lands  of  every  kind,  nature,  and  description,  and  to  work,  mine,  prospect, 
develop,  operate,  and  promote  the  same;  to  mine,  quarry,  and  excavate  copper, 
gold,  silver,  and  other  ores  and  metals  and  minerals  of  all  descriptions. 

(b)  To  buy  and  sell,  or  otherwise  deal  with  or  to  traffic  in  iron,  steel,  man- 
ganese, copper,  and  other  metals,  and  cement,  wood,  lumber,  and  other  materials, 
and  any  products  thereof,  and  any  articles  consisting  or  partly  consisting  thereof. 

(cj  To  engage  in  any  other  manufacturing,  mining,  construction,  or  trans- 
portation business  of  any  kind  or  character  whatsoever,  and  to  that  end  to  acquire, 
hold,  own,  and  dispose  of  any  and  all  property,  assets,  stocks,  bonds,  and  rights 
of  any  and  every  kind;  but  not  to  engage  in  any  business  hereunder  which  shall 
require  the  exercise  of  the  right  of  eminent  domain  within  the  State  of  New  Jersey. 

(d)  To  acquire  by  purchase,  subscription,  or  otherwise,  and  to  hold  or  to 
dispose  of  stocks,  bonds,  or  any  other  obligations  of  any  corporation  formed  for,  or 
then  engaged  in  or  pursuing,  any  one  or  more  of  the  kinds  of  business,  purposes, 
objects,  or  operations  above  indicated,  or  owning  or  holding  any  property  of  any 
kind  herein  mentioned;  or  of  any  corporation  owning  or  holding  the  stock  or  the 
obligations  of  any  such  corporation. 


Form  40.     Oil 


The  nature  of  the  business  of  this  corporation  and  the  objects  or  purposes 
proposed  to  be  transacted,  promoted  or  carried  on  by  it  are  as  follows,  namely: 

1.  To  buy,  contract  for,  lease,  and  in  any  and  all  other  ways,  acquire,  take, 
hold  and  own,  and  to  sell,  mortgage,  lease  or  otherwise  dispose  of  lands,  mining 
claims,  mineral  rights,  oil  wells,  gas  wells,  oil  lands,  gas  lands  and  other  real  prop- 
erty, and  rights  and  interests  in  and  to  real  property,  and  to  manage,  operate, 
maintain,  improve,  and  develop  the  said  properties,  and  each  and  all  of  them. 

2.  To  buy,  contract  for,  lease,  and  in  any  and  all  other  ways,  acquire,  take, 
hold  and  own,  and  to  sell,  mortgage,  lease,  and  otherwise  dispose  of  all  rights  of 
way,  easements,  franchises,  and  rights  thereto,  and  to  deal  in  the  same  in  every  way. 

3.  To  buy,  contract  for,  lease,  and  in  any  and  all  other  ways  acquire,  take, 
hold  and  own  personal  property  of  every  character  and  description,  and  to  sell, 
mortgage,  lease  and  otherwise  dispose  of  the  same. 


Ch.  2]  SPECIAL  CHARTER  CLAUSES  1455 

4.  To  engage  in  any  kind  of  manufacturing  business  and  to  buy,  contract  for, 
lease,  construct  and  otherwise  acquire,  take,  hold  and  own,  and  to  sell,  mortgage, 
lease  or  otherwise  dispose  of,  manufacturing  plants,  and  to  manage,  operate,  main- 
tain, improve  and  develop  the  same. 

5.  To  buy,  construct,  contract  for,  lease  and  in  any  and  all  other  ways  acquire, 
take,  hold  and  own  refineries  for  the  treatment  of  petroleum  and  other  mineral  oils 
and  gases;  the  tanks  and  other  facilities  for  the  storage  thereof;  the  pipe  lines  and 
other  facilities  for  the  distribution  thereof;  and  the  manufacturing  plants,  works 
and  appurtenances  for  the  production,  distribution  and  sale  of  petroleum,  oil,  gas 
and  of  any  and  all  refinements  and  by-products  thereof;  to  prospect  for  oil,  to  drill 
oil  wells  and  to  develop  the  same;  to  refine  crude  oil;  to  improve,  maintain,  operate 
and  develop,  and  to  sell,  mortgage,  lease  or  otherwise  dispose  of  the  said  properties, 
and  to  sell  or  otherwise  dispose  of  such  petroleum,  oil,  and  all  refinements  and  by- 
products thereof. 

6.  To  enter  into,  maintain,  operate  or  carry  on  in  all  its  branches  the  business 
of  mining  and  of  drilling,  boring  and  exploring  for,  producing,  refining,  treating, 
distilling,  manufacturing,  piping,  carrying,  handling,  storing  and  dealing  in,  buying 
and  selling  petroleum,  oil,  natural  gas,  asphaltum,  bitumen,  bituminous  rock,  and 
any  and  all  other  mineral  and  hydro-carbon  substances,  and  any  and  all  products 
or  by-products  which  may  be  derived  from  said  substances  or  either  of  them;  and 
for  such  or  any  of  such  purposes  to  buy,  contract  for,  lease  and  in  any  and  all  other 
ways  acquire,  take,  hold,  and  own,  and  to  sell,  mortgage,  lease  and  otherwise  dis- 
pose of,  and  to  construct,  manage,  maintain,  deal  in  and  operate  mines,  refineries, 
pipe  lines,  tanks,  machinery,  wharves,  steam,  sailing  and  other  vessels  or  water- 
craft  of  every  kind,  character  and  description,  and  otherwise  to  deal  in,  operate, 
establish,  promote,  carry  on,  conduct  and  manage  any  and  all  other  property  and 
appliances  that  may  in  any  wise  be  deemed  advisable  in  connection  with  the  busi- 
ness of  the  corporation  or  any  branch  thereof,  or  that  may  be  deemed  convenient 
at  any  time  by  the  Board  of  Directors  of  the  Corporation. 

7.  To  do  engineering  and  contracting  in  the  designing,  construction,  improve- 
ment, extension,  maintenance  and  repair  of  oil  or  gas  plants,  including  pipe  lines, 
tanks  and  other  appliances  thereto  appertaining;  also  in  the  opening,  developing 
and  operating  of  petroleum,  gas  and  oil  wells,  both  for  the  corporation  and  for 
others. 

8.  To  manufacture,  buy,  sell  and  otherwise  deal  in  gas  and  oil  machinery  and 
appliances;  also,  lumber,  stone,  brick,  steel,  iron  and  other  materials  in  connection 
with  the  building,  erection,  construction,  development,  improvement,  extension, 
maintenance  and  repair  of  the  properties  herein  enumerated,  both  for  this  corpora- 
tion and  for  others. 

(From  charter  of  Pacific  Oil  Company,  Delaware.) 
Form  41.     Opticians 

(a)  To  buy,  sell,  manufacture,  and  generally  to  deal  in  and  with  lenses, 
glasses,  mirrors,  and  reflectors  of  all  kinds  and  descriptions;  and  to, grind,  polish, 
mount,  and  prepare  the  same  for  use  in  optical,  surgical,  medical,  dental,  photo- 
graphic, electrical,  and  scientific  and  mechanical  work,  and  instruments  of  all  kinds. 

(b)  To  buy,  sell,  manufacture,  and  generally  to  deal  in  and  with  optical, 
scientific,  surgical,  medical,  dental,  and  experimental  tools,  appliances,  apparatus, 
instruments,  reflectors,  microscopes,  telescopes,  spy-glasses,  opera  glasses,  magni- 
fjang  glasses,  spectacles,  cameras,  magic  lanterns,  stereopticons,  stereoscopes,  and 
similar  wares  and  merchandise  of  all  sorts  and  descriptions. 


I4S6  CORPORATE  FORMS  [Bk.  IV- 

Form  42.    Paints  and  Painters'  Supplies 

(a)  To  manufacture,  prepare,  and  sell  oils,  turpentine,  paints,  painters 
supplies,  and  kindred  articles. 

(b)  To  buy,  sell,  import,  export,  and  generally  deal  in  and  with  paints,  oils, 
turpentine,  and  painters'  supplies  of  all  kinds. 

(c)  To  buy,  manufacture,  lease,  and  sell  all  raw  materials,  mills,  machinery, 
and  other  articles  useful  or  convenient  in  connection  with  the  said  business  herein 
mentioned. 

Form  43.    Periodical  or  Newspaper 

(a)  To  take  over  the  publication  known  as  the  "Carlton  Monthly  Maga- 
zine," to  print,  publish,  and  issue  the  same;  to  secure  and  publish  news  and  literary 
material  suitable  for  the  said  periodical;  and  to  do  all  thmgs  necessary  in  connec- 
tion with  its  publication  and  distribution. 

(b)  Generally  to  carry  on  the  business  of  owning  and  publishing  newspapers, 
magazines,  and  other  periodicals;  and  in  connection  therewith  to  carry  on  business 
as  printers,  bookbinders,  stationers,  photographers,  lithographers,  and  such  other 
businesses  or  manufactures  as  may  be  convenient  or  necessary. 

(c)  To  purchase,  build,  lease,  construct,  or  otherwise  acquire  such  buildings, 
offices,  plants,  and  machinery  as  may  be  necessary  o'r  useful  to  carry  out  the 
objects  and  purposes  of  this  company. 

Form  44.    Photographic  Apparatus 

To  buy,  sell,  manufacture,  and  generally  deal  in  and  with  cameras,  tripods, 
dry  plates,  films,  photographic  chemicals,  sensitized  papers,  plate-holders,  screens, 
slides,  printing  frames,  and  all  other  apparatus,  devices,  supplies,  and  materials 
used  in  the  art  of  photography  or  in  connection  therewith. 


Form  45.    Pianos  and  Musical  Instruments 

To  buy,  sell,  import,  export,  and  generally  deal  in  and  with  pianos,  organs 
and  other  musical  instruments;  and  in  all  things,  fixtures,  furniture,  and  appliances 
useful  or  convenient  in  connection  with  the  said  business  for  the  use  of  musical 
instruments;  to  manufacture,  buy,  sell,  import,  and  export  any  and  all  kinds  of 
musical  instruments,  materials,  and  supplies  for  the  same,  musical  articles,  furni- 
ture, cases,  or  conveniences  used  in  the  production  of  music,  or  in  connection  with 
the  operation  of  musical  instruments. 


Form  46.    Printing 


(a)  To  buy,  sell  manufacture,  and  carry  on  the  business  of  printers,  publishers, 
stationers,  engravers,  designers;   and  to  engage  generally  in  the  art,  trade,  and 


Ch.  2J  SPECIAL  CHARTER  CLAUSES  1457 

business  of  printing,  engraving,  lithographing,  and  all  other  methods  of  printing, 
or  producing  or  reproducing  printing,  engraving,  drawings,  paintings,  pictures 
and  representations  and  impressions  of  all  kinds  in  color  or  otherwise. 

(b)  To  print,  publish,  bind,  and  buy,  sell,  and  deal  in  books,  papers,  maga- 
zines, periodicals,  and  advertising  and  printed  matter  of  all  kinds;  to  hold,  use,  sell, 
circulate,  distribute,  and  dispose  of  the  same;  and  generally  to  do  all  things  inci- 
dental to  or  connected  with  the  business  of  printing  and  publishing. 

(c)  To  buy,  sell,  rent,  manufacture,  install,  use,  operate,  and  generally  deal 
in  and  with  machines,  mechanisms,  devices,  apparatus,  inventions,  and  improve- 
ments for  printing,  writing,  duplicating,  type-setting,  type-making,  linotyping, 
casting,  or  making  type,  making  printing  slugs,  plates,  platens,  stereotypes,  and  all 
other  things  for  use  in  or  in  connection  with  the  printers'  art,  trade,  and  business. 

(d)  To  apply  for,  obtain,  purchase,  or  otherwise  acquire,  and  to  register,  hold, 
own,  use,  operate,  sell,  assign,  or  otherwise  dispose  of  and  turn  to  account  and 
profit,  any  and  all  trade-marks,  improvements,  processes,  formulae,  trade  secrets, 
inventions,  and  apparatus  of  all  kinds,  whether  secured  under  letters  patent  of  the 
United  States  or  in  any  foreign  countrj',  or  in  any  other  manner. 

(e)  To  apply  for,  obtain,  purchase,  or  otherwise  acquire,  and  to  own,  hold, 
use,  sell,  assign,  or  otherwise  dispose  of  and  turn  to  profit  and  account,  copyrights 
and  pubHshing  rights  of  all  kinds. 


Form  47.    Railroad  Construction 

(a)  To  do  all  things  necessary  or  useful  in  connection  with  the  construction  of 
railways,  railway  bridges,  and  railway  terminals,  and  the  doing  of  all  things  and 
the  making  of  all  contracts  for  such  construction. 

(b)  To  deal  in  stocks,  bonds,  and  other  securities  of  railroad  companies,  and 
to  purchase,  hold,  pledge,  and  sell  the  same. 

(c)  To  buy,  sell,  and  deal  in  real  estate,  rights  of  way,  and  the  selling  or  leasing 
of  the  same. 

(d)  To  promote  and  organize  railroad  corporations,  to  sell  their  stocks  and 
other  securities,  and  to  secure  finance  for  their  construction. 

(e)  To  acquire  franchises,  concessions,  rights  of  way,  and  other  privileges  to 
be  utilized  for  railroads  or  railroad  construction. 


Form  48.    Real  Estate 


(a)  To  take  over  and  acquire  all  or  any  part  or  parts  or  interest  or  interests  in 
the  estate  and  property  of  Wilson  D.  Manning,  deceased,  to  assume  the  payment 
of  any  notes,  indebtedness,  or  obligations  of  such  estate,  and  to  hold,  improve, 
lease,  sell,  and  otherwise  handle  and  dispose  of  the  said  estate  and  property  as  may 
appfear  to  the  adyantage  and  profit  of  the  corporation. 

(b)  To  take,  purchase,  or  otherwise  acquire,  and  to  own,  hold,  sell,  convey, 
exchange,  hire,  lease,  pledge,  mortgage,  and  otherwise  deal  in  and  dispose  of  all 
kinds  of  real  estate,  real  property,  personal  property,  chattels,  chattels  real,  choses 
in  action,  notes,  bonds,  mortgages,  and  securities. 

(c)  To  conduct  and  transact  business  in  any  of  the  states,  territories,  colonies, 
or  dependencies  of  the  United  States  and  in  any  and  all  foreign  countries;  to  have 
one  or  more  offices  therein,  and  therein  to  hold,  purchase,  mortgage,  and  convey 
real  and  personal  property  without  limit  or  restriction  except  as  imposed  by  the 
local  laws. 


I4S8  CORPORATE  FORMS  [Bk.  IV- 

(d)  To  do  any  and  all  things  set  forth  in  this  certificate  as  objects,  purposes, 
powers,  or  otherwise,  to  the  same  extent  and  as  fully  as  natural  persons  might  do, 
and  in  any  part  of  the  world  as  principals,  agents,  contractors,  lessees,  or  otherwise. 

See  also  purposes  in  Form  i.) 

Form  49.    Refrigerating  Company 

(a)  To  plan,  design,  lay  out,  construct,  and  contract  to  install  plants,  ma- 
chinery, factories,  and  apparatus  for  mixing,  making,  freezing,  preparing,  and  mar- 
keting ices,  ice-creams,  and  all  kinds  of  frozen  and  refrigerated  substances. 

(b)  To  contract  and  undertake  the  planning,  designing,  manufacture,  and 
construction  of  ice,  cold  storage,  and  refrigerating  plants,  machinery,  apparatus, 
and  conveyances,  and  of  all  buildings,  structures,  piping,  and  storing  facilities 
necessary  or  pertaining  thereto. 

(c)  To  carry  on  a  general  contracting  and  engineering  business  in  all  its 
branches;  particularly  to  carry  on  the  business  of  refrigerating  engineering;  and 
to  design,  erect,  construct,  enlarge,  repair,  improve,  and  manufacture  all  kinds  of 
ice,  cold  storage,  and  refrigerating  plants,  engines,  machinery,  insulation,  and 
apparatus. 

(d)  To  carry  on  the  business  of  ice-making,  cold  storage,  refrigeration,  and 
making  ice-cream,  and  do  all  things  incidental  thereto;  to  buy,  sell,  construct, 
operate,  and  maintain  ice  plants,  cold  storage  warehouses,  refrigerating  apparatus, 
and  conveyances  for  the  transportation  in  cold  storage  of  all  goods,  products,  and 
wares. 


(See  also  Form  28.) 

Form  50.    Schools 

(a)  To  establish,  organize,  manage,  and  conduct  schools  and  educational 
institutions,  and  to  employ  teachers,  educators,  and  instructors,  and  to  provide 
courses  of  study  preparatory  for  business  and  professional  life  and  for  general  in- 
formation and  culture. 

(b)  To  erect,  lease,  or  otherwise  acquire  suitable  buildings  and  structures 
in  which  to  conduct  such  schools  and  educational  institutions,  and  to  provide  books, 
libraries,  furniture,  and  apparatus  for  the  same. 

(c)  To  establish  and  conduct  institutes,  lecture  courses,  correspondence  and 
extension  courses,  training  schools,  home  classes,  and  to  use  and  adapt  such  other 
means  as  may  from  time  to  time  seem  effective  in  promoting  the  work  of  education. 

(d)  To  give  such  diplomas,  certificates,  and  other  evidences  of  proficiency  as 
may  be  compatible  with  the  laws  of  the  state,  or  such  as  may  be  hereafter  authorized 
by  the  educational  authorities  of  the  "^tate. 

(e)  To  establish  scientific,  business,  technical,  cultural,  artistic,  and  musical 
courses  of  education  and  training;  to  secure,  print,  and  publish  books,  charts, 
and  courses  of  study  to  use  in  connection  with  such  courses;  and  to  do  all  other 
things  necessary  or  convenient  in  connection  with  such  educational  work. 


Form  51.    Securities  Company  (New  York) 

(a)  To  buy,  sell,  hold,  and  generally  to  deal  in  and  with  stocks,  bonds,  deben- 
tures, mortgages,  and  securities  of  all  kinds;  to  borrow  money,  make  loans,  advance 


Ch.  2]  SPECIAL  CHARTER  CLAUSES  1459 

money  on  contracts,  make  investments,  and  generally  act  as  investment  brokers; 
to  issue  notes,  bonds,  securities,  and  debentures  which  may  be  secured  by  mortgage 
or  otherwise  upon  property  real  and  personal  of  the  corporation  under  the  provisions 
of  Section  2  of  the  Stock  Corporations  Law  of  the  State  of  New  York;  and  to  pur- 
chase, hold,  improve,  sell,  lease,  or  exchange  real  estate. 

(b)  To  act  as  agents,  factors,  brokers,  commission  merchants,  contractors, 
lessees,  and  managers  of  estates  or  otherwise  in  entering  into,  undertaking,  per- 
forming, negotiating,  executing,  conducting,  and  transacting  for  persons,  firms, 
and  corporations  upon  commission  or  otherwise,  any  and  all  the  things  set  forth 
in  this  certificate  that  it  can  do  for  itself;  and  to  exercise  all  of  its  powers  to  the 
same  extent  that  a  natural  person  might  do,  and  in  any  part  of  the  world  to  the 
full  extent  permitted  to  corporations  organized  under  the  Business  Corporations 
Law  of  the  State  of  New  York. 

(c)  To  purchase,  acquire,  hold,  and  dispose  of  the  stocks,  bonds,  and  other 
evidences  of  indebtedness  of  any  corporation,  domestic  or  foreign,  and  issue  in 
exchange  therefor  its  stock,  bonds,  or  other  obHgations;  and  to  exercise  while 
owner  of  the  stock  of  other  corporations  all  the  rights,  powers,  and  privileges  of 
ownership,  including  the  right  to  vote  thereon. 

(d)  To  guarantee  or  cause  to  be  guaranteed  the  payment  of  dividends  or 
interest  on  any  bonds,  stocks,  debentures,  or  other  securities  of  this  corporation; 
and  to  guarantee  or  cause  to  be  guaranteed  the  contracts  and  obligations  of  this 
corporation  whenever  proper  or  necessary  for  its  business  in  the  judgment  of  its 
Board  of  Directors. 

(See  also  Form  9.) 

Form  52.    Smelting  and  Allied  Operations  (New  Jersey) 

(a)  To  buy,  lease,  or  otherwise  acquire  mines,  mining  rights  quarries  and 
mineral  lands  and  claims  of  every  kind,  nature,  and  description,  and  to  work,  mine, 
prospect,  develop,  and  promote  the  same;  to  mine,  quarry,  and  excavate  gold, 
silver,  copper,  and  other  o.es  and  metals  and  minerals  of  all  descriptions. 

(b)  To  buy,  lease,  co  istruct,  own,  control,  operate,  and  maintain  mills,  works, 
and  plants  for  the  crushing,  sampling,  milling,  smelting,  reduction,  and  concen- 
tration of  minerals  and  metal-bearing  ores,  and  the  extraction  therefrom  of  all 
kinds  of  metals  and  mineral  products  and  by-products,  on  its  own  account  and  as 
factor  and  agent  for  others. 

fc)  To  carry  on  the  business  of  mining,  milling,  concentrating,  converting, 
smelting,  treating,  preparing  for  market,  reducing,  buying,  selling,  and  merchan- 
dising in  gold,  silver,  copper,  and  other  metals  and  metallic  compounds,  coal, 
coke,  charcoal,  and  other  fuels,  and  all  products  and  by-products  of  all  ores  and 
minerals. 

(d)  To  treat,  prepare,  and  manufacture,  and  to  buy,  sell,  and  generally  to  deal 
in  iron,  steel,  manganese,  coke,  copper,  lumber,  and  other  materials,  and  all  or  any 
articles  consisting  of  or  partly  consisting  of  metal,  wood  or  other  materials,  and 
any  and  all  products  and  by-products  thereof. 

(e)  To  buy,  sell,  manufacture,  produce,  and  dispose  of  all  kinds  of  goods, 
wares,  merchandise,  manufactures,  commodities,  foodstuffs,  drugs,  furniture, 
machinery,  tools,  supplies,  and  agricultural  products,  and  generally  to  engage 
in  and  carry  on  any  forms  of  manufacturing  or  mercantile  enterprise,  necessary  or 
incidental  to  the  business  of  the  Company. 

(f)  To  construct  bridges,  buildings,  machinery,  ships,  boats,  engines,  cars,  and 
other  equipment,  railroads,  docks,  slips,  elevators,  water-works,  gas-works,  electric- 
works,  viaducts,  aqueducts,  canals,  and  other  waterways,  and  any  other  means  of 
transportation;  and  to  sell  the  same,  or  otherwise  dispose  thereof;^  or  to  maintain 


1460  CORPORATE  FORMS  [Bk.  I\'- 

and  operate  the  same,  except  that  the  Company  shall  not  maintain  or  operate  any 
railroad  or  canal  in  the  State  of  New  Jersey. 


Form  53.    Textile  Fibers 

(a)  To  buy,  sell,  grow,  prepare,  manufacture,  and  generally  deal  in  and  with 
flax,  hemp,  jute,  wool,  silk,  cotton,  and  fibers  and  fibrous  materials  of  all  kinds;  to 
buy,  sell,  prepare,  manufacture,  and  generally  deal  in  all  products  and  by-products 
of  said  materials  and  substances,  or  products  and  by-products  consisting  in  part  of 
such  materials  and  substances;  to  bleach,  dye,  print,  color,  and  otherwise  treat 
and  manipulate,  and  to  spin,  comb,  weave,  and  prepare  for  market,  either  wholly 
or  in  part;  and  to  buy,  sell,  market,  and  deal  in  any  and  all  such  products,  by-prod- 
ucts, materials,  manufactures,  and  substances;  and  to  do  all  other  things  and 
engage  in  any  and  all  kinds  of  business  which  may  be  necessary,  ancillary,  incidental, 
profitable,  or  convenient  in  connection  with  said  business  or  any  portion  thereof. 

(b)  To  buy,  sell,  own,  hold,  use,  operate,  and  generally  to  deal  in  and  with 
all  devices  machines,  mechanisms,  and  engines  that  may  be  useful  or  convenient  in 
the  treatment,  preparation,  manufacture,  and  manipulation  of  flax,  hemp,  jute, 
wool,  silk,  cotton,  and  other  fibers  and  fibrous  materials  of  all  kinds. 

(See  also  Form  14.) 

Inclusive  Clauses 

The  use  of  these  general  clauses  is  shown  in  the  charters  of 
Forms  i  to  4.  In  some  states  clauses  of  this  kind,  giving  vast 
and  almost  unlimited  powers,  are  not  allowed. 

Form  54.    To  Buy  and  Hold  Real  Estate 


To  purchase  or  otherwise  acquire,  and  to  own,  develop,  sell,  mortgage,  or 
otherwise  dispose  of  real  estate,  real  property,  and  all  interests  and  rights  therein, 
without  limit  or  amount,  and  to  the  same  extent  as  natural  persons  might  or  could 
do,  and  in  any  part  of  the  world. 


Form  55.    To  Conduct  Any  Other  Business 

To  conduct  and  carry  on  any  other  business,  manufacturing  or  otherwise, 
which  may  be  capable  of  being  profitably  carried  on  in  connection  with  the  Com- 
pany's business,  or  to  carry  on  any  business  that  is  adapted  directly  or  indirectly 
to  add  to  the  value  of  the  Company's  property  and  the  profits  of  its  authorized 
business. 


Form  56.     To  Acquire  Other  Enterprises 

To  buy  or  otherwise  to  acquire  any  other  enterprise  adapted  to  be  carried  on 
in  connection  with  the  Company's  business,  together  with  the  good-will,  rights. 


Ch.  2]  SPECIAL  CHARTER  CLAUSES  146 1 

property,  and  assets  of  all  kinds  thereto  pertaining,  and  in  connection  therewith 
to  assume  any  of  the  liabilities  of  any  person,  hrm,  or  corporaton,  and  to  pay  for 
the  same  in  cash,  stock,  debentures,  or  other  securities  of  the  Company. 


Form  57.    To  Carry  on  Business  in  Other  States 

To  conduct  its  business  and  to  have  one  or  more  offices,  and  to  acquire,  hold, 
mortgage,  lease,  and  convey  real  and  personal  property,  unlimitedly  and  without 
restriction,  in  any  of  the  states  or  territories  of  the  United  States,  or  in  any  foreign 
place  or  country,  so  far  as  is  permitted  by  the  laws  thereof. 


Form;  58.    To  Promote  Other  Undertakings 

To  promote  or  to  aid  in  any  manner,  financially  or  otherwise,  any  corporation 
or  association  of  which  any  stocks,  bonds,  or  other  evidences  of  indebtedness  or 
securities  are  held  directly  or  indirectly  by  this  corporation;  and  for  this  purpose 
to  guarantee  the  contracts,  dividends,  stocks,  bonds,  notes,  and  other  obligations 
of  such  other  corporations  or  associations;  and  to  do  any  other  acts  or  things  de- 
signed to  protect,  preserve,  improve  or  enhance  the  value  of  such  stocks,  bonds,  or 
other  evidences  of  indebtedness  or  securities. 


Form  59.    To  Enter  into  Contracts 

To  contract  freely  with  any  person,  firm,  or  corporation,  private  or  public, 
and  to  carry  out  and  fulfill  contracts  of  every  sort  and  kind,  and  to  purchase,  lease 
or  otherwise  acquire  any  and  all  rights,  privileges,  and  franchises  convenient  or 
profitable  to  carry  out  in  connection  with  the  corporate  purposes  and  corporate 
Dusiness  of  the  Company. 


Form  60.    To  Borrow  Money 

To  borrow  money  from  any  person,  firm,  or  corporation;  to  make  and  issue, 
notes,  bills,  bonds,  debentures,  and  other  evidences  of  indebtedness  of  all  kinds, 
and  to  secure  the  same  by  pledge,  mortgage,  or  otherwise,  without  limit  as  to 
amount,  and  to  provide  for  payment  of  the  same  by  deposited  cash,  sinking  funds, 
or  otherwise. 


Form  61.    To  Acquire  the  Company's  Own  Stock 

The  corporation  may  utilize  and  apply  its  surplus  earnings  or  profits  authorized 
by  law  to  be  so  reserved,  to  the  purchase  or  acquisition  of  its  own  capital  stock, 
from  time  to  time,  and  in  such  manner  as  may  be  legal  and  equitable  as  to  other 
stockholders,  and  upon  such  terms  as  its  Board  of  Director  shall  determine. 


1462  '  CORPORATE  FORMS  [Bk.  IV- 

Form  62.    To  Acquire  Stock  of  Other  Companies 

To  hold,  purchase,  or  otherwise  acquire,  and  to  sell,  assign,  transfer,  mortgage, 
pledge,  or  otherwise  dispose  of,  shares  of  the  capital  stock  and  securities  created 
by  any  other  corporation  or  corporations,  and  while  the  holder  thereof  to  exercise 
all  the  privileges  of  ownership  including  the  right  to  vote  thereon. 

Form  63.     Strengthening  Clause 

To  do  any  or  all  of  the  things  in  this  certificate  set  forth  as  objects,  purposes, 
powers,  or  otherwise,  to  the  same  extent  and  as  fully  as  natural  persons  might  or 
could  do,  and  in  any  part  of  the  world,  as  principals,  agents,  trustees,  or  otherwise. 

Form  64.    Interpretation  Clause 

The  objects  and  powers  specified  in  this  certificate  of  incorporation  shall 
except  where  expressly  limited,  be  in  nowise  limited  or  restrained  by  inference  from 
the  terms  of  any  other  clause  in  any  other  part  of  this  charter,  but  the  objects  and 
powers  specified  in  each  of  the  clauses  of  this  charter  shall  be  regarded  as  inde- 
pendent and  separate  purposes  and  powers  of  the  corporation. 


CHAPTER  III 

BY-LAW  FORMS 

The  comprehensive  and  detailed  by-laws  required  for  the 
operation  of  a  large  corporation  are  neither  necessary  nor  desir- 
able for  those  of  lesser  size.  For  most  small  corporations  the 
following  short  set  of  by-laws,  prepared  for  the  use  of  a  New 
York  corporation  will  be  found  adequate,  and  may  be  easily 
changed  to  meet  special  requirements  of  other  states  or  other 
corporations. 

It  may  be  noted  that  in  New  York  and  some  other  states, 
inspectors  of  election  are  required  by  the  statute  law  for  the 
annual  election  of  directors;  also  that  in  New  York  State,  at 
the  annual  meeting  of  stockholders,  the  by-law  specifications 
for  stockholders'  quorums  will  not  apply  in  the  election  of  direc- 
tors, as  the  statutes  specifically  provide  that  the  directors  shall 
be  "elected  by  a  plurality  of  the  votes  at  such  election,"  regard- 
less of  whether  a  quorum  be  present,  and,  if  at  a  special  meeting 
for  the  election  of  directors,  "members  attending  shall  con- 
stitute a  quorum."! 

Form  65.    By-Laws — Short 

By-Laws 

of  the 

MAYSWOOD  MOTOR  COMPANY 

New  York  City 

Article  I.    Stock 

I .  Certificates  of  Stock  shall  be  issued  in  numerical  order  from  the  stock  certifi- 
cate book  to  each  stockholder  of  record  whose  stock  has  been  paid  in  full,  be  signed 

'  For  general  discussion  of  by-laws,  see  Book  I,  Part  VI,  "The  By-Laws." 

1463 


1464  CORPORATE  FORMS  [Bk.  IV- 

by  the  President  and  Treasurer,  and  be  sealed  by  the  Secretary  with  the  corporate 
seal.     A  record  of  each  certificate  issued  shall  be  kept  on  the  stub  thereof. 

2.  Transfers  of  Slock  shall  be  made  only  upon  the  books  of  the  Company,  and 
before  a  new  certificate  is  issued  the  old  certificate  must  be  surrendered  for  cancella- 
tion. The  stock  books  of  the  Company  shall  be  closed  for  transfer  twenty  days 
before  general  elections  and  ten  days  before  dividend  days. 

3.  The  Treasury  Stock  of  the  Company  shall  consist  of  such  issued  and  out- 
standing stock  of  the  Company  as  may  be  donated  to  the  Company  or  otherwise 
acquired,  and  shall  be  held  subject  to  disposal  by  the  Board  of  Directors.  Such 
stock  shall  neither  vote  nor  participate  in  dividends  while  held  by  the  Company. 

Article  II.  Stockholders 

1.  The  Annual  Meeting  of  the  stockholders  of  this  Company  shall  be  held 
in  the  principal  office  of  the  Company,  in  New  York  City,  on  the  second  Monday 
in  January  of  each  year,  at  3  p.m.  if  not  a  legal  holiday,  but  if  a  legal  holiday,  then 
on  the  next  business  day  following. 

2.  Special  Meetings  of  the  stockholders  may  be  called  at  the  principal  office  of 
the  Company  at  any  time  by  resolution  of  the  Board  of  Directors,  or  upon  written 
request  of  stockholders  holding  one-third  of  the  outstanding  stock. 

3.  Notice  of  Meetings,  written  or  printed,  shall  be  prepared  and  mailed  to  the 
last  known  post-office  address  of  each  stockholder  not  less  than  ten  days  before 
any  regular  or  special  meeting  of  stockholders,  and  if  for  a  special  meeting,  such 
notice  shall  state  the  object  or  objects  thereof.  No  failure  of  or  irregularity  of 
notice  of  any  regular  meeting  shall  invalidate  such  meeting  or  any  proceeding 
thereat. 

4.  A  Quorum  at  any  meeting  of  the  stockholders  shall  consist  of  a  majority  of 
the  voting  stock  of  the  Company,  represented  in  person  or  by  proxy.  A  majority 
of  such  quorum  shall  decide  any  question  that  may  come  before  the  meeting. 

5.  The  Election  of  Directors  shall  be  held  at  the  annual  meeting  of  stockholders, 
and  shall,  after  the  first  election,  be  conducted  by  two  inspectors  of  election, 
appointed  by  the  President  for  that  purpose.  The  election  shall  be  by  ballot 
and  each  stockholder  of  record  shall  be  entitled  to  cast  one  vote  for  each  share  of 
stock  held  by  him. 

6.  The  Order  of  Business  at  the  annual  meeting,  and,  as  far  as  possible,  at  all 
other  meetings  of  the  stockholders,  shall  be: 

1.  Calling  of  roll 

2.  Proof  of  due  notice  of  meeting 

3.  Reading  and  disposal  of  any  unapproved  minutes 
4    Annual  reports  of  ofi&cers  and  committees 

5.  Election  of  directors 

6.  Unfinished  business 

7.  New  business 

8.  Adjournment 

Article  III.    Directors 

1.  The  Business  and  Property.oi  the  Company  shall  be  managed  by  a  Board 
of  five  Directors,  who  shall  be  stockholders  of  the  Company  and  who  shall  be 
elected  annually  by  ballot  by  the  stockholders  for  the  term  of  one  year,  and  shall 
serve  until  the  election  and  acceptance  of  their  duly  qualified  successors.  Any 
vacancies  may  be  filled  by  the  Board  for  the  unexpired  term.  Directors  shall 
receive  no  compensation  for  their  services  as  such. 

2.  The  Regular  Meetings  of  the  Board  of  Directors  shall  be  held  in  the  principal 
office  of  the  Company  in  New  York  City  on  the  third  Tuesday  of  each  month,  at 
3  P.M.  if  not  a  legal  holiday,  but  if  a  legal  holiday,  then  on  the  next  business  day 
following. 


Ch.  3]  BY-LAW  FORMS  1465 

3.  Special  Meetings  of  the  Board  of  Directors  may  be  held  in  the  principal 
office  of  the  Company  in  New  York  City  at  any  time  on  call  of  the  President,  or 
of  any  three  members  of  the  Board,  or  may  be  held  at  any  time  and  place  without 
notice,  by  unanimous  written  consent  of  all  the  members,  or  with  the  presence  and 
participation  of  all  members  at  such  meeting. 

4.  Notices  of  both  regular  and  special  meetings,  save  when  held  by  unanimous 
consent  or  participation,  shall  be  mailed  by  the  Secretary  to  each  member  of  the 
Board  not  less  than  five  days  before  any  such  meeting,  and  notices  of  special  meet- 
ings shall  state  the  purposes  thereof.  No  failure  or  irregularity  of  notice  of  any 
regular  meeting  shall  invalidate  such  meeting  or  any  proceeding  thereat. 

5.  A  Quorum  at  any  meeting  shall  consist  of  a  majority  of  the  entire  member- 
ship of  the  Board.  A  majority  of  such  quorum  shall  decide  any  question  that  may 
come  before  the  meeting. 

6.  Officers  of  the  Company  shall  be  elected  by  ballot  by  the  Board  of  Directors 
at  their  first  meeting  after  the  election  of  Directors  each  year.  If  any  office 
becomes  vacant  during  the  year,  the  Board  of  Directors  shall  fill  the  same  for  the 
unexpired  term.  The  Board  of  Directors  shall  fix  the  compensation  of  the  officers 
and  agents  of  the  Company. 

7.  The  Order  of  Business  at  any  regular  or  special  meeting  of  the  Board  of 
Directors  shall  be: 

1.  Reading  and  disposal  of  any  unapproved  minutes 

2.  Reports  of  officers  and  committees 

3.  Unfinished  business 

4.  New  business 

5.  Adjournment 

Article  IV.    Officers 

1.  The  Officers  of  the  Company  shall  be  a  President,  a  Vice-President,  a  Secre- 
tary, and  a  Treasurer,  who  shall  be  elected  for  one  year  and  shall  hold  office  until 
their  successors  are  elected  and  qualify.  The  position  of  Secretary  and  Treasurer 
may  be  united  in  one  person. 

2.  TIte  President  shall  preside  at  all  meetings,  shall  have  general  supervision 
of  the  affairs  of  the  Company,  shall  sign  or  countersign  all  certificates  of  stock, 
contracts,  and  other  instruments  of  the  Company  authorized  by  the  Board  of 
Directors,  except  as  otherwise  directed  by  the  board;  shall  make  such  reports  to 
the  Directors  and  stockholders  as  he  may  deem  necessary  or  as  may  be  required  of 
him,  and  perform  all  such  other  duties  as  are  incident  to  his  office  or  are  properly 
required  of  him  by  the  Board  of  Directors.  In  the  absence  or  disability  of  the 
President,  the  Vice-President  shall  exercise  all  his  functions. 

3.  The  Secretary  shall  issue  notices  for  all  meetings  of  stockholders  and  direc- 
tors, shall  keep  their  minutes,  shall  have  charge  of  the  seal  and  the  corporate  books, 
shall  sign,  with  the  President,  such  instruments  as  require  such  signature,  and  shall 
make  such  reports  and  perform  such  other  duties  as  are  incident  to  his  office,  or  are 
properly  required  of  him  by  the  Board  of  Directors. 

4.  The  Treasurer  shall  have  the  custody  of  all  moneys  and  securities  of  the 
Company  and  shall  keep  regular  books  of  account  and  balance  the  same  each 
month.  He  shall  sign  or  countersign  such  instruments  as  require  his  signature, 
shall  perform  all  duties  incident  to  his  office  or  that  are  properly  required  of  him 
by  the  Board,  and  shall  give  bond  for  the  faithful  performance  of  his  duties  in  such 
sum  and  with  such  sureties  as  may  be  required  by  the  Board  of  Directors. 

Article  V.    DivroENos  and  Finance 

1.  Dividends  shall, be  declared  from  the  surplus  profits  of  the  Company  at 
such  times  as  the  Board  of  Directors  shall  direct,  and  no  dividend  shall  be  declared 
that  will  impair  the  capital  of  the  Company. 


1466  CORPORATE  FORMS  [Bk.  IV- 

2.  The  Moneys  of  the  Company  shall  be  deposited  in  the  name  of  the  Company 
in  such  banks  or  trust  companies  as  the  Board  of  Directors  shall  designate,  and 
shall  be  drawn  out  only  by  check  signed  by  the  Treasurer  and  countersigned  by  the 
President 

Article  VI.    Seal 

I.  The  Corporate  Seal  of  the  Company  shall  consist  of  two  concentric  circles 
between  which  is  the  name  of  the  Company,  and  in  the  centre  shall  be  inscribed 
"Incorporated  1922,  New  York,"  and  such  seal,  as  impressed  on  the  margin 
hereof,  shall  be  the  Corporate  Seal  of  the  Company. 

Article  VII.     Amendments 

1.  These  By-Laws  may  be  amended,  repealed,  or  altered,  in  whole  or  in  part, 
by  a  majority  vote  of  the  entire  outstanding  stock  of  the  Company,  at  any  regular 
meeting  of  the  stockholders,  or  at  any  special  meeting  where  such  action  has  been 
announced  in  the  call  and  notice  of  such  meeting. 

2.  The  Board  of  Directors  shall  not  alter  or  repeal  any  by-laws  adopted  by  the 
stockholders  of  the  Company,  but  may  adopt  additional  by-laws  in  harmony 
therewith. 


The  following  by-laws  for  a  New  Jersey  corporation  are  more 
detailed  and  comprehensive  than  those  just  shown,  providing 
for  a  much  higher  degree  of  organization.  They  will  be  found 
adequate  for  most  corporations  of  moderate  size  and  may  be 
readily  modified  to  meet  the  requirements  of  any  particular  state. 

Form  66.     By-Laws — Extended 

By-Laws 

of  the 

OGDEN  IRON  AND  STEEL  COMPANY 

Incorporated  under  the  Laws  of  New  Jersey 

Article  I.    Stock 

Sec.  I.     Certificates  of  Stock 

Each  stockholder  of  the  company  whose  stock  has  been  paid  for  in  full  shall 
be  entitled  to  a  certificate  or  certificates  showing  the  amount  of  stock  of  the  Com- 
pany standing  on  the  books  in  his  name.  Each  certificate  shaU  be  numbered,  bear 
the  signatures  of  the  President  and  Treasurer  and  the  seal  of  the  Company,  and  be 
issued  in  numerical  order  from  the  stock  certificate  book.  A  full  record  of  each 
certificate  of  stock,  as  issued,  shall  be  entered  on  the  corresponding  stub  of  the 
stock  certificate  book. 

Sec.  2.     Transfers  of  Stock 

Transfers  of  stock  shall  be  made  upon  the  proper  stock  books  of  the  Company, 
and  must  be  accompanied  by  the  surrender  of  the  duly  indorsed  certificate  or 


Ch.  3l  BY-LAW   FORMS  1467 

certificates  representing  the  transferred  stock.  Surrendered  certificates  shall  be 
canceled  and  attached  to  the  corresponding  stubs  in  the  stock  certificate  book  and 
new  certificates  issued  to  the  parties  entitled  thereto.  The  stock  books  shall  be 
closed  to  transfers  twenty  days  before  general  elections  and  twenty  days  before 
dividend  days. 

Sec.  3.    Lost  Certificates 

The  Board  of  Directors  may  order  a  new  certificate  or  certificates  of  stock 
to  be  issued  in  the  place  of  any  certificate  or  certificates  of  the  Company  alleged 
to  have  been  lost  or  destroyed,  but  in  every  such  case  the  owner  of  the  lost  certifi- 
cate or  certificates  shall  first  cause  to  be  given  to  the  Company  a  bond  in  such  sum, 
not  less  than  the  par  value  of  such  lost  or  destroyed  certificate  or  certificates  of 
stock,  as  said  Board  may  direct,  as  indemnity  against  any  loss  that  the  Company 
may  incur  by  reason  of  such  replacement  of  the  lost  certificate  or  certificates; 
but  the  Board  of  Directors  may,  in  their  discretion,  refuse  to  replace  any  lost 
certificate  of  stock,  save  upon  the  order  of  some  court  having  jurisdiction  in  such 
matter. 

Sec.  4.    Stock  and  Transfer  Books 

The  stock  and  transfer  books  of  the  Company  shall  be  kept  in  its  principal 
office.  No.  525  Main  Street,  East  Orange,  New  Jersey,  and  shall  be  open  during 
business  hours  to  the  inspection  of  any  stockholder  of  the  Company.  All  other 
books  and  records  of  the  Company  shall  be  kept  in  its  office  in  New  York  City, 
and  shall  include  a  stock  book,  which  shall  be  open  during  business  hours  to  the 
inspection  of  any  stockholder  or  judgment  creditor  of  the  Company. 

Sec.  5.    Preferred  Slock 

The  capital  stock  of  this  Company  shall  be  One  Hundred  Thousand  Dollars 
($100,000),  consisting  of  One  Thousand  (1,000)  Shares,  each  of  the  par  value  of 
One  Hundred  Dollars  ($100),  and  of  these,  Five  Hundred  (500)  Shares  shall  be 
preferred  stock,  and  Five  Hundred  (500)  Shares  shall  be  common  stock. 

The  said  preferred  stock  of  the  Company  shall  receive  from  its  net  earnings 
a  Six  Per  Cent  (6%)  annual  cumulative  dividend  before  any  dividends  are  paid 
upon  the  common  stock,  but  the  holders  of  preferred  stock  shall  not  be  entitled 
to  vote  at  the  meetings  of  the  stockholders  of  the  Company. 

Sec.  6.     Treasury  Stock 

All  issued  and  outstanding  stock  of  the  Company  that  may  be  donated  to  or 
be  purchased  by  the  Company  shall  be  termed  treasury  stock,  and  shall  be  held 
subject  to  disposal  by  action  of  the  Board  of  Directors.  Such  stock  shall  neither 
vote  nor  participate  in  dividends  while  held  by  the  Company. 

Article  II.    Stocb^iolders 
Sec.  I.    Annual  Meetings 

The  regular  annual  meetings  of  the  stockholders  shall  be  held  in  the  office  of 
the  Company,  at  No.  525  Main  Street,  East  Orange,  New  Jersey,  at  11  A.M.,  on 
the  second  Monday  of  January  in  each  year  if  not  a  legal  holiday,  but  if  a  legal 
holiday,  then  on  the  next  business  day  following.  At  this  meeting  the  Directors 
for  the  ensuing  year  shall  be  elected,  the  officers  of  the  Company  shall  present  their 
annual  reports,  and  the  Secretary  shall  have  on  file  for  inspection  and  reference,  an 
alphabetical  list  of  the  stockholders  of  the  Company,  giving  the  amount  of  stock  " 
held  by  each,  as  shown  by  the  stock  books  twenty  days  before  the  date  of  such 
annual  meeting. 

Sec.  2.    Special  Meetings 

Special  meetings  of  the  stockholders  may  be  held  at  any  time,  in  the  office  of 
the  Company,  pursuant  to  a  resolution  of  the  Board  of  Directors,  or  to  a  call 


1468  CORPORATE  FORMS  [Bk.  IV- 

signed  by  stockholders  holding  a  majority  of  the  voting  stock  of  the  Company. 
Calls  for  special  meetings  shall  specify  the  time,  place,  and  object  or  objects  thereof, 
and  no  other  business  than  that  specified  in  the  call  shall  be  considered  at  any  such 
meeting. 

Sec.  3.    Notice  of  Meetings 

A  written  or  printed  notice  of  every  regular  or  special  meeting  of  the  stock- 
holders, stating  the  time  and  the  place,  and,  in  case  of  special  meetings,  the  objects 
thereof,  shall  be  prepared  and  mailed  by  the  Secretary,  postage  prepaid,  to  the 
last  known  post-ofhce  address  of  each  stockholder,  at  least  ten  days  before  the  date 
of  any  such  meeting  No  failure  or  irregularity  of  notice  of  any  regular  meeting 
shall  invalidate  the  same  or  any  proceeding  thereat. 

Sec.  4.     Voting 

Only  stockholders  of  record  of  the  common  stock  of  the  Company  shall  be 
entitled  to  vote  at  the  regular  and  special  meetings  of  stockholders.  At  such 
meetings  each  stockholder  shall  be  entitled  to  one  vote  for  each  share  of  stock 
standing  on  the  books  of  the  Company  in  his  name. 

Sec.  5.    Election  of  Directors 

At  the  first  meeting  of  the  stockholders  and  at  each  annual  meeting  of  the 
stockholders  thereaft2r,  a  Board  of  seven  Directors  shall  be  elected,  who  shall 
serve  until  the  election  and  acceptance  of  their  duly  qualified  successors.  All 
elections  for  Directors  shall  be  by  ballot,  and  the  candidates,  to  the  number  to  be 
elected,  receiving  the  highest  number  of  votes,  shall  be  declared  elected. 

If  for  any  reason  Directors  are  not  elected  at  the  annual  meeting  of  stock- 
holders, a  special  meeting  shall  be  called  for  the  purpose  within  thirty  days  there- 
after, at  which  Directors  shall  be  elected  in  all  respects  as  at  the  annual  meeting. 

Two  inspectors  of  election  shall  be  appointed  by  the  President  to  conduct 
the  election  of  Directors  to  serve  for  the  ensuing  year.  These  inspectors  shall  be 
sworn  to  the  faithful  discharge  of  their  duty  and  shall  then  take  charge  of  the 
election.  No  person  who  is  a  candidate  for  the  office  of  Director  shall  act  as  an 
inspector  of  election. 

Sec.  6.    Quorum 

A  majority  of  the  outstanding  stock,  exclusive  of  treasury  stock,  shall  be 
necessary  to  constitute  a  quorum  at  meetings  of  stockholders.  When  a  quorum  is 
present  at  any  meeting,  a  majority  of  the  stock  represented  thereat  shall  decide 
any  question  brought  before  such  meeting.  In  the  absence  of  a  quorum  those 
present  may  adjourn  the  meeting  from  day  to  day,  but  xmtil  a  quorum  is  secured 
no  business  may  be  transacted. 

Sec.  7.    Proxies 

Any  stockholder  entitled  to  vote  may  be  represented  at  any  regular  or  special 
meeting  of  stockholders  by  »  duly  executed  proxy.  Proxies  shall  be  in  writing  and 
properly  signed,  but  shall  require  no  other  attestation.  No  proxy  shall  be  recog- 
nized unless  executed  within  eleven  months  of  the  date  of  the  meeting  at  which  it 
is  presented. 

Sec.  8.     Officers  of  Meetings 

The  President,  if  present,  shall  preside  at  all  meetings  of  the  stockholders.  In 
his  absence,  the  next  officer  in  due  order  who  may  be  present  shall  preside.  For 
the  purposes  of  these  by-laws,  the  due  order  of  officers  shall  be  as  follows :  President, 
Vice-President,  Treasurer,  and  Secretary. 

The  Secretary  of  the  Company  shall  keep  a  faithful  record  of  the  proceedings 
of  all  stockholders'  meetings. 


Ch.  3]  BY-LAW  FORMS  1469 

Sec.  9.    Order  of  Business 

The  order  of  business  at  the  annual  meeting,  and,  so  far  as  practicable,  at  all 
other  meettings  of  the  stockholders,  shall  be  as  follows: 

1.  Calling  of  roll 

2.  Proof  of  due  notice  of  meeting 

3.  Reading  and  disposal  of  any  unapproved  minutes 

4.  Annual  reports  of  officers  and  committees 

5.  Election  of  directors 

6.  Unfinished  business 

7.  New  business 

8.  Adjournment 

Article  III.    Directors 

Sec.  I.     Number  and  Authority 

A  Board  of  seven  Directors  shall  be  elected,  who  shall  have  entire  charge  of 
the  property,  interests,  business,  and  transactions  of  the  Company,  with  full  power 
and  authority  to  manage  and  conduct  the  same. 

Sec.  2.    Qualifications 

No  person  shall  be  elected,  nor  shall  be  competent  to  act  as  a  Director  of  this 
Company,  unless  he  is  at  the  time  of  election  the  holder  of  record  of  at  least  one 
share  of  its  stock.  At  least  one  of  the  Directors  of  the  Company  must  be  resident 
in  the  Sta'te  of  New  Jersey. 

Sec  3.     Vacancies 

Any  vacancy  occurring  in  the  Board  of  Directors  may  be  filled  for  the  unex- 
pired term  by  a  majority  vote  pf  the  remaining  members.  In  event  of  the  member- 
ship of  the  Board  falling  below  the  number  necessary  for  a  quorum,  a  special  meet- 
ing of  the  stockholders  shall  be  called  and  such  number  of  Directors  shall  be  elected 
thereat  as  may  be  necessary  to  restore  the  membership  of  the  Board  to  its  full 
number. 

Sec.  4.     Regular  Meetings 

The  regular  meetings  of  the  Board  of  Directors  shall  be  held  in  the  office  of 
the  Company,  in  the  City  of  New  York,  at  3  p.m.,  on  the  second  Monday  of  each 
month  if  not  a  legal  holiday,  but  if  a  legal  holiday,  then  on  the  next  business  day 
following. 

Sec.  5.    Special  Meetings 

Special  meetings  of  the  Board  of  Directors  may  be  held  at  any  time,  in  the 
office  of  the  Company  in  the  City  of  New  York,  on  the  written  call  of  the  President 
or  of  any  three  members  of  the  Board.  Special  meetings  may  be  held  at  any  time 
and  place  and  without  notice,  by  unanimous  consent  of  the  Board. 

Sec.  6.     Notice  of  Meetings 

The  Secretary  shall  notify  each  member  of  the  Board  of  all  regular  or  special 
meetings,  by  mailing  to  each  member's  last  known  post-office  address,  postage 
prepaid,  at  least  five  days  before  any  such  meeting,  a  written  or  printed  notice 
thereof,  giving  the  time,  place,  and,  in  case  of  special  meetings,  the  objects  thereof, 
and  no  other  business  shall  be  considered  at  any  special  meeting  than  shall  have  been 
so  notified  to  the  members.  No  failure  or  irregularity  of  notice  of  any  regular 
meeting  shall  invalidate  the  same  or  any  proceeding  thereat. 

Sec.  7.     Quorum 

A  majority  of  the  Board  of  Directors  shall  constitute  a  quorum,  and  a  majority 
of  the  members  in  attendance  at  any  Board  meeting  shall,  in  the  presence  of  a 


I470  CORPORATE  FORMS  [Bk.  IV- 

quorum,  decide  its  action.  A  minority  of  the  Board  present  at  any  regular  or 
special  meeting  may,  in  the  absence  of  a  quorum,  adjourn  to  a  later  date,  but  may 
not  transact  any  business. 

Sec.  8.     Election  of  Officers 

At  the  first  meeting  of  the  Board  of  Directors  after  the  election  of  Directors 
each  year,  a  President,  Vice-President,  Secretary,  Treasurer,  and  General  Manager 
shall  be  elected  to  serve  for  the  ensuing  year  and  until  the  election  of  their  respective 
successors.  Election  shall  be  by  ballot,  and  a  majority  of  the  votes  cast  shall  be 
.necessary  to  elect.  If  not  detrimental  to  the  business  or  operations  of  the  Com- 
pany, any  two  offices  may  be  conferred  upon  one  person.  The  Directors  shall  fix 
the  compensation  of  officers  subject  to  any  limitations  of  the  Charter  and  the  By- 
Laws.  Any  vacancies  that  occur  may  be  filled  by  the  Boa'-d  for  the  unexpired 
term.  The  Board  shall  have  the  right  to  remove  any  officer  for  cause  by  a  two- 
thirds  vote  of  the  entire  membership  of  the  Board. 

Sec.  9.     Compensation  of  Directors 

Each  Director  shall  receive  the  sum  of  five  dollars  for  his  attendance  at  any 
regular  or  special  meeting  of  the  Board  of  Directors,  but  shall  receive  no  other 
salary  or  compensation  for  his  services  as  a  Director  of  the  Company. 

Sec.  10.     Power  to  Pass  By-Laws 

The  Board  of  Directors  shall  have  no  power  to  amend,  alter,  or  repeal  by-laws 
adopted  by  the  stockholders  of  the  Company,  but  may  pass  such  additional  by-laws 
in  conformity  therewith  as  may  be  necessary  or  convenient  to  facilitate  the  business 
of  the  Company. 

Sec.  II.    Executive  Committee 

The  President,  Vice-President,  and  Treasurer  shall  together  constitute  an 
Executive  Committee,  which  shall  be  a  part  of  the  permanent  executive  organiza- 
tion of  the  Company,  and  shall,  in  the  interim  between  meetings  of  the  Board  of 
Directors,  exercise  all  the  powers  of  that  body,  in  accordance  with  the  general 
policy  of  the  Company  and  the  directions  of  the  Board. 

Meetings  of  the  Executive  Committee  shall  be  held  oa  call  of  the  President, 
or  of  any  two  members  of  the  Committee.  All  of  the  members  of  the  Committee 
must  be  duly  notified  of  meetings,  and  a  majority  of  the  members  shall  constitute  a 
quorum.  The  Executive  Committee  shall  keep  a  record  of  all  meetings  and  actions 
of  the  Committee,  and  such  records  shall  at  all  times  be  open  to  the  inspection  of 
any  Director. 

Sec.  12.     Corporation  Offices 

The  principal  office  of  the  Company  within  the  State  of  New  Jersey  shall  be 
at  525  Main  street.  East  Orange,  and  the  agent  therein  and  in  charge  thereof  upon 
whom  process  may  be  served  shall  be  the  Registration  Trust  Company  of  New 
Jersey.  An  office  shall  also  be  maintained  in  New  York  City,  and  such  other  offices 
for  the  transaction  of  its  business  shall  be  maintained  at  such  other  places  in  or  out- 
side of  the  State  of  New  Jersey,  as  may  be  determined  upon  by  the  Board  of 
Directors. 

Sec.  13.    Order  of  Business 

The  regular  order  of  business  at  meetings  of  the  Bioard  of  Directors  shall  be 
as  follows: 

1.  Reading  and  disposal  of  any  unapproved  minutes 

2.  Reports  of  officers  and  committees 

3.  Unfinished  business 

4.  New  business 

5.  Adjournment 


Ch.  3]  BY-LAW  FORMS  1471 

Akticle  IV.    Officers 
Sec.  I.    Enumeration,  Election,  and  Qualification 

The  officers  of  the  Company  shall  be  a  President,  Vice-President,  Treasurer, 
Secretary,  and  General  Manager.  These  officers  shall  be  elected  by  the  Board  of 
Directors  at  the  first  regular  meeting  after  the  election  of  directors  each  year,  and 
shall  hold  office  for  the  term  of  one  year,  and  until  their  respective  successors  are 
duly  elected  and  qualify.  The  President  and  Vice-President  shall  be  elected  from 
from  the  Directors  of  the  Company. 

Sec.  2.     The  President 

The  President,  when  present,  shall  preside  at  all  meetings  of  the  stockholders 
and  of  the  Board  of  Directors;  shall  sign  all  certificates  of  stoqk;  shall  sign  or 
countersign,  as  may  be  necessary,  all  such  bills,  notes,  checks,  contracts,  and  other 
instruments  as  may  pertain  to  the  ordinary  course  of  the  Company's  business;  and 
sign,  when  duly  authorized  thereto,  all  contracts,  orders,  deeds,  liens,  hcenses,  and 
other  instruments  of  a  special  nature. 

He  may  also,  in  the  absence  or  disability  of  the  Treasurer,  indorse  checks, 
drafts,  and  other  negotiable  instruments  for  deposit  or  collection,  and  shall,  with 
the  Secretary,  sign  the  minutes  of  all  meetings  over  which  he  has  presided. 

At  the  first  regular  meeting  of  the  Board  in  January  he  shall  submit  a  com- 
plete report  of  the  operations  of  the  Company  for  the  preceding  year,  together  with 
a  statement  of  the  Company's  affairs  as  existing  at  the  close  of  the  last  fiscal  year, 
and  shall  submit  a  similar  report  at  the  annual  meeting  of  stockholders;  also  he 
shall  report  to  the  Board  of  Directors,  from  time  to  time,  all  such  matters  coming 
within  his  notice  and  relating  to  the  interests  of  the  Company  as  should  be  brought 
to  the  attention  of  the  Board. 

He  shall  be,  ex  officio,  a  member  of  all  standing  committees,  shall  have  such 
usual  powers  of  supervision  and  management  as  may  pertain  to  the  office  of  Presi- 
dent, and  perform  such  other  duties  as  may  be  properly  required  of  him  by  the 
Board  of  Directors. 

Sec.  3.     TIte  Vice-President 

The  Vice-President  shall  familarize  himself  with  the  affairs  of  the  Company, 
and,  in  the  absence,  disability,  or  refusal  to  act  of  the  President,  shall  possess  all 
of  the  powers  and  perform  all  of  the  duties  of  that  officer. 

Sec.  4.     The  Secretary 

The  Secretary  shall  keep  full  minutes  of  all  meetings  of  the  stockholders  and  of 
the  Board  of  Directors;  shall  read  such  minutes  at  the  proper  subsequent  meetings; 
shall  issue  all  calls  for  meetings  and  notify  all  officers  and  directors  of  their  election ; 
shall  have  charge  of  and  keep  the  seal  of  the  corporation,  and  affix  the  same  to 
certificates  of  stock  when  such  certificates  are  signed  by  the  President  and  Treas- 
urer, and  shall  affix  the  seal,  attested  by  his  signature,  to  such  other  instruments 
as  may  require  the  same. 

He  shall  keep  the  stock  certificate  book  and  the  other  usual  corporation  books, 
and  shall  prepare,  record,  transfer,  issue,  seal,  and  cancel  certificates  of  stock,  as 
required  by  the  transactions  of  the  Company  and  its  stockholders.  He  shall  also 
sign  with  the  President  all  contracts,  deeds,  licenses,  and  other  instruments  when 
so  ordered. 

He  shall  make  such  reports  to  the  Board  of  Directors  as  they  may  desire,  and 
shall  also  prepare  such  reports  and  statements  as  are  required  by  the  State  laws. 
He  shall  make  out,  twenty  days  before  any  election  of  Directors,  a  complete 
list  of  the  stockholders  entitled  to  vote  at  such  election,  arranged  in  alphabetical 
order,  and  giving  the  number  of  shares  of  stock  that  may  be  voted  by  each,  and 
shall  keep  the  same  open  to  inspection  at  the  office  of  the  Company  until  the  time 
of  and  during  the  said  election.  He  shall  allow  any  stockholder,  on  application  io 


1472  CORPORATE  FORMS  [Bk.  IV- 

business  hours,  to  inspect  the  stock  certificate  books,  the  stock  transfer  book,  and 
the  stock  ledger. 

He  shall  attend  to  such  correspondence  and  to  such  other  duties  as,  may  be 
incidental  to  his  ofl&ce  or  properly  be  assigned  him  by  the  Board. 

He  shall  receive  such  salary  as  may  be  fixed  by  the  Board  of  Directors. 

Sec.  5.     The  Treasurer 

The  Treasurer  shall  have  the  custody  of  and  be  responsible  for  all  monej^s  and 
securities  of  the  Company;  shall  keep  full  and  accurate  records  and  accounts  in 
books  belonging  to  the  Company,  showing  the  transactions  of  the  Company,  its 
accounts,  liabilities,  and  financial  condition;  and  shall  see  that  all  expenditures  are 
duly  authorized  and  are  evidenced  by  proper  receipts  and  vouchers.  He  shall 
deposit,  in  the  name  of  the  Company,  in  such  depositary  or  depositaries  as  are  • 
approved  by  the  Directors,  all  moneys  that  may  come  into,  his  hands  for  the  Com- 
pany account.  His  books  and  accounts  shall  be  open  at  all  times  during  business 
hours  to  the  inspection  of  any  Director  of  the  Company. 

The  Treasurer  shall  also  indorse  for  collection  or  deposit  all  bills,  notes,  checks, 
and  other  negotiable  instruments  of  the  Company;  shall  pay  out  money  as  may 
be  necessary  in  the  transactions  of  the  Company,  either  by  special  or  general  direc- 
tion of  the  Board  of  Directors,  and  on  checks  signed  by  the  President  and  himself, 
and  shall  generally,  together  with  the  President,  have  supervision  of  the  finances 
of  the  Company. 

He  shall  also  make  a  full  report  of  the  financial  condition  of  the  Company 
for  the  annual  meeting  of  the  stockholders,  and  shall  make  such  other  reports  and 
statements  as  may  be  required  of  him  by  the  Board  of  Directors  or  by  the  laws  of 
the  State. 

He  shall  give  bond  in  the  siun  of  Five  Thousand  Dollars,  with  sureties  satis- 
factory to  the  Board  of  Directors,  for  the  faithful  performance  of  his  duties  and  for 
the  restoration  to  the  Company,  in  event  of  his  death,  resignation,  or  removal  from 
office,  of  all  books,  papers,  vouchers,  money,  and  other  property  belonging  to  the 
Company  that  may  have  come  into  his  custody.  He  shall  receive  such  compensa- 
tion as  may  be  fixed  by  the  Board  of  Directors. 

Sec.  6.     The  General  Manager 

The  General  Manager  shall,  under  the  supervision  of  the  Board  of  Directors 
and  the  President,  have  charge  of  and  manage  the  active  business  operations  of  the 
Company.  He  shall  perform  such  further  duties  and  make  such  reports  as  may  be 
required  of  him  by  the  Board  of  Directors,  and  shall  receive  such  salary,  not  exceed- 
ing Eight  Thousand  Dollars  per  annum,  as  may  be  fixed  by  the  Board  of  Directors. 

Article  V.     Dividends  and  Finances 
Sec.  I.    Dividends 

Dividends  shall  be  declared  at  such  times  as  the  Board  may  direct,  but  no 
dividend  shall  be  declared  or  paid  save  from  surplus  profits  remaining  after  all 
current  liabilities  of  the  Company  have  been  fully  paid,  nor  shall  any  dividend  be 
declared  that  will  impair  the  capital  of  the  Company. 

Sec.  2.    Reserve  Fund 

No  dividend  to  exceed  six  per  cent  per  annum  shall  be  declared  by  the  Board 
of  Directors  until  there  shall  have  been  reserved  from  surplus  profits  a  fund  of 
not  less  than  One  Hundred  Thousand  Dollars,  such  fund  to  be  designated  "Exten- 
sion Fund"  and  to  be  used  for  the  extension  or  enlargement  of  the  business  of  the 
Company  and  the  betterment  of  its  plant,  or  for  such  other  connected  purposes 
as  may  be  deemed  necessary  or  advisable  by  the  Board  of  Directors. 

Sec.  3.    Bank  Deposits 

The  Treasurer  shall  deposit  the  moneys  of  the  Company,  as  the  same  may  come 
into  his  hands,  in  such  depositary  or  depositaries  as  may  be  designated  by  the 


Ch.  3]  BY-LAW  FORMS  1473 

Board  of  Directors,  and  such  deposits  shall  be  made  in  the  name  of  the  Company, 
and  moneys  shall  be  withdrawn  therefrom  only  by  check  signed  by  the  Treasurer 
and  countersigned  by  the  President. 

Article  VI.    Sundry  Provisions 

Sec.  I.    Corporate  Seal 

The  corporate  seal  of  the  Company  shall  consist  of  two  concentric  circles, 
between  which  shall  be  the  name  of  the  Company,  and  in  the  centre  shall  be  in- 
scribed "Incorporated  1922,  New  Jersey,"  and  such  seal,  as  impressed  on  the  mar- 
gin hereof,  is  hereby  adopted  as  the  corporate  seal  of  the  Company. 

'Sec.  2.     Penalties 

Any  officer,  director,  or  stockholder  who  shall  disobey  or  violate  any  of  the 
provisions  of  these  by-laws  shall  be  fined  in  an  amount  not  to  exceed  Twenty 
Dollars,  such  fine  to  be  imposed  by  the  Board  of  Directors,  and  if  not  paid  at  the 
time,  to  be  deducted  from  any  salary  or  dividend  then  due  or  that  may  thereafter 
become  due  said  person. 

Sec.  3.    Amendment 

These  by-laws  may  be  amended,  repealed,  or  altered,  in  whole  or  in  part,  at 
any  regular  meeting  of  the  stockholders,  or  at  any  special  meeting  where  such 
action  has  been  duly  announced  in  the  call,  provided  that  a  majority  of  the  entire 
voting  stock  of  the  Company  shall  vote  for  such  amendment,  repeal,  or  alteration. 

The  Board  of  Directors  shall  have  no  power  to  amend,  alter,  or  repeal  the 
by-laws  adopted  by  the  stockholders,  but  may  pass  such  additional  by-laws  in 
conformity  therewith  as  may  be  necessary  or  convenient  to  facilitate  the  business 
of  the  Company. 


CHAPTER  IV 

SUBSCRIPTION  LISTS 

The  subject  of  subscription  lists  and  subscription  contracts 
is  treated  very  fully  elsewhere. i  No  general  discussion  is  there- 
fore attempted  here. 

Form  67.    Subscription  List — Simple  Form 

Subscription  List 
THE  INTERLOCKING  SWITCH  COMPANY 

To  be  Incorporated  under  the  Laws  pf  New  York 
By  John  H  Mills,  Harvey  Chandler,  and  Thomas  Wilson 

Capital  Stock $100,000 

Shares $100  each 


We,  the  undersigned,  hereby  severally  subscribe  for  and  agree  to  take  at  their 
par  value  the  number  of  shares  of  the  capital  stock  of  the  Interlocking  Switch 
Company  set  opposite  our  respective  signatures,  said  subscriptions  to  become  due 
so  soon  as  said  Company  is  organized  and  to  be  then  payable  in  cash  on  demand  of 
the  Treasurer  of  the  Company. 

New  York  City,  N.  Y. 
May  21,  1922 

NAMES  addresses  SHARES  AMOUNTS 

Harry  H.  Collins  235  West  23rd  St.,  N.  Y.  10  $1,000 

David  B.  White  975  Willis  Ave.,  N.  Y.  8  800 

Willard  H.  Ellison  Brooklyn,  N.  Y.  8  800 


The  names  of  the  incorporators  are  brought  into  the  heading 
of  the  foregoing  subscription  list  and  into  that  of  the  list  that 
follows  as  a  rneans  of  identifying  more  clearly  the  proposed  cor- 
poration. 

When  subscriptions  are  solicited  widely  or  from  parties  at  a 


1  Book  I,  Ch.  V,  "Subscription  Lists  and  Contracts." 

1474 


Ch.  4]  SUBSCRIPTION  LISTS  1475 

distance,  an  individual  subscription  blank  is  usually  employed 
and  is  mailed  with  such  statements  and  prospectuses  as  may  be 
necessary.     The  following  is  a  common  form: 

Form  68.     Subscription  Blank — Individual 

THE  CORD-TREAD  TIRE  COMPANY 

175  Montgomery  St. 

Jersey  City,  N.  J.  i 

To  be  Incorporated  under  the  Laws  of  New  Jersey 

for  the  Manufacture  of  Automobile  Tires 
By  Frank  Alston,  John  Stone,  and  Howard  Cole 

Capital  Stock $500,000 

Shares $10  each 

I  hereby  subscribe  for shares  of  the  capital  stock  of  the  Cord- 
Tread  Tire  Company  at  the  par  value  thereof,  and  agree  to  pay  Twenty-Five  Per 
Cent  (25%)  of  such  subscription  on  demand  of  the  Treasurer  as  soon  as  said  Com- 
pany is  incorporated,  and  Twenty-Five  Per  Cent  (25%)  on  demand  of  the  Treasurer 
of  the  Company  at  any  time  after  ninety  days  from  the  incorporation  of  said  Com- 
pany; the  remainder  of  said  subscription  to  be  paid  at  such  times  and  in  such 
amounts,  not  exceeding  ten  per  cent  of  said  subscription  in  any  one  month,  as  may 
be  required  by  the  Board  of  Directors  of  said  Company. 


Dated  at. 


The  right  is  reserved  to  reject  or  prorate  any  or  all  subscription  ^ 

The  reservation  of  the  right  to  reject  or  prorate  subscriptions 
enables  the  parties  in  control  to  exclude  undesirable  subscribers 
and  also  to  scale  or  reject  applications  in  case  of  oversub- 
scriptions. 

Stockholders  of  financial  institutions  in  New  York  are  liable 
for  debts  of  the  company  to  an  amount  equal  to  the  par  value  of 
the  stock  of  the  institution  owned  by  them.  This  double  lia- 
bility is  usually  provided  for  at  the  time  of  organization  by 
placing  the  price  of  shares  at  twice  their  par  value,  as  in  the  fol- 
lowing application.    This,  when  paid,  creates  a  surplus  equal  in 


1476  CORPORATE  FORMS  [Bk.  IV- 

amount  to  the  capital  stock  of  the  institution,  and  the  stock- 
holders having  already  paid  in  twice  the  par  value  of  their  stock, 
are  relieved  of  any  further  liability  thereon. 

Form  69.    Subscription  to  Bank  Stock — Individual 

Subscription  for  ^Stock 

THE  SECURITY  NATIONAL  BANK 

No.  57  Broadway,  New  York 

Capital,  $1,000,000  Shares  $100  each  Surplus,  $1,000,000 

New  York, 1922 

The  undersigned  applies  for shares  of  the  Capital  Stock  of  The 

Security  National  Bank  of  New  York,  at  Two  Hundred  Dollars  ($200)  per  share 
and  agrees  to  accept  such  portion  as  may  be  allotted  and  pay  for  same  when  called. 

Place No.  of  Shares 

Date Name 

Address 


The  foregoing  blank  was  sent  out  accompanied  by  a  list  of 
the  proposed  directors  and  by  the  following  letter:  ' 

New  York,  March  26,  1922 
Mr.  John  Edwards, 
New  York,  N.  Y. 

Dear  Sir: 

It  is  proposed  to  organize  a  National  Bank  with  One  Million  Dollars  ($1,000,- 
000)  Capital,  divided  into  Ten  Thousand  (10,000)  Shares  at  One  Hundred  Dollars 
($100)  per  share,  and  a  surplus  of  a  like  amount.  The  offices  of  the  bank  will  be 
located  at  No.  57  Broadway,  New  York  City.  Upwards  of  One  Million,  Five 
Hundred  Thousand  Dollars  ($1,500,000)  have  already  been  subscribed  towards  the 
proposed  organization  and  the  gentlemen  named  on  the  opposite  page  will  act  as 
Directors. 

A  form  of  subscription  is  herewith  enclosed  and  you  are  invited  to  become  a 
subscriber  to  the  capital  stock. 

Subscribers  are  requested  to  forward  their  subscriptions  to  the  undersigned  at 
the  above  address. 

Truly  yours, 

Willis  S.  Parker, 
Chairman  of  Organization  Committee 

N.B. — Subscription  books  will  close  on  May  first. 

Subscriptions  made  under  the  terms  of  the  foregoing  list  or 
application  are  of  the  nature  of  a  continuing  proposition,  and. 


Ch.  4]  SUBSCRIPTION  LISTS  1477 

until  the  company  is  organized  and  has  actually  accepted  them, 
are  revocable  at  the  will  of  the  subscribers.2  To  avoid  this  ele- 
ment of  uncertainty,  subscription  lists  are  sometimes  drawn  as 
in  the  following  form,  with  a  trustee  acting  for  the  corporation. 

Form  70.    Subscription  List — Trustee's 

StTBSCRiPTioN  List 

WARREN  CEMENT  COMPANY 

215  Broad  St.,  Newark,  N.  J. 

To  be  Incorporated  under  the  Laws  of  the  State  of  New  Jersey 
for  the  Manufacture  of  Portland  Cement 


Capital  Stock $1,000,000 

Shares $100  each 

We,  the  undersigned,  hereby  agree  with  James  J.  McLaren  as  Trustee  for  the 
Warren  Cement  Company,  to  subscribe,  and  do  hereby  severally  subscribe,  for  the 
number  of  shares  of  the  capital  stock  of  said  Company  set  opposite  our  respective 
signatures,  and  agree  to  pay  the  par  value  thereof  as  follows: 

Ten  Per  Cent  (^10%)  on  demand  to  James  J.  McLaren  as  Trustee  for  said 
Company,  such  payment,  or  so  much  thereof  as  may  be  necessary,  to  be  used  for 
the  preliminary  and  incorporating  expenses  of  said  Company;  Thirty  Per  Cent 
(30%)  to  the  Treasurer  of  the  Company  so  soon  as  said  corporation  is  organized; 
Twenty-Five  Per  Cent  (25%)  on  demand  of  the  Treasurer  of  the  Company  at  any 
time  after  ninety  days  from  the  date  of  incorporation;  and  the  remainder  at  such 
times  and  in  such  instalments  as  may  be  prescribed  by  the  Board  of  Directors. 

Newark,  New  Jersey, 
March  15,  1922 

NAMF.S  ADDRESSES  SHARES  AMOUNTS 

Mr.  Alfred  H.  Braum  Paterson,  N.  Y.  50  $SiCoo 

James  H.  Allen  25  Wall  St.,  N.  Y.  75  7, 500 

William  Raymond  Brooklyn,  N.  Y.  50  5, 000 


Subscriptions  under  the  preceding  form  are  held  to  be  a  con- 
tract between  the  subscribers  and  the  trustee.  They  cannot 
therefore  be  withdrawn  nor  revoked  but  are  binding  from  the 
date  when  made.  The  subscription  list  which  follows  is  of  a 
similar  nature. 


•See  Book  I,  {{  47.48. 


1478  CORPORATE  FORMS  [Bk.  IV- 

Form  71.     Subscription  List — Agreement  with  Promoters 

SuBSCBiPTioN  List 
HARRISON  COTTON  MILLS 


Capital  Stock $500,000 

Shares $100  each 

We,  the  undersigned,  hereby  agree  with  William  H.  Hamilton  and  John  B. 
Ravvley,  both  of  New  York  City,  New  York,  as  Promoters  and  Trustees  of  the 
Harrison  Cotton  Mills,  a  corporation  to  be  organized  under  the  laws  of  the  State  of 
North  Carolina  for  the  purposes  and  under  the  conditions  set  forth  in  the  attached 
statement,  to  subscribe,  and  do  hereby  severally  subscribe  for  the  number  of  shares 
of  the  Treasury  Stock  of  said  Company  set  opposite  our  respective  signatures  at  the 
rate  of  Seventy-five  Dollars  ($75)  for  each  One  Hundred  Dollar  share,  and  agree  to 
pay  the  amounts  of  our  respective  subscriptions  to  the  Treasurer  of  the  Harrison 
Cotton  Mills  as  soon  as  the  said  Company  is  incorporated  and  its  treasury  stock 
ready  for  issue;  said  stock  to  be  delivered  to  the  respective  subscribers  therefor 
full-paid  and  non-assessable  upon  payment  of  the  said  subscription  price. 

It  is  mutually  agreed  between  the  subscribers  hereto  and  the  said  William  H. 
Hamilton  and  John  B.  Rawley,  Promoters  and  Trustees  of  said  proposed  corpora- 
tion, that  the  subscriptions  of  this  present  contract  are  conditioned  upon  bona  fide 
subscriptions  for  stock  to  the  par  value  of  Three  Hundred  Thousand  Dollars 
($300,000)  being  secured  hereunder  within  ninety  days  from  the  date  hereof,  and 
otherwise  are  null  and  void. 


New  York  City,  New  York, 
January  18,  1922 

NAMES                                                   ADDRl 

Samuel  H.  French                        Raleigh, 
Charles  H.  Wellbourne                Raleigh, 
H.  G.  Williamson                         New  Yoi 

N.Y. 

SHARES 
SO 

SO 
100 

2SSES 

N.  C. 

N.  C. 
rk  City, 

AMOUNTS 

$3,750 
3,750 

7.SOO 

Such  a  subscription  list  is  usually  circulated  with  a  statement 
attached  giving  full  details  as  to  the  capitalization  and  purposes 
of  the  company.  When  signed  it  forms  an  irrevocable  contract 
between  the  subscribers  and  the  trustees. 

This  subscription  contract  requires  the  delivery  of  full-paid 
treasury  stock,  notwithstanding  the  fact  that  the  subscription 
price  amounts  to  but  75%  of  its  face  value.  This  is  usually 
accomplished  by  the  issuance  of  the  stock  for  property  and  the 
return  of  a  portion  of  this  issued  stock  to  the  company  to  be 
sold  for  operating  capital.  Full-paid  treasury  stock  is  thus 
secured  to  fill  the  contract  requirements.' 

•See  Book  I,  i  125. 


CHAPTER  V 

SUBSCRIPTION  RECEIPTS  AND  RECORDS 

After  incorporation,  payments  of  stock  subscriptions  are 
made  to  the  treasurer  of  the  company  and  receipts  are  issued 
by  him.  If  payments  are  to  be  made  before  incorporation,  a 
trustee  or  trustees  must  necessarily  be  appointed  to  act  for  the 
company.  Such  trustees  are  usually  selected  by  those  having 
charge  of  the  subscription  and  are  named  in  the  subscription 
list — as  shown  in  Forms  70  and  71  and  thereby  made  parties 
to  the  transaction. 

Form  72.    Trustee's  Receipt 

No.  56  15  Shares 

LANSFORD  MANUFACTURING  CORPORATION  1 

Trustee's  Certificate 

$150.00 

I  hereby  certify  that  Henry  M.  McGill,  a  subscriber  for  Fifteen  Shares  of  the 
Capital  Stock  of  the  Lansford  Manufacturing  Corporation  at  its  par  value  of  One 
Hundred  Dollars  per  share,  has  paid  to  me  as  Trustee  for  said  Corporation,  on 
account  of  said  subscription  and  in  accordance  with  its  terms,  the  sum  of  One  Hun- 
dred and  Fifty  Dollars. 

This  receipt  will,  upxjn  the  organization  of  the  said  Lansford  Manufacturing 
Corporation,  be  received  and  credited  by  the  Treasurer  thereof  to  its  full  amount 
as  a  payment  upon  said  subscription. 

New  York,  Gerald  H.  McNell, 

February  20,  1922  Trustee 

Receipts  of  this  nature  are  usually  printed  and  bound  in  book 
form  with  stub  attached,  and  are  so  perforated  that  the  receipt 
may  be  easily  torn  out  and  given  to  the  party  making  the  pay- 
ment. The  stub  is  the  trustee's  record  of  the  transaction.  It 
should  show  the  number  of  the  receipt,  the  amount  paid  in, 
the  name  of  the  payee,  the  number  of  shares  subscribed  for, 

1479 


1480  CORPORATE  FORMS  [Bk.  IV- 

the  percentage  or  other  details  of  the  instalment,  and  the  date. 
When  instalments  are  paid  after  incorporation,  a  treasurer's 
receipt  may  be  given  for  each  payment.     The  following  is  a 
simple  form: 

Form  73.    Treasurer's  Receipt  for  Instalment 


Wf5 


No.  34  15  Shares 

THE  WTLCOX  RADIATOR  COMPANY 
30  Broad  Street 
New  York 

$150.00 

Received  of  Edward  H.  Williamson  the  sum  of  One  Hundred  Dol- 
lars, instalment  payment  No.  5,  of  Ten  Per  Cent  upon  his  subscription  for 
Fifteen  Shares  of  the  Capital  Stock  of  The  Wilco^x  Radiator  Company. 
New  York  City,  *    J.  H.  Wilcox, 

April  14,  1922  Treasurer 

This  receipt  should  also  have  its  stub  upon  which  the  im- 
portant items  are  entered. 

When  payment  is  made  in  full  of  a  stock  subscription,  and 
the  stock  certificates  are  ready  for  delivery,  they  are  in  them- 
selves a  sufficient  receipt.  If  not  ready  for  delivery,  temporary 
certificates  are  frequently  issued  and  are  exchanged  for  the 
permanent  certificates  of  the  company  as  soon  as  the  latter  are 
ready  for  delivery.  These  temporary  certificates  are  in  the 
form  of  the  regular  stock  certificate,  but  are  usually  prepared 
at  no  greater  expense  than  is  justified  by  their  temporary  nature. 
In  some  cases,  however,  the  temporary  certificate  is  a  hand- 
somely engraved  instrument  fully  equal  in  appearance  to  the 
usual  permanent  certificate. 

When  permanent  stock  certificates  are  not  ready  for  deliv- 
ery at  the  time  payments  are  made,  and  temporary  certificates 
are  either  not  ready  or  are  not  to  be  issued  at  all,  the  treasurer's 
receipt  can  be  used  to  bridge  over  the  interim,  and  in  such  case 
is  usually  more  formal  than  the  ordinary  receipt.  The  treas- 
urer's receipt  which  follows  is  of  this  nature;  it  is  usually  in- 
tended for  very  temporary  use  and  is  then  severely  plain  in  style. 


Ch.  s]  SUBSCRIPTION  RECEIPTS  AND  RECORDS  1481 

Form  74.    Treasurer's  Receipt  for  Stock  Subscription 

:     No.  50  10  Shares 

HOWARD  PUBLISHING  COMPANY 

o3        •  No.  225  Atlantic  Avenue, 

«        :  Brooklyn,  N.  Y. 


P^ 


This  is  to  certify  that  Harry  H.  Wilson  has  paid  into  the  Treasury  of 
the  Howard  Publishing  Company  the  sum  of  One  Thousand  Dollars, 
payment  in  full  of  his  subscription  for  Ten  Shares  of  its  Capital  Stock, 
duly  executed  Certificates  for  which  will,  upon  surrender  of  this  Receipt, 
be  issued  to  his  order  so  soon  as  said  Certificates  are  ready  for  delivery. 

March  3,  1922  Frank  J.  Ardwald, 

Treasurer 


At  times  when  payment  of  stock  subscriptions  has  been 
made  and  neither  permanent  nor  temporary  certificates  are 
ready  for  delivery,  the  president  will  join  the  treasurer  in 
the  signature  of  the  foregoing  treasurer's  receipt,  which  then 
becomes  in  effect  a  stock  scrip.  The  usual  form  of  stock  scrip 
is,  however,  as  shown  in  Form  75.  This  scrip  might  or  might  not 
be  sealed.  Ordinarily  the  corporate  seal  is  affixed  and  the  stock 
scrip  then  becomes  for  all  practical  purposes  a  temporary  stock 
certificate. 

Stock  scrip  is  sometimes  employed  when  subscription  pay- 
ments are  made  in  instalments.  The  face  of  the  scrip  evidences 
the  first  instalment,  and  subsequent  instalments  are  either 
indorsed  on  the  back  of  the  scrip,  the  treasurer's  signature 
verifying  each  payment,  as  shown  in  Form  76,  or,  if  personal 
payment  is  impossible,  are  evidenced  by  separate  receipts.  In 
such  case  each  receipt  will  of  course  "tie  up"  closely  with  the 
scrip  so  that  the  two  are  easily  corrected. 

When  the  indorsement  plan  is  followed,  the  stub  should 
also  have  rulings  to  permit  the  entry  of  payments  and  their 
date,  so  that  both  the  scrip  and  its  stub  will  show  a  complete 
record  of  the  transaction. 

\ 


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Ch.  si  SUBSCRIPTION  RECEIPTS  AND  RECORDS 

Form  76.    Indorsement  Form  for  Stock  Scrip 


1483 


Date 


Number  of 
Instalment 


Amount 
Paid 


Signature  of  Treasurer 


June  14,  1922 

September  14,  1922. 


).oo 
250.00 


William  H.  Hansford 
William  H.  Hansford 


A  subscription  to  stock  and  the  payments  thereon  are 
assignable.  A  general  form  of  assignment  to  be  indorsed  upon 
the  back  of  a  receipt  for  subscription  payments  is  as  follows : 

Form  77.     Assignment  of  Subscription  and  Payments 


For  Value  Received,  I  hereby  sell,  assign  and  transfer  unto  John  H.Wardwell 
of  New  York  City  my  subscription  to  Twenty-Five  Shares  of  the  Capital  Stockof 
the  Warner  Export  Corporation,  together  with  the  payments  made  thereon,  all  as 
evidenced  by  the  within  certificate,  and  I  do  hereby  authorize  and  instruct  the 
proper  officials  of  said  Company  upon  completion  of  the  conditions  of  my  said  sub- 
scription, to  issue  said  stock  to  the  order  of  my  said  assignee. 

New  York,  Henry  H.  McGill 

May  4,  1922 


In  the  presence  of 

Samuel  H.  Kennard 


CHAPTER  VI 
STOCK  CERTIFICATES 

From  the  legal  standpoint  the  style  of  a  stock  certificate 
does  not  bear  in  any  way  upon  its  effectiveness.  From  the 
business  standpoint,  however,  the  certificate  should  at  least 
be  neat  and  attractive.  Whether  the  highly  colored  and  em- 
bellished stock  certificates  so  frequently  seen  are  desirable,  will 
depend  upon  the  conditions.^ 

When  the  item  of  cost  is  not  important  or  when  stock 
exchange  requirements  are  to  be  complied  with,  the  finest  bond 
paper  is  employed  for  stock  certificates  and  the  subject  matter 
is  engraved  on  steel.  The  cost  then  runs  up  into  the  hundreds 
or  thousands  of  dollars  according  to  the  style  and  number  of 
certificates.  On  the  other  hand,  if  the  issue  is  but  temporary 
or  the  incorporators  indifferent,  the  certificates  are  frequently 
printed  or  even  written  on  ordinary  paper  and  in  plainest  de- 
sign. Usually,  however,  a  good  quality  of  bond  paper  is  em- 
ployed with  the  body  and  design  Hthographed  and  the  variable 
data  printed  in,  the  cost  ranging  from  $5  to  $10  per  hundred 
for  the  cheaper  forms,  up  to  six  or  eight  times  this  amount 
for  the  better  grades.  A  neat,  attractive  certificate  on  good  bond 
paper,  with  the  variable  data  printed  and  the  certificates  num- 
bered and  bound,  will  cost  from  $10  to  $15  for  a  book  of  100 
certificates. 

The  regular  or  "stock"  forms  for  certificates  of  stock  are 
usually  prepared  in  quantity.  The  body  and  general  design  of 
the  certificate  are  lithographed  or  engraved,  blanks  being  left 
for  the  variable  data  such  as  the  name  of  corporation,  capital 
stock,  etc.    These  are  filled  in  by  local  printers  at  the  time  the 

1  For  general  discussion  of  stock  certificates,  see  Book  I,  5  §  97.  2S9,  344. 

1484 


Ch  6]  STOCK  CERTIFICATES  1485 

certificates  are  to  be  used.  For  this  reason  any  variation  of  the 
ordinary  form  involves  the  preparation  of  a  special  certificate 
at  a  considerably  increased  cost.  As  the  wording  of  the  regular 
forms  is  fairly  good,  the  cost  of  a  special  certificate  merely  to 
secure  better  wording  is  but  seldom  justified. 

The  certificates  which  follow  are  correct  as  to  wording. 
Two  forms  of  stub  are  given.  The  one  presented  in  connec- 
tion with  Form  80,  "Preferred  Stock,"  is  the  clearer  and  better, 
but  the  stub  given  in  connection  with  Form  78,  "Common 
Stock,"  is  so  frequently  supplied  with  the  regular  stock  certi- 
ficates that  it  is  also  presented. 

The  name  of  the  company  is  usually  printed  in  full  upon 
the  certificates,  though  the  abbreviation  "Co."  may  be  employed 
if  desired.  A  seal  is  not  essential  to  the  validity  of  the  certifi- 
cate unless  so  provided  by  charter,  by-law,  or  some  other  com- 
petent authority.    In  practice,  however,  it  is  invariably  affixed. 

In  the  absence  of  statutory  regulation,  any  form  of  seal 
desired  by  the  corporate  authorities  may  be  adopted  and  there- 
upon becomes  the  corporate  seal.  The  usual  and  preferable 
form  consists  of  an  outer  and  inner  circle,  between  which  appears 
the  name  of  the  corporation.  Within  appears  the  year  of  in- 
corporation and  the  name  of  the  state  in  which  the  company 
is  incorporated.  Seals  for  corporate  purposes  are  made  in  a 
variety  of  styles,  ranging  in  cost  from  $2.50  up.  A  good,  or- 
dinary seal  should  be  secured  for  from  $3  to  $5. 

Occasionally  stock  is  issued  subject  to  restrictions,  and  in 
any  such  case  either  the  restrictions,  or  a  notice  of  them  with  a 
reference  to  the  instrument  in  which  they  may  be  found,  should 
appeaj"  on  the  face  of  the  stock  certificate.  Such  restrictions 
are  frequently  of  doubtful  validity,  at  the  best,  but  even  where 
proper  and  legally  enforcible  against  the  original  holders  of  the 
stock,  they  would  not  be  effective  against  any  subsequent  holder 
for  value  unless  it  could  be  proved  that  he  took  the  stock  with 
knowledge  or  notice  of  the  restrictions.  The  printed  statement 
on  the  stock  certificate  is  convenient  and  sufficient  proof  of  this. 


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Ch.  61  STOCK  CERTIFICATES  1487 

Certificates  for  shares  of  no  par  value  differ  but  little  in  form 
from  the  common  stock  certificate  shown  in  Form  78.  As  the 
shares  have  no  par  value  the  total  capital  stock  of  the  company 
cannot  be  given.  The  certificate,  however,  as  shown  in  Form  79, 
usually  states  the  number  of  shares  of  no  par  value  and,  if  there 
is  preferred  stock  with  a  stated  par  value,  the  number  of  its 
shares  with  the  par  value  of  each. 

Form  79.     Stock  Certificate — No-Par- Value  Shares 

No.  35  icx)  Shares 

Incorporated  under  the  Laws  of 

the  State  of  Delaware 

KINSEY-MORGAN  MOTORS  COMPANY 
r     "t  1  Qf    I  /Common  Stock,  10,000  shares  without  nominal  or  par  value 
Full-Paid  and  Non-Assessable 

This  is  to  Certify  that  Henry  P.  Williams  is  the  owner  of  One  Hundred 
Shares  of  the  no-par-value  Common  Stock  of  the  Kinsey-Morgan  Motors  Company, 
transferable  on  the  books  of  the  Company  by  the  owner  thereof  in  person  or  by 
duly  authorized  attorney,  upon  surrender  of  this  certificate  properly  indorsed. 

rcoRPORATE\  Witness  the  Seal  of  the  Company  and  the  signatures  of  its 

\      SEAL      /  duly  authorized  officers  this  tenth  day  of  January,  1922. 

Howard  McAlpin, 
President 
Frank  W.  Kinsey 
Treasurer 


When  certificates  for  preferred  stock  are  prepared,  the  con- 
ditions of  issue  should  be  set  out  in  full  on  the  face  of  the  cer- 
tificate, though,  if  lengthy,  the  certificate  may  merely  embody 
the  more  important  provisions,  and  reference  be  made  on  the 
certificate  to  the  charter,  the  by-law,  or  the  resolution  under 
which  the  stock  is  issued. 

When  a  reference  of  this  kind  is  to  be  made,  the  wording  of 
Form  80  would  be  followed  to  the  end  of  the  first  paragraph. 
The  next  paragraph  would  then  read  as  follows:    "The  preferred 


1488 


CORPORATE  FORMS 


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Ch.  6]  STOCK  CERTIFICATES  1489 

stock  represented  by  this  certificate  is  authorized  by  the  Certif- 
icate of  Incorporation  of  the  said  Company  as  filed  in  the 
office  of  the  Secretary  of  State  of  New  York  on  the  first  day 
of  May,  1922,  and  is  issued  under  the  terms  and  conditions 
therein  set  forth." 

In  some  few  states  the  statutes  prescribe  that  the  condi- 
tions of  preferred  stock  must  appear  with  greater  or  less  ful- 
ness on  the  face  of  the  certificate. 

Preferred  stock  is  sometimes  issued  in  very  crude  form, 
"Preferred  Stock"  being  printed  across  the  face  of  the  ordinary 
certificate  in  red  or  some  other  distinctive  color  or  style,  fol- 
lowed by  the  conditions  under  which  the  preferred  stock  is 
issued. 

Preferred  stock  certificates  are  numbered  independently  of 
the  common  stock  certificates.  That  is,  the  first  certificate  of 
preferred  stock  is  numbered  "i"  reg^ardless  of  the  fact  that 
the  first  certificate  of  common  stock  is  also  numbered  "i," 
the  two  series  being  sufficiently  distinguished  by  the  fact  that 
they  are  respectively  common  and  preferred  stock. 

Stock  is  transferred  by  assignment,  the  form  being  printed 
upon  the  back  of  the  certificate.  There  is  but  one  form  of  this 
assignment  in  common  use,  which,  though  informal  and  incom- 
plete in  some  respects,  is  almost  invariably  employed.  When  this 
assignment  is  executed  by  the  owner  of  record,  and  the  certif- 
icate is  duly  delivered,  the  stock  represented  thereby  becomes 
the  property  of  the  party  named  in  the  assignment  form.  If 
this  party  wishes  to  assign  the  certificate  again,  he  might  execute 
another  similar  assignment,  either  written  on  the  back  of  the 
certificate,  or  prepared  as  a  separate  document  and  attached 
to  the  certificate.  More  commonly  he  surrenders  the  certificate 
and  takes  out  a  new  one  in  his  own  name,  or  in  the  name  of 
the  party  to  whom  he  wishes  the  stock  to  be  transferred. 

Or — a  very  common  practice  when  stock  is  assigned — the 
assignment  is  duly  executed,  but  the  blanks  for  the  names  of 
the  assignee  and  the  attorney  are  not  filled  in  at  all.    The 


I490  CORPORATE  FORMS  [Bk.  IV- 

certificate  is  then  said  to  be  * 'assigned  in  blank"  and  may  be 
passed  from  hand  to  hand  without  further  formality,  the  equi- 
table ownership  of  the  stock  following  the  certificate.  Any  owner 
who  wishes  to  make  himself  a  stockholder  of  record,  i.e.,  appear 
upon  the  stock  books  of  the  company  as  the  owner  of  the  stock, 
may  then  fill  out  the  blanks  in  the  assignment,  turn  the  cer- 
tificate in  to  the  secretary  of  the  company  for  cancellation, 
and  receive  a  new  certificate  in  his  own  name. 2 

The  following  assignment  is  complete,  the  parts  which 
have  been  filled  in  being  indicated  by  parentheses : 

Form  81.     Assignment  of  Stock  Certificate 

For  Value  Received,  (I)  hereby  sell  and  transfer  unto  (John  J.  McMillan  of 
New  York  City,  Twenty-five)  Shares  of  the  Capital  Stock  represented  by  the 
within  Certificate,  and  do  hereby  irrevocably  constitute  and  appoint  (Harry  S. 
Gunnison)  my  attorney  to  transfer  the  said  stock  on  the  books  of  the  within  named 
Company  with  full  power  of  substitution  in  the  premises. 

Dated  (March  2,  1922)  (Howard  S.  Allen) 

In  presence  of 

(Anna  H.  Marshall) 


Usually  the  secretary  of  the  company  is  designated  as  the 
attorney  who  is  to  make  the  transfer  on  the  books  of  the  com- 
pany, though  any  other  suitable  person  might  be  named  instead. 

Sometimes  stock  is  held  by  trustees  under  the  terms  of  a 
voting  trust  agreement. s  In  such  case,  at  the  time  the  trust 
is  formed  the  certificates  of  stock  to  be  held  under  it  are  duly 
assigned  and  are  turned  in  to  the  trustees,  who  surrender  them 
for  cancellation  and  take  out  certificates  in  their  own  names 
as  voting  trustees. 

Voting  trustees'  certificates  are  then  usually  prepared  in 
the  general  style  of  the  ordinary  stock  certificate,  and  are  de- 
livered to  the  parties  to  whom  the  stock  belongs  to  evidence 


«  See  Book  I,  Chs.  XXXVIII  and  XXXIX,  "Transfers  of  Stock." 
•  For  text  of  a  voting  trust  agreement,  see  Form  104. 


Ch.  6]  STOCK  CERTIFICATES  1491 

its  real  ownership.  These  trustees'  certificates  pass  by  assign- 
ment, the  equitable  ownership  of  the  stock  being  thereby  vest- 
ed in  the  assignee.  Forms  82  and  83  give  the  general  wording  of 
a  voting  trustees'  certificate. 

Form  82.    Voting  Trustees'  Certificate 

Organized  under  the  Laws  of  the  State  of  New  York 

Number  125  35  Shares 

ALBANY  PAPER  COMPANY 

Capital  Stock,  $750,000 

Certificate  for  Stock  Deposited 
Under  Voting  Trust  Agreement  of  April  12,  1922 

The  undersigned  Trustees,  by  the  National  Trust  Company,  their  agent,  hav- 
ing received  on  deposit  the  entire  capital  stock  of  the  Albany  Paper  Company,  full- 
paid  and  non-assessable,  all  being  held  under  the  above-named  agreement,  to  the 
terms  of  which  the  holder  hereof  assents  by  receiving  this  certificate,  certify  that 
John  N.  Allen  is  entitled,  subject  to  the  provisions  of  said  agreement,  to  Thirty-five 
Shares  of  the  stock  deposited  thereunder.  This  Certificate  entitles  the  holder  to 
all  rights,  dividends,  and  privileges  belonging  to  the  actual  stock,  excepting  only 
the  right  to  vote.  The  Trusteeship  herein  agreed  to  may  be  terminated  after  three 
years  upon  the  terms  set  forth  in  the  above-named  agreement,  and  is  ended  by 
limitation  in  ten  years  from  date  of  agreement. 

Transferable  only  on  the  books  of  the  undersigned  at  the  ofiice  of  the  National 
Trust  Company,  New  York  City,  by  the  holder  hereof  in  person  or  by  duly  author- 
ized attorney,  upon  surrender  of  this  certificate  properly  indorsed. 

Dated  April  15,  1922  Henry  W.  Turner, 

Frank  D.  McCall, 
William  H.  Montgomery, 
Howard  F.  Bergman, 
Philip  T.  Atwater, 

Trustees 

By  National  Trust  Company, 

Depositary  and  Agent 
By  Howard  T.  Latham, 

Secretary 


When  the  voting  trust  is  terminated,  these  trustees'  certif- 
icates are  exchanged  for  the  usual  stock  certificates.* 


*  See  Book  I,  Ch.  LVI,  for  discussion  of  voting  trusts,  and  Form  104,  for  voting  trust 
agreement. 


1492  CORPORATE  FORMS  [Bk.  IV- 

A  simpler  form  of  trustees'  certificate  is  as  follows: 
Form  83.    Voting  Trustees'  Certificate — Simple  Form 

Number  65  25  Shares 

HANDSEL  CHROME  OXIDE  COMPANY 

Trustees'  Certificate  of  Beneficial  Interest 


The  undersigned,  as  Trustees  under  a  certain  Trust  Agreement  entered  into 
fcetween  themselves  and  John  H.  Baldwin  on  the  seventh  day  of  December,  192 1, 
whereby  the  entire  Capital  Stock  of  the  Handsel  Chrome  Oxide  Company  has  been 
placed  in  their  hands  subject  to  the  terms  of  said  agreement,  do  hereby  certify 
that  Henry  P.  Bowman  is  the  owner  of  Twenty-five  Shares  of  the  beneficial  interest 
set  forth  in  said  agreement. 

Transferable  only  on  the  books  of  the  Trustees  in  person  or  by  attorney,  and 
upon  the  surrender  of  this  certificate  duly  indorsed. 

In  Witness  Whereof,  the  Trustees  have  signed  this  certificate  this 
15th  day  of  January,  1922. 

Howard  Coleman  ] 

John  W.  Willard  i  Trustees 

Sargent  P.  Cummings  J 


The  form  of  assignment  on  the  back  of  either  of  these  certif- 
icates would  be  in  the  following  general  form : 

Form  84.     Assignment  of  Voting  Trustees'  Certificate 

For  Value  Received,  I  hereby  sell,  assign,  and  transfer  to  Charles  Campbell 
the  interest  in  the  stock  of  the  Albany  Paper  Company  represented  by  the  within 
Certificate,  and  do  hereby  irrevocably  constitute  and  appoint  Howard  T.  Latham 
my  attorney  to  transfer  the  said  interest  on  the  books  of  the  within-named  Trus- 
tees, with  full  powers  of  substitution  in  the  premises. 

Dated  June  15,  1922  John  N.  Allen 


vV. 

,  "^•''  CHAPTER  VII  ,  Z^Z  '~yn 


STOCK  BOOKS 


The  usual  stock  books  are  the  transfer  book  and  the'  stock 
ledger,  this  latter  being  also  frequently  referred  to  as  the  stock 
book.i  ^^^  XJ^  L^iiiip^. 


Form  85.     Stock  Transfer  Book 


.d] 


Ledger  Folio  27  Transfer  No.  556 

ALLIANCE  MOTOR  COMPANY 

For  Value  Received,  I  hereby  sell,  assign  and  transfer  unto  John  H.  Lansing, . 
of  Newark,  New  Jersey,  Seventy-six  Shares  of  the  Capital  Stock  of  the  above- 
mentioned  Company,  now  standing  in  my  name  on  the  Company  books  and  repre- 
sented by  surrendered  Certificates  Nos.  32,  37,  and  44. 

. .        Witness  my  hand  and  seal  this  28th  day  of  May,  1922.  ,j-[j 

George  B.  Goldman    [l.  s.] 
By  George  Gale,  Attorney 
New  Certificate  No.  224 
Issued  to  John  H.  Lansing 
Ledger  Folio  84  |<)J< 

.TJTT"" ~"~-~::rrrmmTX^Tri\rij:"V3iim\r-t['^^^^^ 

The  transfer,  books  supplied  by  stationers  usually  have  a 
stub  attached  to  the  transfer.  As  the  transfer  itself  remains 
in  the  book,  this  stub  is  merely  an  unnecessary  repetition  of 
matter  already  shown  on  the  transfer.  '''^ 

The  transfer  book  itself  is  practically  a  duplication  of  the 

assignment  appearing  upon  the  stock  certificate,  and  by  many 

corporations  is  not  kept  at  all,  the  duly  executed  assignment 

on  the  back  of  the  certificate  being  regarded  as  an  all-sufficient 

authorization  for  the  transfer  of  the  assigned  stock.   "  "  '  ^ 
^^M   rrO 

>  For  discussion  of  the  stock  books,  see  Book  I,  i  262,  and  Ch.  XXXVII,  "The  Stock 
Records";  also  Book  III,  {{  38-42.  For  form  of  stock  register  and  transfer  register,  see  Ch. 
XXVI,  "Miscellaneous  Books  of  Record."  UlIO  IIJ' I 

1493 


1494  CORPORATE  FORMS  [Bk.  IV- 

The  signature  to  the  assignment  of  the  stock  transfer  book 
is  sometimes  witnessed.  This  signature  is,  however,  usually 
that  of  the  secretary  or  the  transfer  agent,  or  is  affixed  in  their 
presence,  and  as  the  assignment  is  at  the  most  but  supple- 
mentary to  the  duly  witnessed  assignment  on  the  back  of 
the  surrendered  certificate,  a  witness  to  its  signature  is  gen- 
erally regarded  as  superfluous. 

In  many  states  a  stock  book  or  stock  ledger — the  two  being 
practically  synonymous — is  required  by  the  statutes.  Whether 
required  by  the  statutes  or  not,  some  book  of  the  kind  must 
necessarily  be  kept  in  order  to  provide  an  accurate  record  of 
the  issued  and  outstanding  stock  of  the  company.  The  form 
of  stock  book  or  stock  ledger  shown  in  Form  86  will  be  found  con- 
venient and  will  meet  the  statutory  requirements  of  almost 
every  state. 

The  leaves  of  this  book  are  indexed,  usually  as  a  matter 
of  convenience,  but  in  some  states  to  secure  the  alphabetical 
arrangement  required  by  statute.  The  name  and  address  of 
the  stockholder  with  whom  the  particular  account  is  kept 
appears  at  the  head  of  the  page  as  in  an  ordinary  ledger.  On 
the  right-hand  side  of  the  page  the  party  is  credited  with  the 
stock  he  purchases  or  otherwise  acquires,  and  on  the  left-hand 
side  is  debited  with  any  stock  sold  or  otherwise  disposed  of. 
The  difference  between  the  two  sides  shows  at  any  time  the 
amount  of  stock  standing  to  his  credit. 

On  the  debit  or  sale  side  of  the  account,  the  first  column 
gives  the  date  of  the  transaction;  the  second  the  name  of  the 
party  to  whom  the  stock  is  transferred;  the  third  the  number 
of  the  surrendered  certificate;  the  fourth  the  number  of  the 
certificate  reissued  to  the  transferrer  when  but  a  portion  of  the 
stock  represented  by  the  surrendered  certificate  is  sold;  and  the 
fifth  column  shows  the  number  of  shares  sold. 

On  the  credit  side,  which  shows  stock  acquired  by  the 
party  with  whom  the  account  is  kept,  the  first  column  gives 
the  date  of  purchase;  the  second  the  name  of  the  party  as- 


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STOCK  BOOKS 


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CORPORATE  FORMS 


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Ch.  7]  STOCK  BOOKS  1497 

signing  the  purchased  stock;  the  third  shows  what  amount  has 
been  paid  on  the  stock,  thereby  indicating  whether  it  is  full 
paid  or  otherwise;  the  fourth  column  gives  the  number  of 
the  certificates  issued  to  the  party;  and  the  last  column  the 
number  of  shares  acquired. 

Where  a  number  of  certificates  in  the  same  name  are  issued 
or  canceled  in  a  single  transaction,  the  entry  will  vary  accord- 
ing to  the  conditions.  If  but  a  few  certificate  numbers  are 
involved,  they  may  usually  be  entered  in  small  figures  on  the 
line  in  the  proper  column.  If  the  numbers  of  certificates  are 
too  great  to  be  so  entered,  two  or  more  lines  may  be  devoted 
to  the  transaction,  or  the  numbers  may  be  noted  at  the  bottom 
of  the  page,  reference  to  these  numbers  being  inserted  in  the 
column  where  the  numbers  ordinarily  appear.  If,  however, 
the  certificates  canceled  or  issued  are  in  different  names,  one 
line  must  necessarily  be  given  for  each  certificate. 

In  New  York,  acting  under  authority  of  §276  of  the  Stock 
Transfer  Tax  Law  (as  amended  by  Laws  192 1,  Chapter  443, 
Section  216),  a  special  form  of  stock  book  has  been  prescribed 
by  the  Tax  Commission.  The  use  of  this  form  by  New  York 
corporations  is  obligatory.  Form  87  shows  a  stock  book  for 
the  use  of  brokers;  Form  88  a  stock  book — or  as  stated  in  the 
law,  "transfer  ledger  or  register" — for  the  use  of  corporations 
and  transfer  agents.  The  only  new  feature  in  these  prescribed 
forms  is  the  introduction  of  the  special  columns  for  the  record 
of  the  stamp  tax  paid  on  transfers  in  the  broker's  stock  book. 
In  some  other  states  the  statutes  prescribe  similar  forms. 


v.in 


CHAPTER  VIII 
^'organization  meeting  of  stockholders 

The  general  subject  of  the  first  or  organization  meeting 
of  stockholders  has  already  been  discussed  at  length  in  a  pre- 
ceding chapter.!  The  forms  of  the  present  chapter  are  supple- 
mentary thereto. 

In  most  states  the  first  directors  of  a  corporation  are  elected 
by  the  stockholders,  and  when  a  corporation  is  organized  a 
stockholders'  meeting  must  of  necessity  precede  the  directors' 
meeting.  In  some  states,  however,  as  in  New  York,  Colorado, 
and  California,  the  first  directors  are  appointed  by  the  charter, 
and  in  such  states  the  first  meeting  of  stockholders  loses  much 
of  its  importance,  particularly  when  the  directors  have  power 
to  adopt  by-laws.  In  such  case  it  may  or  may  not  precede  the 
first  meeting  of  directors  at  the  discretion  of  the  incorporators. 

Usually  at  the  first  meeting  of  stockholders,  the  charter 
is  to  be  received,  by-laws  adopted,  directors  to  be  elected, 
other  details  of  organization  to  be  provided  for,  and,  as  almost 
invariably  property  of  some  kind  is  to  be  taken  over  or  pur- 
chased by  the  new  corporation,  the  stockholders  pass  a  resolu- 
tion authorizing  the  directors  to  accept  the  proposition  as 
submitted. 

The  procedure  at  the  first  corporate  meetings  varies  ac- 
cording to  the  requirements  of  the  particular  state.  In  the 
great  majority  of  states  the  first  meeting  of  stockholders  must 
be  held  within  the  state.  If  all  or  a  majority  of  the  incor- 
porators reside  outside  the  state  of  incorporation — a  condition 
which  frequently  arises — the  requirement  that  the  first  meet- 
ing of  stockholders  must  be  held  within  the  home  state  is  com- 

»  Book  I,  Ch.  XXXV,  "First  Meeting  of  Stockholders." 

1498 


Ch.  8]  STOCKHOLDERS'  ORGANIZATION  MEETING  1499 

plied  with  by  means  of  proxies.  The  non-resident  incorpor- 
ators send  their  proxies  to  the  attorney  or  other  agent  who 
represents  the  company  within  the  state  in  which  the  corpora- 
tion is  to  be  formed,  who  thereupon  holds  the  first  meeting 
of  stockholders,  transacts  all  necessary  business,  complies  with 
the  legal  requirements,  prepares  the  proper  minutes  of  the 
meeting,  has  them  duly  signed  by  the  acting  president  and 
secretary  of  the  meeting,  and  turns  the  minutes  and  the  com- 
pany over  to  its  "incorporators"  legally  qualified  to  conduct 
its  business.  Such  meetings,  though  purely  formal  and  per- 
functory, are  perfectly  legal. 

The  following  minutes  of  a  first  or  organization  meeting  of 
stockholders  are  drawn  in  compliance  with  the  laws  of  New 
Jersey.  They  may  be  easily  adapted  to  the  requirements  of 
any  other  state. 

Form  89.     Minutes  of  Stockholders'  First  Meeting 


THE  BARSTOW  MOTOR  CORPORATION      ' 

of  New  Jersey 

Minutes  of  First  Meeting  of  Stockholders 

Held  December  5,  1921  l  '^ 

Pursuant  to  written  call  and  waiver  of  notice  signed  by  all  of  the  incorporators, 
the  first  meeting  of  stockholders  of  The  Barstow  Motor  Corporation  was  held  in 
the  ofl&ce  of  George  H.  Madison,  845  Broad  Street,  Newark,  New  Jersey,  at  3  o'clock 
in  the  afternoon,  on  the  sth  day  of  January,  1922. 

The  meeting  was  called  to  order  by  Howard  Milliken,  and  on  motion,  George 
H.  Barstow  was  appointed  Chairman  of  the  meeting  and  Sargent  Davison  was 
appointed  its  Secretary. 

The  Secretary  presented  and  read  the  call  and  waiver  of  notice  pursuant  to 
which  the  meeting  was  held.  On  motion  it  was  ordered  to  be  entered  in  the  minute 
Book  following  the  minutes  of  the  meeting.     (See  Form  90.) 

The  proxy  of  Frank  Harris  appointing  James  C.  McCormick  his  representa- 
tive was  presented,  and  was  ordered  to  be  filed. 

There  were  present  in  person : 

NAMES  NO.    of   SHARES 

George  H.  Barstow i 

Howard  Milliken i 

Sargent  Davis i 

Wilson  P.  Noble i 


*a^-rs^ 


I500  CORPORATE  FORMS  [Bk.  IV- 

There  were  present  by  proxy: 

NAME  NAME   OF   PROXY  NO.    OF   SHARES 

.,,...,  Frank  Harris         James  C.  McCormick  i 

The  Chairman  presented  a  certified  copy  of  the  Certificate  of  Incorporation 
and  stated  that  the  original  had  been  recorded  in  the  office  of  the  Clerk  of  Essex 
County  on  the  3rd  day  of  January,  1922,  and  was  filed  in  the  office  of  the  Secretary 
of  State  at  Trenton,  on  the  4th  day  of  January,  1922,  and  that  the  organization 
tax,  and  statutory  fiUng  and  recording  fees  had  been  duly  paid.  On  motion  it  was 
ordered  that  the  said  Certificate  of  Incorporation  be  entered  on  the  first  pages  of 
the  Book  of  Minutes. 

The  Secretary  presented  a  form  of  By-Laws  prepared  by  counsel  for  the  Com- 
pany, which  was  read  article  by  article,  and  ^s,  a  whole  unanimously  adopted  and 
ordered  to  be  entered  in  the  Book  of  Minutes'immediately  following  the  Certificate 
of  Incorporation.  " i ! ! ' 

The  Chairman  announced  that  the  next  Dusiness  in  order  was  the  election  of 
seven  directors  as  provided  in  the  by-laws,  aind  thereupon  appointed  Messrs. 
Harold  Conrow  anci  John  Miner  inspectors.  Said  inspectors  then  proceeded  to 
open  the  polls  and  receive  ballots.  All  the  stockholders  present  in  person  or  by 
proxy  having  voted,  the  inspectors  reported  that  ballots  were  cast  as  follows: 

FOR  DIRECTORS  VOTES 

George  H.  Barstow 5 

Howard  Milliken S 

Sargent  Davis 5 

Wilson  P.  Noble 5 

Frank  Harris 5 

Harvey  Crawford 5 

Ellis  C.  Sherman 5 

and  that  the  gentlemen  named  were  therefore  duly  elected  directors  of  the  Com- 
pany. It  was  ordered  that  the  report  of  the  inspectors  be  entered  in  the  Minute 
Book  following  the  minutes  of  the  meeting.     {See  Form  92.) 

On  motion  duly  made  and  seconded,  the  following  resolution  was  unanimously 
adopted: 

Resolved,  That  the  principal  office  of  this  Company  in  the  State  of  New 
Jersey  shall  be  at  No.  845  Broad  Street,  Newark,  and  the  agent  in  charge  upon 
whom  process  may  be  served,  shall  be  George  H.  Madison. 

The  Secretary  presented  a  waiver  of  notice  of  assessment  and  of  the  time  and 
place  of  payment  thereof  signed  by  all  the  incorporators.  The  waiver  was  ordered 
to  be  entered  in  the  Minute  Book  following  the  minutes  of  the  meeting.  (See 
Form  gj.) 

The  Secretary  presented  a  proposal  from  George  P.  Willis  of  Montclair,  New 
Jersey,  offering  to  assign  to  the  Company  in  exchange  for  its  entire  common  stock, 
the  United  States  letters  patent  granted  him  for  motors  of  the  internal  combustion 
type,  together  with  his  agreement  to  assign  to  the  Company  any  future  inventions 
or  improvements  made  by  him  in  motors  of  the  internal  combustion  type. 

Said  proposal  was  ordered  received  and  the  following  resolution  in  regard 
thereto  was  moved,  seconded  and  unanimously  adopted: 

Whereas,  George  P.  Willis,  for  and  in  consideration  of  the  issue  to  his 
order  of  the  entire  common  stock  of  this  Company  of  the  par  value  of  Two 
Hundred  Thousand  Dollars  ($200,000),  has  offered  to  sell  and  assign  to  this 
Company  the  United  States  rights  for  his  improvements  in  motors  of  the  in- 
ternal combustion  type,  together  with  his  agreement  to  assign  to  the  company 
all  future  improvements  and  inventions  in  motors  of  the  internal  combustion 
type,  all  as  set  forth  in  his  written  proposal  submitted  to  this  meeting;  and 

CLARENCE  A.  JOU^S 

ATTO  R  N  EY-AT-LAW 

SUITE  709  BRYSON  BLDG..  145  S.  SPRtNc  ST 

LOS  ANGELES,  CALIFORNIA' 


Ch.  8]  STOCKHOLDERS'  ORGANIZATION  MEETING  1501 

Whereas,  It  appears  to  the  stockholders  of  this  Company  that  such 
property  is  necessary  for  the  business  and  lawful  purposes  of  the  Company, 
ancf  that  the  same  is  of  the  reasonable  value  of  Two  Hundred  Thousand  Dol- 
lars ($200,000); 

Now,  Therefore,  Be  It  Resolved,  That  the  Board  of  Directors  of  this 
Company  be  and  hereby  are  authorized  and  empowered  and  directed  to  accept 
the  said  proposition  and  to  issue  the  said  common  stock  of  this  Company  m 
exchange  for  the  said  letters  patent  and  agreement  of  the  said  George  P.  Willis. 
There  being  no  further  business,  the  meeting  was  declared  adjourned. 
George  H.  Barstow,  Sargent  Davis, 

Chairman  Secretary 

In  pursuance  of  the  motions  of  the  preceding  minutes,  the  following  forms  are 
entered  in  the  minutes : . 

1.  Certificate  of  Incorporation 

2.  By-Laws 

3.  Call  and  Waiver  of  Notice 

4    Report  of  Inspectors  of  Election 
5.  Waiver  of  Notice  of  Assessment 

Sargent  Davis, 
■■'--•;   ■-•■'-'   -•.-'!■  Secretary 


Important  instruments  received  during  the  course  of  a 
meeting  are  frequently  ordered  embodied  in  the  minutes  or 
entered  in  the  minute  book  immediately  following  the  minutes. 
There  is  no  legal  objection  to  either  arrangement.  The  minutes 
are,  however,  clearer  and  more  closely  connected  when  the 
instruments  are  appended  instead  of  being  brought  into  the 
body  of  the  minutes. 

Form  90.     Call  and  Waiver  of  Notice — Stockholders' 
THE  BARSTOW  MOTOR  CORPORATION 


Call  and  Waiver  of  Notice 

FOR 

First  Meeting  of  Stockholders 

We,  the  undersigned,  being  all  of  the  incorporators  of  the  above-named  cor- 
poration and  all  of  the  subscribers  to  its  capital  stock  entitled  to  notice  of  said 
meeting,  do  hereby  call  the  first  meeting  of  the  stockholders  of  said  corporation  to 
be  held  in  the  office  of  George  H.  Madison,  845  Broad  Street,  Newark,  New  Jersey, 
at  3  P.M.,  on  the  5th  day  of  January,  1922,  for  the  purpose  of  receiving  the  charter, 
adopting  by-laws,  electing  directors,  considering  and  acting  upon  a  proposal  for 
the  issue  of  the  capital  stock  of  the  corporation  in  exchange  for  property,  and  the 
transaction  of  all  such  other  business  as  may  be  necessary  or  convenient  in  connec- 
tion with  the  organization  of  said  corporation;  and  we  do  hereby  waive  all  require- 


I502  CORPORATE  FORMS  [Bk.  IV- 

ments  as  to  notice  or  publication  of  the  time,  place,  and  purposes  of  this  first  meet- 
ing and  do  consent  to  the  transaction  thereat  of  any  and  all  business  pertaining  to 
the  affairs  of  the  Company. 

Dated  Newark,  N.  J.,  George  H.  Barstow 

January  4,  1922  Howard  Milliken 

Sargent  Davis 
Wilson  P.  Noble 
Frank  Harris 

This  call  and  waiver  must  be  signed  by  every  person  en- 
titled to  be  present  at  the  meeting.  The  presence  at  the  meeting 
of  any  person  not  signing  the  waiver  would,  however,  be  held 
in  itself  to  be  a  waiver  of  notice  and  an  acceptance  of  the  call. 

Form  91.     Proxy — First  Meeting  of  Stockholders 

THE  BARSTOW  MOTOR  CORPORATION 
Proxy 

FOR 

First  Stockholders'  Meeting 

Know  All  Men  by  These  Presents: 

That  I,  the  undersigned,  one  of  the  incorporators  and  a  subscriber  to  the  stock 
of  the  above-named  corporation,  do  hereby  constitute  and  appoint  James  C.  Mc- 
Cormick,  my  true  and  lawful  attorney,  with  full  powers  of  substitution  and  revo- 
cation, to  represent  me  at  the  first  meeting  of  the  stockholders  of  said  corporation 
to  be  held  on  the  5th  day  of  January,  1922,  and  at  any  meeting  postponed  or 
adjourned  therefrom,  hereby  granting  my  said  attorney  full  power  and  authority 
to  act  for  me  at  said  meeting,  and  in  my  name,  place,  and  stead  to  vote  thereat 
iapon  the  said  stock  of  said  corporation  subscribed  for  by  me,  or  upon  which  I  may 
then  be  entitled  to  vote,  in  the  election  of  directors  and  in  the  transaction  of  any 
and  all  other  business  pertaining  to  the  aflfairs  of  the  Company  that  may  be  brought 
before  said  meeting,  all  as  fully  as  I  might  or  could  do  if  personally  present,  and  I 
hereby  ratify  and  confirm  all  that  my  said  attorney,  or  his  substitute,  shall  lawfully 
do  at  such  meeting  in  my  name,  place,  and  stead. 

In  Witness  Whereof,  I  have  hereunto  affixed  my  signature  and  seal, 
this  4th  day  of  January,  1922. 
In  presence  of  Frank  Harris     [l.  s.] 

Florence  Harris 


In  the  majority  of  the  states  inspectors  of  election  are  not 
required  by  law.  They  are,  however,  frequently  appointed  in 
order  to  secure  the  proper  conduct  of  the  election. 

In  New  York  the  certificate  of  the  inspectors  of  election 
must   be   sworn    to,    and   oath  and  certificate  be  filed  in  the 


Ch.  8]  STOCKHOLDERS'  ORGANIZATION  MEETING  1503 

office  of  the  county  clerk.    In  New  Jersey  this  is  not  required, 
nor  need  the  inspectors  be  sworn. 

Form  92.     Inspectors'  Report 

Inspectors'  Report^ 

We,  the  undersigned,  Inspectors  of  Election,  duly  appointed  to  conduct  the 
election  for  directors  of  The  Barstow  Motor  Corporation  at  the  meeting  of  the 
stockholders  thereof,  held  this  date  at  the  office  of  the  Company,  845  Broad  Street, 
Newark,  New  Jersey,  do  hereby  certify  and  report  that  we  did  hold  and  conduct 
the  said  election  by  ballot  in  due  form  and  that  the  votes  cast  thereat  are  as  follows; 

VOTES 
NAMES  RECEIVED 

George  H.  Barstow 5 

Howard  MUliken 5 

Sargent  Davis '.!.'.. S 

Wilson  P.  Noble. . is .  hi  .V S 

Frank  Harris 5 

Harvey  Crawford 5 

Ellis  C.  Sherman S 

Newark,  New  Jersey  Harold  Conrow 

January  5,  1922  John  Miner 

The  following  form  is  local.  If  such  a  waiver  is  not  signed, 
30  days'  notice  must  be  given  the  incorporators  before  their 
subscriptions  can  be  enforced  under  the  laws  of  New  Jersey. 

Form  93.     Waiver  of  Notice  of  Assessment 

Waiver  of  Notice  of  Assessment 

We,  the  undersigned,  subscribers  to  the  Capital  Stock  of  The  Barstow  Motor 
Corporation  of  New  Jersey,  hereby  waive  notice  of  the  time  and  place  of  payment 
of  our  respective  subscriptions  to  the  Capital  Stock  with  which  said  Company 
begins  business,  and  also  waive  all  other  requirements  of  the  laws  of  New  Jersey 
as  to  notice  of  assessment  and  payment  thereof,  and  we  agree  to  pay  our  respective 
subscriptions  to  the  Treasurer  of  the  Company  in  such  amounts  and  at  such  times 
as  the  Board  of  Directors  may  require. 

Newark,  New  Jersey,  George  H.  Barstow 

January  5,  1922  Howard  Milliken 

Sargent  Davis 
Wilson  P.  Noble 
Frank  Harris 
Harvey  Crawford 


'  For  other  forms  of  inspectors'  report  and  forms  for  oaths  of  inspectors,  see  Forms  163-165. 


CHAPTER  IX 
ORGANIZATION  MEETING  OF  DIRECTORS  i 

In  the  organization  of  a  corporation,  the  first  meeting  of 
directors  usually  follows  immediately  after  the  first  meeting 
of  stockholders,  its  precise  date  or  time  being  fixed  by  the  call 
and  waiver  of  notice  signed  by  the  newly  elected  directors. 
Unless  notice  is  waived  in  this  formal  manner,  or  informally 
by  the  presence  and  participation  of  all  the  newly  elected 
directors  at  the  meeting,  the  first  meeting  of  directors  must 
either  be  called  as  a  special  meeting  in  accordance  with  the  re- 
quirements of  the  by-laws,  or  the  directors  must  wait  until  the 
time  fixed  by  the  by-laws  for  their  first  regular  meeting. 

At  this  first  meeting  of  directors,  officers  are  to  be  elected 
and  various  details  connected  with  the  commencement  of  the 
corporate  business  are  to  be  attended  to,  including  the  taking 
over  or  purchase  of  property  to  be  acquired  by  the  new  cor- 
poration. The  following  minutes  are  of  a  New  Jersey  corpora- 
tion and  comply  with  the  requirements  of  that  state.  They 
may  easily  be  adapted  to  meet  requirements  of  other  states. 

Form  94.    Minutes  of  Directors'  First  Meeting 


THE  BARSTOW  MOTOR  CORPORATION 

of  New  Jersey 

Minutes  of  First  Meeting  of  Directors 
Held  January  5,  1922 

Pursuant  to  written  call  and  waiver  of  notice,  the  Board  of  Directors  of  The 
Barstow  Motor  Corporation  held  its  first  meeting  in  the  office  of  George  H.  Madison, 
845  Broad  Street,  Newark,  New  Jersey,  at  4  p.m.,  on  the  5th  day  of  January,  1922 

'  For  general  discussion  of  the  first  meeting  of  directors,  see  Book  I,  Ch.  XXVII,  "First 
Meeting  of  Directors." 

1504 


Ch.  9]  DIRECTORS'  ORGANIZATION  MEETING  1505 

Howard  Milliken  called  the  meeting  to  order  and  on  motion,  George  H. 
Barstow  was  appointed  Chairman,  and  Sargent  Davis  was  appointed  Secretary  of 
the  meeting. 

There  were  present: 
George  H.  Barstow 
Howard  Milliken 
Sargent  Davis 
Wilson  P.  Noble 
Harvey  Crawford 
Ellis  C.  Sherman 
constituting  a  quorum  of  the  Board.     Absent:  Frank  Harris. 

The  Secretary  presented  the  call  and  waiver  of  notice  signed  by  all  the 
Directors,  pursuant  to  which  the  meeting  was  held.  It  was  ordered  spread  upon  the 
Minute  Book  immediately  following  the  minutes  of  the  meeting.  (See  Form  p5.) 
The  Chairman  announced  the  first  business  in  order  to  be  the  election  of 
officers  to  serve  for  the  remainder  of  the  corporate  year  and  until  the  election  of 
their  successors,  and  appointed  Messrs.  Howard  Milliken  and  Ellis  C.  Sherman 
tellers  to  conduct  the  election.  The  votes  of  those  present  were  duly  cast  by 
ballot,  resulting  in  the  unanimous  election  of  the  following  oflScers: 

President George  H.  Barstow 

Vice-President Frank  Harris 

Secretary Sargent  Davis 

Treasurer Harvey  Crawford 

It  was  ordered  that  the  Secretary  be  sworn  and  subscribe  a  written  oath  of 
office,  and  that  said  oath  be  spread  upon  the  Minute  Book  immediately  following 
the  minutes  of  the  present  meeting.  The  Secretary  thereupon  took  said  oath  and 
entered  upon  the  discharge  of  his  duties.     (See  Form  g6.) 

It  was  ordered  that  the  Treasurer  give  bond  as  provided  in  the  by-laws,  in  the 
sum  of  Five  Thousand  Dollars  ($5,000),  the  form  and  sureties  of  same  to  be 
approved  by  the  Board  of  Directors.  The  Treasurer  thereupon  submitted  a  bond 
signed  by  himself  as  principal  and  by  the  Fidelity  Surety  Company  of  Maryland  as 
surety.  The  bond  as  presented  was  approved  and  ordered  to  be  filed  in  the  custody 
of  the  Secretary  of  the  Company. 

Upon  motion  duly  made  and  seconded  the  following  resolutions  were  unan- 
imously adopted. 

Resolved,  That  the  officers  of  the  Company  be  authorized  to  lease  an 
office  for  the  use  of  the  Company  at  80  Broadway,  New  York  City,  the  rental 
thereof  not  to  exceed  One  Hundred  and  Fifty  Dollars  ($150)  per  month,  and 
that  the  meetings  of  the  Board  of  Directors  be  from  time  to  time  held  there 
or  at  the  designated  office  of  the  Company  in  the  State  of  New  Jersey  as  the 
Board  of  Directors  may  direct. 

Resolved,  That  the  Treasurer  be  and  hereby  is  authorized  and  instructed 
to  open  an  account  for  the  Company  with  the  Irving  National  Bank  of  New 
York  City,  and  to  deposit  therein  all  funds  of  the  Company  coming  into  his 
possession,  such  account  to  be  in  the  name  of  the  Company  and  funds  deposited 
therein  to  be  withdrawn  only  by  check  signed  by  the  Treasurer  and  counter- 
signed by  the  President. 

Resolved,  That  certificates  for  common  and  preferred  stock  as  sub- 
mitted to  the  Board  and  identified  by  the  signature  of  the  President,  be  and 
hereby  are  adopted  as  the  stock  certificates  of  the  Company,  and  that  the  same 
be  spread  on  the  pages  of  the  Minute  Book  immediately  following  the  minutes 
of  the  present  meeting. 

Resolved,  That  the  Secretary  be  instructed  to  procure  Five  Hundred 
(500)  certificates  of  common  stock  and  Five  Hundred  (500)  certificates  of 


1506  CORPORATE  FORMS  [Bk.  IV- 

preferrcd  stock  in  form  as  adopted,  also  a  corporate  seal  as  provided  in  the 
by-laws,  and  in  addition  thereto  such  records,  stock  and  transfer  books,  books 
of  account,  and  stationery  and  office  supplies  as  may  seem  necessary  for  the 
proper  conduct  of  the  Company's  operations  and  business. 

Resolved,  That  the  Treasurer  be  hereby  authorized  and  instructed  to 
pay  from  the  Company  funds  all  expenses  properly  incurred  in  connection 
with  the  incorporation  of  the  Company,  the  total  of  such  payments  not  to 
exceed  Eight  Hundred  Dollars  ($800). 

Resolved,  That  an  assessment  of  One  Hundred  Per  Cent  (100%)  be 
levied  upon  the  shares  of  stock  subscribed  for  by  the  incorporators  as  shown  by 
the  certificate  of  incorporation. 

Resolved,  That  the  Secretary  prepare  the  certificate  of  election  of 
directors  and  officers  required  by  the  New  Jersey  statutes,  and  that  the  proper 
officers  of  the  Company  execute  and  file  the  same  in  the  office  of  the  Secretary 
of  State  of  New  Jersey  within  thirty  days  from  date,  and  that  a  copy  thereof 
be  spread  upon  the  Minute  Book  immediately  following  the  minutes  of  the 
present  meeting. 

The  President  then  brought  to  the  attention  of  the  meeting  (i)  the  written 
proposal  of  Mr.  George  P.  Willis  of  Montclair,  New  Jersey,  to  transfer  and  assign 
his  patents  for  improvements  in  motors  of  the  internal  combustion  type  to  the 
Company,  together  with  an  agreement  to  assign  all  future  inventions  and  improve- 
ments in"  motors  of  the  internal  combustion  type  made  by  him,  in  exchange  and 
full  payment  for  the  entire  common  stock  of  the  Company;  and  (2)the  resolution 
of  the  stockholders  approving  said  proposal  and  instructing  the  Board  of  Directors 
to  accept  the  same. 

Mr.  Willis'  proposal  was  ordered  received  and  spread  upon  the  Minute  Book 
immediately  following  the  minutes  of  the  meeting,  and  on  motion  duly  made  and 
seconded  the  following  resolution  relating  thereto  was  unanimously  adopted : 

Whereas,  The  patents  and  agreement  offered  by  George  P.  Willis  in 
exchange  for  the  entire  common  stock  of  this  Company  is  adjudged  by  this 
Board  to  be  of  the  reasonable  value  of  Two  Hundred  Thousand  Dollars 
($200,000)  and  to  be  necessary  for  the  use  and  lawful  purposes  of  this  Company : 

Now,  Therefore,  Be  It  Resolved,  That  the  said  proposed  assignment 
of  Letters  Patent  and  the  agreement  for  the  assignment  of  future  rights  and 
patents  in  exchange  for  the  entire  common  stock  of  this  Company,  as  set  forth 
in  the  said  proposition  of  George  P.  Willis  and  spread  upon  the  Minute  Book 
of  this  Company,  is  hereby  accepted  and  the  proper  officers  of  the  Company 
are  hereby  authorized  and  instructed  to  receive  the  duly  executed  assignments 
and  agreements  of  said  George  P.  Willis  in  form  approved  by  counsel  for  the 
Company,  and  to  issue  in  exchange  therefor  the  entire  common  stock  of  the 
Company  consisting  of  Two  Thousand  (2,000)  Shares  of  the  par  value  of  One 
Hundred  Dollars  ($100)  per  share,  to  such  person  or  persons  as  may  be 
designated  by  the  written  orders  of  the  said  George  P.  Willis,  and  to  do  all 
other  things  necessary  and  convenient  to  consummate  the  said  exchange  and 
issue  of  stock  for  property. 

There  being  no  further  business,  the  meeting  was  adjourned. 

Sargent  Davis, 

Secrdcary 
George  H.  B.arstow, 
President 


Ch.  g]  DIRECTORS'  ORGANIZATION  MEETING  1507 

In  pursuance  of  the  motions  of  the  preceding  minutes,  the  following  forms  are 
hereunto  appended: 

1 .  Call  and  Waiver  of  Notice 

2.  Secretary's  Oath  of  Office 

3.  Report  to  Secretary  of  State 

4.  Forms  of  Stock  Certificates— Common  and  Preferred 

5.  Written  Proposal  of  George   P.  Willis   to   Exchange  Patents  for  the 

Common  Stock  of  the  Company 

Sargent  Davis, 

Secretary 


The  forms  required  by  these  minutes  follow  in  part.  The 
form  for  treasurer's  bond — if  a  personal  bond  is  required— - 
is  shown  in  Form  248.  If  a  surety  company's  bond  is  to  be 
used,  forms  may  be  obtained  from  any  surety  company.  The- 
report  to  the  Secretary  of  State  is  omitted  as  being  purely 
local.  New  Jersey  corporations  may  obtain  the  necessary 
blanks  by  application  to  the  Secretary  of  State  at  Trenton, 
New  Jersey. 

Form  95.     Call  and  Waiver — Directors' 

THE  BARSTOW  MOTOR  CORPORATION 

Call  and  Waiver  of  Notice 

FOR 

First  Meeting  of  Directors 

We,  the  undersigned,  being  all  of  the  Directors  of  The  Barstow  Motor  Corpo- 
ration, do  hereby  call  the  first  meeting  of  the  Directors  of  said  Company  to  be 
held  in  the  office  of  George  H.  Madison,  No.  845  Broad  Street,  Newark,  New  Jersey, 
at  4  P.M.,  on  the  sth  day  of  January,  1922,  for  the  purpose  of  electing  officers,  acting 
upon  a  proposal  to  assign  property  to  the  Company  in  exchange  for  stock,  and  for 
doing  all  such  other  things  as  may  be  necessary  or  desirable  in  connection  with  the 
organization  of  the  Company  or  the  promotion  of  its  business,  and  we  hereby 
waive  all  statutory  or  by-law  requirements  as  to  notice  of  time,  place,  and  objects 
of  said  meeting  and  consent  to  the  transaction  thereat  of  any  and  all  business 
pertaining  to  the  affairs  of  the  Company. 
Newark,  New  Jersey, 

January  5,  1922  Frank  Harris 

George  H.  Barstow 
Howard  Milliken 
Sargent  Davis 
Wilson  P.  Noble 
Harvey  Crawford 


1508  CORPORATE  FORMS  [Bk.  IV- 

Frequently  when  directors'  meetings  are  to  be  assembled 
by  call  and  waiver,  the  signatures  of  all  the  directors  are  not 
secured  at  the  time  but  are  secured  subsequently — and  some- 
times long  after  the  date  of  the  meeting.  It  is  worthy  of  note 
that  it  has  been  held  that  a  director's  signature  to  a  waiver 
after  the  meeting  "looking  to  ratification  of  what  was  done 
is  without  force  to  validate  the  action  taken."  2  in  this  case 
the  action  of  a  meeting  held  pursuant  to  a  waiver  which  was 
not  signed  by  some  of  the  directors  until  after  the  meeting, 
was  held  to  be  invalid. 

Form  96.     Secretary's  Oath  of  Office 

Secretary's  Oath 

State  of  New  Jersey  1 
County  of  Essex  J   ^^" 

Sargent  Davis,  the  Secretary  of  The  Barstow  Motor  Corporation,  being  by 
me  duly  sworn,  upon  his  oath,  does  promise  and  swear  that  he  will  faithfully  and 
impartially  discharge  the  duties  of  Secretary  of  said  Company  to  the  best  of  his  skill 
and  ability. 

Sargent  Davis 
Subscribed  and  sworn  to  before  me 
this  5th  day  of  January,  1922. 
Frank  B.  Esmond, 

Commissioner  of  Deeds  for 
the  State  of  New  Jersey 

The  New  Jersey  statutes  require  that  the  secretary  be  sworn. 
It  would  seem  to  be  a  somewhat  empty  formality. 

Form  97.    Proposal  to  Exchange  Property  for  Stock 

•j    ~ "^ 

(  Proposal  to  Exchange  Property  for  Stock 


To  The  Barstow  Motor  Corporation, 
84s  Broad  Street, 

Newark,  New  Jersey 
Gentlemen: 

I  hereby  offer  in  exchange  and  full  payment  for  the  Common  Stock  of  your 
Company,  amounting  to  Two  Thousand  (2,000)  Shares  of  the  par  value  of  One 


2  Hol'-ombe  et  al.  v.  Trenton  White  City  Co.,  82  Atl.  (N.  J.)  618  (igia^ 


Ch.  9]  DIRECTORS'  ORGANIZATION  MEETING  1509 

Hundred  Dollars  ($100)  per  share,  United  States  Letters  Patents  Numbers  605,949 
and  605,950,  issued  to  me  October  7,  1921,  for  Improvements  in  Internal  Combus- 
tion Motors,  said  Patents  to  be  assigned  to  your  Company  together  with  my 
agreement  to  assign  without  further  consideration  all  other  inventions  and  im- 
provements in  Internal  Combustion  Motors  which  I  may  at  any  time  hereafter 
make,  own  or  control. 

If  this  proposition  is  accepted,  the  said  Two  Thousand  (3,000)  Shares  of  Stock 
are  to  be  issued  to  my  order,  full-paid  and  non-assessable,  against  the  delivery  to 
your  Company  of  due  assignments  of  said  Letters  Patent  and  of  my  duly  executed 
agreement  for  the  assignment  of  any  future  inventions  and  improvements  that  I 
may  make  in  Internal  Combustion  Motors. 

Yours  truly, 

George  P.  Willis 

New  York  City,  January  5,  1922 


This  proposal  provides  for  the  issue  of  the  entire  common 
stock  in  exchange  for  the  property  mentioned.  The  incor- 
porators have  already  subscribed  for  at  least  a  portion  of  the 
common  stock  of  the  company.  On  the  face  of  it,  therefore, 
the  proposal  calls  for  the  issue  of  stock  already  under  contract 
to  the  incorporators  and  this  must  be  adjusted  in  some  way  be- 
fore the  proposal  is  accepted.  The  matter  may  be  easily  ar- 
ranged in  either  one  of  two  ways :  by  agreement  with  the  party 
making  the  proposal,  that  his  payment — as  far  as  the  incor- 
porators' subscriptions  are  concerned — may  be  regarded  as 
paid  on  their  account,  the  stock  being  issued  to  them;  or  the 
incorporators  may  assign  their  subscriptions  to  the  party 
making  the  proposal. 

If  this  latter  plan  is  the  one  adopted,  the  following  form 
will  apply: 

Form  98.     Assignment  of  Subscriptions 

Assignment  of  Subscriptions 


We,  the  undersigned,  all  the  subscribers  to  the  Common  Stock  of  the  Barstow 
Motor  Corporation,  for  and  in  consideration  of  the  sum  of  One  Dollar  to  each  of 
us  in  hand  paid,  and  of  other  good  and  valuable  considerations,  the  receipt  of  which 
is  hereby  acknowledged,  do  hereby  respectively  sell,  assign,  and  make  over  to 
George  P.  Willis  all  our  subscription  rights  to  the  Stock  of  said  Company : 

It  is  understood,  however,  that  this  assignment  is  conditioned  upon  the 
acceptance  by  said  Company  of  the  proposal  of  this  date  of  said  George  P.  Willis  to 
purchase  the  entire  Common  Stock  of  said  Company,  and  is  to  go  into  efifect  only 


I5IO  CORPORATE  FORMS  "  [Bk.  IV- 

upon  due  tender  by  him  of  payment  for  said  Common  Stock  in  accordance  with  the 

terms  of  the  said  proposal. 

Witness  our  hands  and  seals  this  fifth  day  of  January,  1922. 

George  H.  Barstow 
Howard  Milliken 
Sargent  Davis 
Wilson  P.  Noble 
Frank  Harris 


The  directors'  minutes  on  a  preceding  page  give  a  form  of 
resolution  for  designating  the  corporate  depositary.  This 
form  is  simple  but  sufficient  for  all  practical  purposes.  In 
many  cases,  however,  the  banks  have  their  own  forms  of  desig- 
nating resolution  which  they  prefer  and  in  some  cases  insist 
upon.  These  forms  are  for  the  most  part  unobjectionable, 
but  in  some  cases  will  be  found  to  confer  excessive  powers 
upon  the  officers  of  the  corporation.  If  this  is  not  desired, 
any  such  resolution  may  be  so  modified  as  to  eliminate  the 
undesirable  features  while  still  preserving  the  general  form 
preferred  by  the  bank. 

The  banks  usually  require  the  resolution  designating  the 
corporate  depositary  to  be  certified.  Such  certification  is  best 
made  by  the  secretary  of  the  company  and  may  be  as  shown 
in  Forms  224  and  225. 

Under  some  circumstances  it  is  impossible  to  secure  the 
signatures  of  all  the  directors  to  a  call  and  waiver.  In  such 
case,  if  by-laws  have  been  adopted  by  the  stockholders  and  the 
first  regular  meetings  of  directors  under  these  is  near  at  hand, 
the  business  of  the  first  meeting  may  be  postponed  until  this 
regular  meeting.  Usually,  however,  a  more  immediate  meet- 
ing is  necessary,  and  in  such  case  it  must  be  assembled  by 
means  of  a  call. 

In  the  absence  of  any  conflicting  provisions  in  the  by-laws, 
such  call  signed  by  a  majority  of  the  board  of  directors  will 
be  effective.    The  following  form  may  be  used. 

Under  ordinary  conditions  the  period  between  the  send- 
ing of  notice  and  the  time  of  meeting  must  be  sufficient  to 
allow  every  member  of  the  board  to  receive  the  notice  and  be 


Ch.  9l  DIRECTORS'  ORGANIZATION  MEETING  151 1 

present  at  the  meeting.  Any  by-law  provisions  as  to  the  num- 
ber of  days  to  elapse  between  the  notice  of  the  special  meet- 
ing and  the  special  meeting  held  pursuant  thereto,  should  be 
observed. 

Form  99.     Call  for  First  Directors'  Meeting 

Call  for  First  Meeting  of  Directors 

of  the 

MIDVALE  COAL  COMPANY 

We,  the  undersigned,  Directors  of  the  Midvale  Coal  Company,  hereby  call 
the  first  meeting  of  the  Directors  of  said  Company  to  be  held  in  the  office  of  John 
H.  Welch,  229  Broadway,  New  York  City,  New  York,  at  3  p.m.  on  the  3rd  day  of 
January,  1922,  for  the  purpose  of  electing  officers,  acting  upon  a  proposal  to  assign 
property  to  the  Company  in  exchange  for  stock,  and  doing  all  such  other  things  as 
may  be  necessary  or  desirable  in  connection  with  the  organization  of  the  Company 
and  the  promotion  of  its  business. 

New  York  City,  Thomas  L.  Sherman 

December  30,  1921.  Daniel  T.  Brown 

John  H.  Welch 


CHAPTER  X 

OPTIONS  AND  VOTING  TRUST  AGREEMENTS 

Option  Agreements 

When  a  corporation  is  to  be  formed  for  the  purpose  of 
purchasing  or  taking  over  certain  properties,  option  contracts 
are  usually  employed  to  hold  these  properties  until  the  cor- 
poration can  be  organized  and  act  for  itself.  Such  contracts, 
even  though  made  by  trustees  for  the  corporation,  are  not 
binding  upon  the  corporation  until  accepted  or  ratified  by  its 
formal  action.  In  drawing  such  contracts,  therefore,  care 
should  be  taken  that  the  parties  acting  for  the  corporation 
are  not  individually  bound  or  involved  by  the  contract  terms 
unless  this  is  intended. 

Form  100.    Option  on  Capital  Stock 

Option  Agreement 


An  Agreement  made  and  entered  into  this  14th  day  of  May,  1922,  by  and 
between  John  H.  WyckofE  of  Philadelphia,  Pennsylvania,  party  of  the  first  part, 
and  George  Andrew  Dennison  of  New  York  City,  party  of  the  second  part: 

Whereas,  The  said  John  H.  WyckofiF  owns  or  controls  the  capital  stock  of  the 
Wyckofif  Publishing  Company,  a  corporation  duly  organized  under  the  laws  of 
Delaware  and  carrying  on  its  business  in  the  City  of  Philadelphia,  said  business 
being  the  publication  of  "The  Household,"  a  monthly  magazine  owned  by  the  said 
Wyckofif  Publishing  Company;   and 

Whereas,  The  said  George  Andrew  Dennison  owns  or  controls  a  monthly 
magazine  known  as  "Home  Topics"  and  desires  to  purchase  and  combine  there- 
with "The  Household,"  and  to  form  a  corporation  to  own  and  publish  the  maga- 
zines so  combined; 

Now,  Therefore,  In  consideration  of  the  sum  of  Two  Hundred  and  Fifty 
Dollars  ($250)  paid  the  said  Wyckofif  by  the  said  Dennison,  the  receipt  whereof  is 
hereby  acknowledged,  the  said  Wyckofif  for  himself  and  his  associates  agrees  to 
sell  to  said  party  of  the  second  part  or  his  assigns,  at  any  time  on  or  before  the 
ist  day  of  July,  1922,  all  and  singular  the  entire  right,  title,  and  interest  in  and  to 

1512 


Ch.  lo]  OPTION  AGREEMENTS  1 513 

the  said  monthly  magazine,  including  subscription  lists,  advertising  contracts, 
good-will,  and  all  things  incident  to  or  pertaining  to  said  magazine  and  its  publica- 
tion; or  at  the  option  of  said  party  of  the  second  part,  the  entire  capital  stock  of 
the  aforementioned  Wyckoff  Publishing  Company,  consisting  of  Four  Hundred 
(400)  Shares  of  Common  Stock  of  the  par  value  of  Forty  Thousand  Dollars  ($40,- 
000);  the  consideration  for  the  transfer  and  assignment  of  said  magazine,  or  said 
capital  stock,  to  be  Twenty  Thousand  Dollars  ($20,000)  in  cash  and  one-fourth  of 
the  capitalization  of  the  corporation  formed  to  take  over  said  publication. 

This  option  shall  expire  and  be  of  no  further  force  or  effect  after  the  ist  day 
of  July,  1922,  unless  on  or  before  that  date  said  Dennison  or  his  assigns  shall  deposit 
with  the  Guaranty  Trust  Company  of  140  Broadway,  New  York  City,  said  sum  of 
Twenty  Thousand  Dollars  ($20,000)  in  cash,  together  with  certificates  issued  in  the 
name  of  John  H.  Wyckoff,  for  one-fourth  of  the  entire  capital  stock  of  said  new 
corporation,  said  cash  and  stock  to  be  held  in  escrow  by  the  said  Guaranty  Trust 
Company  and  to  be  released  and  delivered  to  the  said  Wyckoff  upon  the  delivery 
to  said  Trust  Company  of  a  duly  executed  and  valid  assignment  of  said  magazine 
to  said  new  corporation,  or  otherwise  of  the  entire  duly  assigned  stock  of  the 
Wyckoff  Publishing  Company,  as  may  be  required  by  the  written  demand  of  the 
said  Dennison  or  his  assigns,  as  hereinafter  set  forth. 

So  soon  as  said  cash  and  stock  of  the  said  new  company  are  deposited  in 
escrow  as  aforeprovided  with  the  Guaranty  Trust  Company,  said  Dennison  or  his 
assigns  shall  give  said  Wyckoff  written  notice  thereof  and  shall  specify  therein 
whether  said  Dennison  desires  the  assignment  of  said  magazine,  or  the  stock  of  the 
said  Wyckoff  Publishing  Company  in  exchange  for  the  said  escrowed  cash  and 
stock,  and  said  Dennison  shall  at  the  same  time  file  a  signed  copy  of  said  notice 
with  the  Guaranty  Trust  Company. 

It  is  understood  and  agreed  that  should  the  sale  contemplated  by  this  present 
agreement  fail,  neither  party  hereto  shall  be  liable  in  any  way  under  or  by  reason 
of  this  present  agreement,  and  that  should  this  option  be  assigned  to  any  other 
person  or  to  any  corporation,  the  said  Dennison  shall  be  free  from  all  liability 
thereunder. 

In  Witness  Whereof,  the  said  John  H.  Wyckoff  and  the  said  George 
Andrew  Dennison  have  hereunto  affixed  their  respective  signatures 
and  seals  the  day  and  year  first  above  written. 

John  H.  Wyckoff  [l.  s.] 

George  Andrew  Dennison  [l.  s.j 
Attest  signatures: 

Mary  M.  Westcott 

Willis  Bennett 


In  this  option  no  provision  is  made  for  any  change  during 
the  option  period  in  the  value  of  the  property  involved.  In 
the  option  which  follows,  such  changes  are  guarded  against 
by  means  of  the  provision  that  the  price  is  to  be  the  appraised 
value  at  the  time  of  purchase  plus  a  definite  amount  for  good-will. 

In  drawing  up  an  option,  care  should  be  taken  always  to 
express  the  fact  that  the  price  paid  for  the  option  is  to  be 
deducted  from  the  total  consideration.  There  should  be  no 
ambiguity  in  regard  to  this  feature. 


1514  CORPORATE  FORMS  [Bk.  IV- 

Form  1 01.    Option  on  Business  and  Property 

Option  Agreement 

An  Agreement  entered  into  this  25th  day  of  June,  1922,  by  and  between  the 
Oswego  Hub  and  Spoke  Company,  a  corporation  duly  organized  under  the  laws  of 
the  State  of  New  York,  party  of  the  first  part,  and  Willis  P.  Emerson  of  New  York 
City,  party  of  the  second  part. 

For  and  in  consideration  of  the  sum  of  One  Dollar  paid  said  party  of  the  first 
part  by  the  party  of  the  second  part,  receipt  whereof  is  hereby  acknowledged,  and 
for  other  good  and  valuable  considerations,  said  party  of  the  first  part  does  hereby 
agree  to  sell  to  said  party  of  the  second  part,  as  a  going  concern,  its  entire  business, 
factories,  and  plant  for  the  manufacture  and  sale  of  hubs  and  spokes,  owned  and 
operated  by  said  party  of  the  first  part  in  the  City  and  County  of  Oswego,  State 
of  New  York,  including  therewith  all  machinery,  tools,  and  other  property  and 
appurtenances  thereunto  belonging,  together  with  all  raw  materials  and  manu- 
factured products  on  hand,  and  all  contracts  relating  to  the  purchase  or  sale  of 
such  materials  and  products;  also  the  good-will  of  said  business  and  all  trade- 
marks, brands,  patent  rights,  licenses,  and  shop  rights  used  theYein  and  controlled 
by  said  party  of  the  fiiot  part;  excepting  only  moneys  and  bills  and  accounts 
receivable  on  hand  at  the  time  of  sale ;  all  of  said  property  to  be  delivered  free  and 
clear  from  all  liens,  charges,  encumbrances,  taxes,  and  assessments,  save  and  ex- 
cept for  a  certain  mortgage  upon  the  real  property  of  the  party  of  the  first  part, 
amounting  to  Thirty  Thousand  Dollars  ($30,000)  and  now  on  record  in  the  office 
of  the  County  Clerk  of  Oswego  County. 

The  price  to  be  paid  for  said  property  shall  be  an  amount  Twenty  Thousand 
Dollars  ($20,000)  in  excess  of  the  actual  appraised  value,  at  the  time  of  purchase, 
of  said  real  and  personal  property,  exclusive  of  good-will,  as  above  set  forth,  and 
such  amount  shall  be  paid  in  cash  at  the  time  of  transfer,  the  aforementioned  mort- 
gage being  assumed  by  the  purchaser  and  accounted  as  a  cash  payment  to  the 
amount  of  said  sum  of  Thirty  Thousand  Dollars  ($30,000)  and  accrued  interest 
thereon  due  at  the  time. 

This  option  shall  expire  and  be  of  no  further  effect  on  and  after  the  31st  day 
of  July,  1922,  unless  prior  thereto  said  party  of  the  second  part,  or  his  assigns 
shall,  in  writing,  notify  said  party  of  the  first  part  of  his  or  their  intention  to  exer- 
cise the  same,  and  shall  at  that  time  deposit  in  the  Oswego  National  Bank,  Ten 
Thousand  Dollars  ($10,000)  in  cash  as  a  guaranty  of  good  faith  and  to  apply  upon 
the  purchase  of  said  property,  and  in  such  event  the  party  of  the  first  part  shall 
within  sixty  days  of  such  notice  and  deposit,  transfer  and  convey  said  business  and 
property  by  such  deeds,  conveyances,  and  assignments  and  other  instruments  as 
may  be  necessary  to  vest  the  full  right,  title,  and  interest  in  said  business  and 
property  in  said  party  of  the  second  part  or  his  assigns. 

It  is  further  understood  and  agreed  that  said  party  of  the  second  part  assumes 
no  responsibility  to  purchase  said  property  unless  he  or  his  assigns  shall  elect  so 
to  do  by  written  notice  and  deposit  in  bank  as  aforeprovided,  and  that  in  case  of 
assignment  of  this  present  instrument  by  said  party  of  the  second  part,  all  its  pro- 
visions shall  inure  to  the  benefit  of,  and  run  in  favor  of,  and  be  binding  upon  his 
assignee  or  assignees  in  every  respect  as  theretofore  upon  said  party  of  the  second 
part,  and  in  case  of  such  assignment  the  said  party  of  the  second  part  shall  be  free 
from  all  liability  hereunder. 

In  case  of  any  disagreement  as  to  the  terms  of  this  option  or  as  to  any  matters 
connected  with  the  exercise  thereof,  each  party  hereunto  shall  appoint  an  arbitrator 
and  the  two  so  appointed  shall  appoint  a  third,  and  the  three  arbitrators  so  selected 
shall  be  empowered  to  decide  finally  all  matters  of  disagreement. 


Ch.  lo]  OPTION  AGREEMENTS  15 15 

In  Witness  Whereof,  the  Oswego  Hub  and  Spoke  Company,  party  of 
the  first  part,  has  caused  its  corporate  name  to  be  hereunto  signed 
by  its  President  and  its  duly  attested  seal  to  be  hereunto  affixed  by 
its  Secretary,  and  the  party  of  the  second  part  has  affixed  his  signa- 
ture and  seal,  all  on  the  day  and  year  first  above  written. 

Oswego  Hub  and  Spoke  Company, 
rcoppoRATE\  By  James  O'Reilly, 

\      seal      j  President 

Attest  seal : 

Harris  N.  Seeley, 

Secretary  WiLLis  P.  Emerson    [l,  s.] 

Witness  signature  of  W.  P.  Emerson: 
Mary  N.  Bates 
Clarence  Wymond 


The  following  is  a  simple  form  of  option  on  real  estate.  As 
realty  is  involved,  it  requires  acknowledgment  to  be  legally 
effective. 

Form  102.    Option  on  Real  Estate 

Option  Agreement 


This  Agreement  made  this  i8th  day  of  June,  1922,  for  the  sale  of  Real  Estate, 
by  and  between  Marcus  M.  McComb,  party  of  the  first  part,  and  Melville  H.  Win- 
throp,  party  of  the  second  part,  witnesseth  as  follows : 

1.  That  said  party  of  the  first  part  in  consideration  of  Five  Hundred  Dollars 
($500)  to  him  in  hand  paid,  does  hereby  agree  to  grant  and  convey  to  the  party  of 
the  second  part,  his  heirs,  administrators,  and  assigns,  all  that  certain  lot  of  land 
together  with  the  buildings,  structures,  and  improvements  thereon,  situated, 
bounded,  and  described  as  follows: 

(Full  description) 

2.  That  said  party  of  the  first  part  hereby  agrees  to  receive  and  accept  in  full 
payment  for  the  said  property,  the  sum  of  Twenty-Five  Thousand  Dollars  ($25,- 
000),  payable  Ten  Thousand  Dollars  ($10,000)  cash  on  delivery  of  deed,  and  the 
remainder  in  three  equal  payments  at  one,  two,  and  three  years  respectively,  said 
deferred  payments  to  be  secured  by  mortgage  on  the  said  property  and  to  bear 
interest  at  the  rate  of  Six  Per  Cent  (6%)  per  annum. 

3.  That  said  premises  are  to  be  conveyed  subject  to  the  following  encum- 
brances. 

(Description  of  encumbrances) 

4.  That  said  party  of  the  first  part  agrees  to  convey  said  property  free  from 
all  liens  and  encumbrances,  save  as  above  specified,  by  such  proper  warranty  deed 
containing  full  covenants  duly  executed  and  acknowledged,  as  shall  convey  and 
assure  to  the  grantee  the  absolute  fee  of  said  premises. 

Provided,  However,  That  unless  said  party  of  the  second  part  or  his  assigns 
tenders  the  said  amount  of  Ten  Thousand  Dollars  ($10,000)  and  duly  executed 
mortgage  for  the  remainder  of  such  purchase  price  on  or  before  December,  1922, 


iSi6  CORPORATE  FORMS  [Bk.  IV- 

this  agreement  shall  terminate  and  be  of  no  force  or  efiFect  and  the  party  of  the 
second  part  shall  forfeit  the  amount  already  paid  on  this  Option  Contract,  but  no 
further  liability  of  any  kind  shall  be  incurred  by  either  of  the  parties  hereunto. 
Witness  the  hands  and  seals  of  the  said  parties. 

Marcus  M.  McComb       [l.  s.] 
Melville  H.  Winthrop     [l.  s.| 
In  the  presence  of 

Samuel  M.  Boswick 
Ellen  M.  Judson 

{Notarial  acknovHedgmeni  according  to  the  law  of  the  state  in  which  the  contract 

is  executed.) 


In  the  absence  of  any  prohibiting  provisions  or  conditions, 
an  option  contract  is  assignable  as  is  any  other  fornj  of  con- 
tract.   A  simple  option  assignment  is  as  follows : 

Form  103.    Assignment  of  Option 

Assignment  of  Option 


Whereas,  The  undersigned  holds  and  is  the  lawful  owner  of  a  certain  Option 
Contract,  executed  by  the  George  F.  Harper  Company  of  Philadelphia,  Pennsyl- 
vania, the  undertaking  of  which  is  the  sale  of  the  wholesale  hardware  business  now 
belonging  to  and  conducted  by  the  said  George  F.  Harper  Company,  at  No.  1725 
Chestnut  Street,  in  the  City  of  Philadelphia,  said  business  being  more  particularly 
specified  and  described  in  the  said  Option  Contract  hereunto  attached  and  made 
part  of  this  assignment: 

Now,  Therefore,  I,  Theodore  Paflin,  in  consideration  of  the  sum  of  One  Dol- 
lar, the  receipt  whereof  is  hereby  acknowledged,  and  for  other  valuable  and  suffi- 
cient considerations,  do  by  these  presents  grant,  bargain,  sell,  transfer  and  assign 
unto  the  Allis-White  Hardware  Company,  a  corporation  duly  organized  under  the 
laws  of  the  State  of  New  York,  all  and  singular,  my  entire  right,  title,  and  interest 
in  and  to  the  said  Option  Contract,  to  have  and  hold  the  same  to  the  proper  use 
and  benefit  of  the  said  corporation. 

Witness  my  hand  and  seal  this  i6th  day  of  December,    192 1. 

Theodore    Paflin    [l.  s.] 
Attest: 

Irvin  M.  Rogers 


Voting  Trust  Agreements 

Voting  trusts  are  frequently  formed  at  the  time  a  corpora- 
tion is  organized,  and  less  commonly  thereafter  to  secure  certain 


Ch.  lo]  VOTING  TRUST  AGREEMENTS  1517 

specified    stock    action.  1      The  following  is  a  simple  form  of 
voting  trust  agreement. 

Form  104.     Voting  Trust  Agreement 

Voting  Trust  Agreement 


We,  the  undersigned,  stockholders  of  the  Glen  Harbor  Improvement  Company, 
a  corporation  duly  organized  under  the  laws  of  the  State  of  New  York,  and  having 
its'  principal  office  in  the  City  of  Yonkers,  in  the  State  of  New  York,  having  trans- 
ferred and  delivered  to  Emmett  M.  Brown,  William  Swift,  and  Andrew  McBride, 
all  of  the  said  City  of  Yonkers,  as  Voting  Trustees  hereunder,  the  shares  of  stock 
held  by  each  of  us  in  said  corporation,  do  hereby,  in  consideration  of  the  premises 
and  of  the  mutual  undertakings  hereinafter  set  forth,  agree  with  them  and  with 
each  other  that  said  Trustees  shall  hold  and  vote  the  said  stock  for  the  period  of 
five  years  from  the  date  hereof,  for  the  purposes  and  under  the  following  terms  and 
conditions: 

1.  All  stockholders  of  the  said  Company  may  join  in  the  voting  trust  hereby 
created,  by  signing  this  present  agreement  and  transferring,  in  whole  or  in  part, 
the  shares  of  stock  held  by  them  in  said  Company  to  the  said  Trustees,  under  the 
conditions  and  for  the  purposes  of  this  present  agreerrent. 

2.  Each  stockholder  in  said  Company  joining  this  voting  trust  as  aforepro- 
vided  shall  become  a  party  thereto  from  the  date  on  which  stock  owned  by  such 
stockholder  in  said  Company  shall  be  transferred  and  delivered  to  said  Trustees 
for  the  purposes  of  this  agreement. 

3.  The  said  Trustees  shall  surrender  to  the  proper  officer  of  the  said  Glen 
Harbor  Improvement  Company,  for  cancellation,  the  certificates  for  all  shares  of 
stock  transferred  to  said  Trustees,  and  shall,  in  place  thereof,  have  certificates  of 
said  Company  issued  to  themselves  as  Trustees,  and  on  the  face  of  each  said  Trus- 
tees' certificate  shall  be  stated  the  fact  that  such  certificate  has  been  issued  pur- 
suant to  this  agreement. 

4.  The  said  Trustees  shall  collect  and  receive  all  dividends  and  profits  accruing 
to  said  stock  and  shall  pay  over  the  same  to  the  respective  equitable  owners  thereof. 

5.  The  said  Trustees  shall  issue  to  each  stockholder  becoming  a  party  thereto 
one  or  more  transferable  Trustees'  receipts  for  the  number  of  shares  of  stock  placed 
by  each  of  said  stockholders  respectively  in  this  Voting  Trust,  and  when  such 
Trustees'  receipts  are  duly  transferred  to  other  parties,  said  Trustees  shall  recognize 
such  other  parties  as  the  lawful  assigns  and  successors  of  the  original  parties  hereto, 
entitled  to  all  of  their  rights  in  the  premises. 

6.  The  stock  held  under  this  agreement  shall,  except  as  hereinafter  specially 
provided,  be  voted  at  any  meeting  of  the  stockholders  01  said  Company  by  such  of 
the  said  Trustees  as  may  be  present  thereat,  and  said  stock  shall  be  so  voted  as 
may  in  the  judgment  of  a  majority  of  the  said  Trustees  present  at  any  such  meeting 
be  for  the  best  interest  of  the  stockholders  subscribing  to  this  agreement. 

7.  In  all  elections  of  Directors  the  said  stock  shall  be  voted  for  the  re-election 
of  the  present  members  of  the  Board  of  Directors  of  said  Company,  or,  in  the  event 
of  death,  disability,  or  refusal  to  serve  of  any  such  members,  the  said  stock  shall  be 
voted  for  such  other  person  or  persons  as,  in  the  judgment  of  said  Trustees,  shall 
be  most  suitable  for  such  office. 


•  For  trustees'  certificates,  see  Forms  82-84;  for  general  discussion  of  voting  trusts,  see 
Book  I,  Ch.  LVI,  "Voting  Trusts." 


I5i8 


CORPORATE  FORMS 


[Bk.  IV- 


8.  This  agreement  shall  terminate  five  years  from  the  date  hereof,  and  upon 
such  termination  the  said  Trustees  shall,  as  the  outstanding  Trustees'  receipts  are 
surrendered  to  them,  duly  indorsed,  give  over  to  the  said  Company  the  certificates 
of  stock  held  by  said  Trustees,  in  pursuance  of  this  agreement,  properly  indorsed, 
and  shall  direct  the  officers  of  said  Company  to  deliver  to  the  respective  owners  of 
the  said  surrendered  Trustees'  receipts  certificates  for  such  numbers  of  shares  of 
stock  as  may  be  necessary  to  satisfy  the  requirements  of  the  said  surrendered  Trus- 
tees' receipts. 

9.  In  the  event  of  the  death,  disability,  resignation,  or  refusal  to  act  of  any  of 
the  Trustees  herein  named,  the  remaining  Trustees  or  Trustee,  shall  have  power 
to  suitably  fill  such  vacancy  or  vacancies,  and  the  person  or  persons  so  appointed 
shall  be  empowered  and  authorized  to  act  hereunder  in  all  respects  as  if  originally 
named  herein. 

10.  A  duplicate  of  this  agreement  shall  be  filed  in  the  principal  office  of  the 
said  Company  in  Yonkers  and  shall  there  be  kept  for  the  inspection  of  any  stock- 
holder of  the  Company,  daily,  during  business  hours. 

In  Testimony  Whereof,  the  parties  to  this  agreement  have  hereunto 
affixed  their  hands  and  seals  in  the  said  City  of  Yonkers  this  27th 
day  of  February,  1922. 


shares 

VOTING 

TRUSTEES 

stockholders 

assigned  to 
trustees 

Emmett  M. 

Brown 

[l. 

s.] 

James  Halsey 

[l. 

s.] 

5° 

William  Swift 

[l. 

s.] 

Ernest  Jurgens 

[L. 

s.] 

1 25 

Andrew  McBride 

[L. 

s.] 

Harold  M,  Gilsey 

[L. 

s.l 

75 

Willis  M.  Ames 

[L. 

S.1 

75 

Part  II — Forms  Relating  to  Corporate  Meetings 


CHAPTER  XI 
CALLS  AND  WAIVERS  FOR  SPECIAL  MEETINGS 

Special  Meetings  of  Stockholders  i 

Regular  meetings  both  of  stockholders  and  directors  are 
held  at  fixed  times  prescribed  by  the  by-laws.  If  in  the  interim 
between  these'  regular  meetings  matters  arise  calling  for  as- 
sembled action,  special  meetings  become  necessary.  Such  meet- 
ings are  convened  either  by  the  call  and  waiver,  or  by  a  formal 
call  followed  by  notice. 

The  call  and  waiver  is  a  single  instrument  consisting  of 
two  parts:  first,  a  call  for  the  desired  meeting;  and  second, 
a  waiver  of  all  statutory,  charter,  or  by-law  requirements 
for  notice  thereof.  This  call  and  waiver  must  be  signed  by 
every  person  entitled  to  be  present  at  its  meeting.  Those 
signing  are  thereby  estopped  from  any  future  objection  to 
the  omission  of  the  usual  or  required  formalities  as  to  notice  of 
the  meeting.  No  one  else  has  a  right  to  object;  hence  the  call 
and  waiver  may  be  safely  used  even  though  the  by-laws  provide 
a  different  method  of  assembling  special  meetings. 

The  call  followed  by  notice  is  the  method  of  assembling 
special  meetings  usually  prescribed  by  the  by-laws,  and  in- 
volves the  use  of  two  separate  instruments :  first,  the  call  signed 
by  some  competent  party  or  parties;  and  second,  pursuant  to 
this  call,  a  notice  of  the  meeting.  The  call  and  waiver  permits 
of  an  immediate  meeting,  or  a  later  meeting,  according  to  its 


'  For  general  discussion,  see  Book  I,  Ch.  XLIII,  "Special  Meetings  of  Stockholders." 

I519 


1520  CORPORATE  FORMS  [Bk.  IV- 

terms.  The  call  with  notice  involves  the  delay  incident  to 
formal  notice,  ranging  from  three  to  ten  days. 

The  first  meetings  of  both  stockholders  and  directors  are 
usually  assembled  by  means  of  calls  and  waivers.  It  is,  however, 
but  seldom  that  the  call  and  waiver  is  employed  thereafter  to 
assemble  meetings  of  stockholders,  on  account  of  the  difficulty — 
save  in  the  smaller  corporations — of  securing  the  signature  of 
every  party  entitled  to  be  present  at  the  meeting.  Special 
meetings  of  the  directors  are  usually  assembled  by  means  of  the 
call  and  waiver. 

Forms  of  calls  and  waivers  to  assemble  the  first  meetings 
of  stockholders  and  directors  have  already  been  presented.  2 
The  following  form  is  for  use  after  organization: 

Form  105.     Call  and  Waiver  for  Special  Meeting  of  Stockholders 

CHELTINGHAM  LINEN  COMPANY 

Call  and  Waiver 
Special  Meeting  of  Stockholders 

We,  the  undersigned,  all  the  stockholders  of  the  Cheltingham  Linen  Company 
of  Trenton,  New  Jersey,  hereby  call  a  special  meeting  of  the  stockholders  of  said 
Company  to  be  held  in  the  Company's  office.  No.  275  Main  Street,  Trenton,  New 
Jersey,  on  the  21st  day  of  May,  1922,  at  3  o'clock  in  the  afternoon,  for  the  purpose 
of  considering  and  acting  upon  a  proposition  for  the  consolidation  of  this  Company 
with  the  Wilson  Thread  Company  of  Trenton,  New  Jersey,  and  we  hereby  waive 
all  statutory  and  by-law  requirements  as  to  notice  of  time,  place,  and  objects  of 
said  meeting,  and  agree  to  the  transaction  thereat  of  any  and  all  business  pertaining 
to  the  affairs  of  the  Company. 
Trenton,  N.  J.,  James  H.  McLain  Frank  H.  Small 

May  17,  1922  Theodore  McGowan       William  T.  Masters 

Joseph  H.  French  John  H.  Meade 

Charles  P.  Henderson  Henry  T.  Arnold 
,,„ri  f  David  B.  Adams  William  Rollands 

Where  the  number  of  stockholders  is  large,  the  call  fol- 
lowed by  notice  is  used  in  assembling  special  meetings.  The 
call  itself  authorizes  the  meeting  as  set  forth  in  its  terms. 

When  a  call  for  a  special  meeting  is  issued  by  the  president, 
it  should  be  addressed  to  the  secretary. 

■'  Forms  90,  95- 


Ch.  ii]  CALLS  AND  WAIVERS  FOR  MEETINGS  1521 

Form  106.    F>resident's  Call  for  Special  Meeting  of  Stockholders 

HUDSON  NAVIGATION  COMPANY 
270  Broadway,  New  York 

Mr.  Henry  H.  Sheldon, 

Secretary  of  the  Hudson  Navigation  Co.: 

You  are  hereby  authorized  and  instructed  to  send  out  notice  of  a  special 
meeting  of  the  stockholders  of  this  Company  hereby  called  by  me,  said  meeting 
to  be  held  in  the  office  of  the  Company,  No.  270  Broadway,  New  York  City,  on  the 
15th  day  of  February,  1922,  at  10  a.m.,  for  the  purpose  of  considering  and  acting 
upon  a  proposition  to  sell  the  entire  property  and  assets  of  the  Company,  and  for  the 
transaction  of  any  and  all  business  in  coimection  therewith  that  may  properly  come 
before  said  meeting. 

February  i,  1922  Harry  M.  Moody, 

President 

A  more  formal  call  for  a  special  meeting  of  stockholders  is 
given  below : 

Form  107.    President's  Call  for  Special  Meeting  of  Stockholders 
— Formal 


PACIFIC  COAST  OIL  COMPANY 

1987  Broadway,  New  York 

Mr.  Howard  A.  Kennard, 

Secretary  of  the  Pacific  Coast  Oil  Company 
Dear  Sir: 

In  accordance  with  the  authority  vested  in  me  by  the  By-laws  of  this  Company 
I  hereby  call  a  special  meeting  of  the  stockholders  of  this  Company,  to  be  held  in 
the  office  of  the  Company,  No.  129  Exchange  Place,  New  York,  on  the  15th  day  of 
March,  1922,  at  10  o'clock  in  the  forenoon,  for  the  purpose  of  considering  and  acting 
upon  a  proposition  to  sell  the  entire  property  and  assets  of  the  Company,  and  for 
the  transaction  of  any  and  all  business  in  connection  therewith  that  may  properly 
come  before  said  meeting,  and  I  hereby  aushorize  and  instruct  you  to  give  due 
notice  of  said  meeting  to  the  stockholders  of  this  Company  in  accordance  with  the 
requirements  of  its  By-laws. 

March  i,  1922  Harry  M.  Casson, 

President 


The  president's  call  for  a  special  meeting  is  handed  or  sent 
to  the  secretary  who  thereupon  sends  out  notices  of  the  meeting,  s 


'See  Forms  11 8- 120. 


f522  CORPORATE  f ORMS  [Bk.  IV- 

A  directors'  call  for  a  special  meeting  of  stockholders  must, 
according  to  the  requirements  of  the  by-laws,  be  addressed 
either  to  the  president,  who  in  his  turn  instructs  the  secretary  to 
issue  notice  of  the  meeting  so  called,  or  to  the  secretary  as  in 
the  following  form.  Occasionally  the  by-laws  permit  direct 
publication  notice  by  the  directors  when  a  special  meeting  of 
stockholders  is  to  be  assembled. 

Form  io8.    Directors'  Call  for  Special  Meeting  of  Stockholders 

Call  for  Special  Meeting  of  Stockholdeks 


We,  the  undersigned,  Directors  of  the  Hudson  Navigation  Company,  do 
hereby  call  a  special  meeting  of  the  stockholders  of  said  Company  to  be  held  in  its 
office.  No.  270  Broadway,  New  York,  on  the  15th  day  of  February,  1922,  at  10 
o'clock  in  the  forenoon,  for  the  purpose  of  taking  action  on  a  proposition  to  sell  the 
entire  property  and  assets  of  the  Company,  and  for  the  transaction  of  any  and  all 
business  necessary  in  connection  therewith,  and  we  do  hereby  authorize  and  instruct 
the  Secretary  of  the  Company  to  send  out  notice  of  said  special  meeting  in  accord- 
ance with  the  by-law  requirements  of  this  Company. 

New  York  City,  New  York,  John  H.  Goodrich 

February  i,  1922  Henry  B.  Merrill 

Arthur  C.  McCall 

To  Mr.  Henry  H.  Sheldon, 

Secretary  of  the  Hudson  Navigation  Co. 


This  call  is  handed  or  sent  to  the  secretary,  and  is  followed 
by  his  notice  of  the  meeting.  When  the]by-laws  provide  that  the 
president  shall  call  special  meetings  on  written  request  or  in- 
struction signed  by  a  prescribed  number  of  directors,  the  fore- 
going call  might  be  modified  to  meet  the  conditions  as' follows: 

Form  109.    Directors'  Instructions  for  Special  Meeting  of  Stock- 
holders 


To  Mr.  Harry  M.  Moody, 

President  of  the  Hudson  Navigation  Co.  : 

We,  the  undersigned.  Directors  of  the  Hudson  Navigation  Company,  do  hereby 
authorize  and  instruct  you  to  call  a  special  meeting  of  the  stockholders  of  said 
Company,  to  be  held  in  its  office,  No.  270  Broadway,  New  York,  on  the  isth  day  of 


Ch.  ii]  CALLS  AND  WAIVERS  FOR  MEETINGS  1523 

February,  1922,  at  10  o'clock  in  the  forenoon,  for  the  purpose  of  taking  action  on  a 
proposition  to  sell  the  entire  property  and  assets  of  the  Company  and  for  the  trans- 
action of  any  and  all  business  necessary  in  connection  therewith. 

New  York  City,  New  York,  John  H.  Goodrich 

February  i,  1922  Henry  B.  Merrill 

Arthur  C.  McCaix 


These  instructions  are  handed  to  the  president,  who  in 
accordance  therewith  issues  his  call  for  the  meeting.  If  Form 
107  is  used  for  the  purpose,  the  first  phrase,  "In  accordance 
with  the  authority  vested  in  me  by  the  By-laws  of  this  Com- 
pany," should  be  modified  to,  "Pursuant  to  written  instructions 
of  Directors  of  this  Company." 

Special  meetings  of  stockholders  may  always  be  called  by 
resolution  of  the  board  of  directors. 


Form  no.    Directors'  Resolution  for  Special  Meeting  of  Stock- 
holders 


Resolution 

Be  It  Resolved,  That  a  special  meeting  of  the  stockholders  of  this  Company 
be  and  hereby  is  called,  said  meeting  to  be  held  in  the  office  of  the  Company  at 
No.  270  Broadway,  New  York  City,  on  the  15th  day  of  February,  1922,  at  10  o'clock 
in  the  forenoon,  for  the  purpose  of  considering  and  acting  upon  a  proposition  to  sell 
the  entire  property  and  assets  of  the  Company,  and  for  the  transaction  of  any  and 
all  business  necessary  or  desirable  in  connection  therewith. 


As  the  secretary  is  presumably  present  at  the  meeting  of 
the  directors,  or  otherwise  has  access  to  the  minutes,  the  mere 
passage  of  such  a  resolution  is  sufficient  notice  to  him  of  the  call, 
and  he  should  send  out  notice  of  the  meeting. 

It  is  but  seldom  that  the  stockholders  issue  a  request  or 
call  for  a  meeting.  Usually  when  they  do,  it  must,  in  accord- 
ance with  by-law  requirements,  pass  through  the  president's 
hands.  If  not  so  prescribed,  their  call  may  be  addressed  to  the 
secretary,  in  which  case  the  president's  only  official  knowledge 
of  the  meeting  is  derived  from  the  notice  sent  him  by  the  secre- 


1524  CORPORATE  FORMS  [Bk.  IV- 

tary.     Occasionally  the  by-laws  authorize  the  stockholders  to 
give  direct  notification  of  the  meeting  by  publication. 

Form  III.     Stockholders'  Request  for  Special  Meeting 

To  the  President  of  the 

Adams  Machine  Company:' 

_  We,  the  undersigned,  owning  or  controlling  not  less  than  two-thirds  of  the 
entire  voting  stock  of  the  Adams  Machine  Company,  do  hereby  request  you  to  call 
a  special  meeting  of  its  stockholders  to  be  held  in  the  office  of  the  Company  at 
No.  35  Broad  St.,  New  York,  at  3  o'clock  in  the  afternoon  on  the  ist  day  of  March, 
1922,  for  the  purpose  of  considering  the  purchase,  proposed  by  the  Directors  of  this 
Company,  of  the  machine  shop  and  equipment  of  the  Harrison  Metal  Working 
Company,  located  at  908  WiUoughby  St.,  Brooklyn,  and  to  take  such  action  in 
regard  thereto  as  may  seem  necessary  or  desirable  to  the  stockholders  present  at 
such  meeting,  and  we  request  you  to  have  due  and  timely  notice  thereof  sent  to 
each  stockholder  of  this  Company. 


New  York  City,  N.  Y. 

NAME 

shares  owned 

February  10,  1922 

David  H.  Bentley 

200 

James  J.  Allison 

250    . 

Oliver  P.  Chandler 

500 

Stanley  S.  Wood 

ISO 

Henry  M.  Sherrill 

300 

Spencer  Harrison 

150 

This  stockholders'  request  i3  handed  to  the  president,  who 
may  either  indorse  his  call  on  the  request  as  in  the  form  which 
follows,  or  may  issue  the  more  formal  call  shown  in  Forms  106 
and  107. 

Form  112.    President's  Indorsement  of  Stockholders'  Request 

To  the  Secretary  of  the 

Adams  Machine  Company: 

You  are  l^ereby  instructed  to  give  due  notice  of  a  special  meeting  of  the  stock- 
holders of  this  Company  hereby  called  by  me  in  pursuance  of  the  within  stock- 
holders' request,  said  meeting  to  be  held  in  the  office  of  the  Company  at  No.  35 
Broad  St.,  New  York  City,  at  3  p.m.,  on  the  ist  day  of  March,  1922,  in  accordance 
with  and  for  the  purposes  set  forth  in  the  said  request. 

New  York  City,  N.  Y.,  John  H.  Harrell, 

February  10,  1922  President 


When  the  stockholders'  call  is  directed  to  the  secretary, 
its  form  will  be  as  follows : 


Ch.  ii]  CALLS  AND  WAIVERS  FOR  MEETINGS  1525 

Form  113.     Stockholders'  Call  for  Special  Meeting 


To  the  Secretary  of  the 

Howard  Woolen  Mills  Co.: 

We,  the  undersigned,  stockholders  of  the  Howard  Woolen  Mills  Company 
owning  or  controlling  not  less  than  two-thirds  of  its  entire  voting  stock,  do  hereby 
call  a  special  meeting  of  the  stockholders  of  the  Company  to  be  held  in  its  office 
at  No.  45  Main  St.,  Dunkirk,  New  York,  at  12  o'clock  noon  on  the  15th  day  of 
January,  1922,  for  the  purpose  of  considering  a  proposition  to  so  amend  the  By-laws 
as  to  restrict  the  President's  power  to  contract  for  the  Company,  and  of  taking  such 
action  in  regard  thereto  as  may  seem  necessary  or  desirable  to  the  stockholders 
present  at  such  meeting,  and  we  do  hereby  authorize  and  instruct  you  to  send  out 
notices  of  said  meeting  in  accordance  with  the  terms  of  this  present  call. 

Dunkirk,  New  York,  names  shares  owned 

January  3,  1922  Henry  B.  Clarke  575 

Harry  H.  Howard  1200 

Frank  B.  Johnson  725 

Samuel  Furman  500 


Special  Meetings  of  Directors* 

Special  meetings  of  directors  are  usually  assembled  by 
means  of  calls  and  waivers,  except  where  the  board  is  large 
or  some  of  its  members  are  inaccessible.  The  common  form 
of  call  and  waiver  for  directors'  meetings  is  as  follows: 

Form  114.    Call  and  Waiver  for  Special  Meeting  of  Directors 

Call  and  Waiver 
Special  Meeting  of  Directors 

We,  the  undersigned,  all  the  Directors  of  the  Long  Island  Power  Company  of 
Flushing,  Long  Island,  do  hereby  call  a  special  meeting  of  the  Board  of  Directors 
of  said  Company  to  be  held  in  its  office  at  No.  285  Duane  St.,  New  York  City,  at 
4  P.M.,  on  this  2ist  day  of  May,  1922,  for  the  purpose  of  acting  upon  a  proposition 
for  the  sale  of  the  Company's  Flushing  plant;  and  we  do  hereby  waive  all  statutory 
and  by-law  requirements  as  to  notice  of  time,  place,  and  purposes  of  said  meeting, 
and  consent  to  the  transaction  thereat  of  any  and  all  business  pertaining  to  the 
afifairs  of  the  Company. 

New  Yoik  City,  N.  Y.,  John  McFerguson 

May  21,  1922  Harold  H.  Harding 

Benton  Creller 
Howard  H.  Maurice 
Horace  Evans 


<Por  general  discussion  of  special  meetings  of  directors,  see  Book  I,  if  422-425. 


1526  CORPORATE  FORMS  [Bk.  IV- 

Special  meetings  of  directors  are  sometimes  irregularly 
assembled,  as  for  instance  where  all  the  members  of  a  board 
come  together  on  some  informal  notice  or  without  previous 
notice,  and  then  and  there,  agree  to  waive  all  the  usual  formali- 
ties and  hold  an  immediate  meeting.  Such  meetings,  termed 
"consent  meetings,"  are  entirely  legal  and  are  not  uncommon 
where  boards  of  directors  or  executive  committees  are  small 
and  easily  assembled. 

For  such  meetings  a  written  validation  is  not  strictly  neces- 
sary. The  participation  of  all  the  parties  entitled  to  be  present, 
duly  entered  on  the  minutes  of  the  meeting,  affords  legal  evi- 
dence of  their  consent  thereto  and  estops  any  subsequent  ob- 
jections on  their  part  to  the  proceedings.  As  a  precautionary 
measure,  however,  the  secretary  should  have  every  member 
of  the  board  sign  the  minutes  of  a  consent  meeting,  or  otherwise 
sign  a  waiver  of  notice  and  agreement  to  the  meeting  as  given 
below: 

Form  115.    Agreement  for  Consent  Meeting  of  Directors 


HARRISON  CUTLERY  COMPANY 

Waiver  of  Notice 


We,  the  undersigned,  all  the  Directors  of  the  Harrison  Cutlery  Company,  being 
now  present,  do  hereby  consent  to  an  immediate  meeting  of  the  Board  of  Directors 
of  said  Company  to  be  held  in  the  office  of  Henry  M.  McCall,  No.  253  Broadway, 
New  York,  at  3  p.m.  this  14th  day  of  February,  1922,  and  we  hereby  waive  all 
requirements  as  to  notice  of  time,  place,  and  purposes  of  such  meeting,  and  agree  to 
the  transaction  thereat  of  any  and  all  busmess  pertaining  to  the  affairs  of  the 
Company. 

Hekry  H.  McCall 
Simon  Frankenstein 
James  J.  McCall 
Howard  H.  Frenkel 
Stanley  T.  Brown 


When  a  special  meeting  of  directors  is  desired  and  it  cannot 
be  assembled  by  call  and  waiver,  perhaps  because  of  the  absence 
of  one  or  more  directors,  or  because  of  a  refusal  on  the  part 


Ch.  ii]  CALLS  AND  WAIVERS  FOR  MEETINGS  1527 

of  one  or  more  directors  to  sign  the  call  and  waiver,'  it  must  be 
assembled  by  call  and  notice.  In  such  case  the  call  must  be 
signed  as  required  by  the  by-laws — usually  by  the  president  or  a 
certain  number  of  the  directors.  A  form  of  president's  call 
is  given  on  the  following  page. 

This  call  is  handed  to  the  secretary  who,  in  accordance 
with  its  instructions,  follows  it  up  with  the  usual  notice  of 
the  meeting.  5 

Form  116.    President's  Call  for  Special  Meeting  of  Directors 

CORLISS  TYPEWRITER  COMPANY 
35  Vesey  St.,  New  York 

January  10,  1922 
Mr.  John  H.  Hammond, 

Secretary  Corliss  Typewmter  Co. 
Dear  Sir: 

In  accordance  with  the  authority  vested  in  me  by  the  By-laws  of  this  Company, 
I  hereby  call  a  special  meeting  of  the  Board  of  Directors  to  be  held  in  ofl&ce  of  the 
Company  on  the  20th  day  of  January,  1922,  at  3  o'clock  in  the  afternoon,  for  the 
purpose  of  considering  and  acting  upon  the  appointment  of  a  western  selling  agent 
and  for  the  transaction  of  any  other  business  in  connection  therewith  that  may  be 
necessary,  and  you  are  hereby  authorized  and  instructed  to  send  out  notices  of  said 
meeting  as  required  by  the  By-laws  of  this  Company. 

John  H.  Phillips, 
/  President 


The  by-laws  frequently  provide  that  special  meetings  of 
the  board  may  be  called  by  a  certain  number  of  the  directors. 
This  call  is  usually  addressed  as  in  the  following  form  and  handed 
to  the  secretary  direct. 

Form  117.    Directors'  Call  for  Special  Meeting  of  Directors 

Call  for  Special  Meeting  of  Directors 

We,  the  undersigned.  Directors  of  the  Manhattan  Photo  Supply  Company, 
hereby  call  a  special  meeting  of  the  Directors  of  said  Company,  to  be  held  in  its 
ofl&ce.  No.  1575  St.  Nicholas  Ave.,  New  York,  on  the  17th  day  of  February,  1922, 

(  See  Form  X2f. 


1528  CORPORATE  FORMS  [Bk.  IV- 

at  II  A.M.,  for  the  purpose  of  considering  and  acting  upon  a  proposition  to  purchase 
the  plant  and  equipment  of  the  Adams  Automatic  Camera  Company,  and  for  the 
transaction  of  any  and  all  business  necessary  in  connection  therewith,  and  we 
hereby  instruct  the  Secretary  of  the  Company  to  send  out  notices  of  said  special 
meeting  in  accordance  with  the  By-law  requirements  of  this  Company. 

New  York  City,  Henry  C.  Carson 

February  5,  1922  Frank  H.  Merrill 

Samuel  Frenkel 
To  Mr.  John  H.  Hersey, 

Secretary  Manhattan  Photo  Supply  Co. 


CHAPTER  XII 

NOTICES  OF  MEETINGS 

Stockholders'  Meetings  i 

Every  person  entitled  to  be  present  at  a  corporate  meeting 
is  also  entitled  to  notice  of  such  meeting.  If  the  notice  to 
be  given  is  prescribed  by  the  charter,  by-laws,  or  statutes,  this 
is  always  sufficient,  but  if  not  so  determined,  "reasonable 
notice"  is  then  necessary  and  this  requires  such  notice  as  will 
under  ordinary  circumstances  enable  the  parties  notified  to 
attend  without  being  specially  inconvenienced. 

Notice  of  a  special  meeting  must  accord  as  to  the  time, 
place,  and  purposes  thereof  with  the  call  by  which  the  meeting 
is  authorized.  The  authority  under  which  it  is  issued  should 
be  stated  in  the  notice. 

Form  ii8.    Notice  of  Special  Meeting  of  Stockholders 

HUDSON  NAVIGATION  COMPANY 

New  York  City,  New  York, 
February  i,  1922 
Mr.  Arthur  C.  McCall, 

227  Broadway,  New  York. 
Dear  Sir: 

You  are  hereby  notified  that  pursuant  to  the  call  of  the  President,  a  special 
meeting  of  the  stockholders  of  the  Hudson  Navigation  Company  will  be  held  in  the 
office  of  the  Company,  No.  270  Broadway,  New  York,  on  the  15th  day  of  February, 
1922,  at  10  A.M.,  for  the  purpose  of  considering  and  acting  upon  a  proposition  to 
sell  the  entire  property  and  assets  of  the  Company,  and  for  the  transaction  of  any 
and  all  business  in  connection  therewith  that  may  properly  come  before  said 
meeting. 

Yours  very  truly, 

Henry  H.  Sheldon, 
Secretary 


For  general  discussion,  see  Book  I,  |{  370,  396,  414, 

1529 


I530  CORPORATE  FORMS  [Bk.  IV- 

When  notice  of  a  special  meeting  is  to  be  published,  the 
following  form  is  frequently  used.  The  same  form  also  serves 
as  a  notice  to  be  sent  by  mail. 

Form  119.    Publication  Notice  of  Special  Meeting  of  Stockholders 


Notice  of  Special  Meeting  of  Stockholders 
CROSS  LABORATORIES,  INC. 

A  special  meeting  of  the  stockholders  of  this  Company  will  be  held  on  the  16th 
day  of  January,  1922,  at  two  o'clock  in  the  afternoon,  at  the  principal  office  of  the 
corporation.  No.  347  Madison  Avenue,  New  York,  N.  Y.,  for  the  purpose  of  chang- 
ing the  name  of  the  company  from  "Cross  Laboratories,  Inc.,"  to  "Larson 
Manufacturing  Company,  Inc.,"  and  for  the  transaction  of  such  other  business 
in  connection  therewith  as  may  properly  come  before  the  meeting. 

George  V.  Larson, 

President 
E.  M.  Hilton, 

Secretary 
New  York  City, 
!     '      December  31,  1921. 


The  following  gives  an  excellent  form  of  notice  for  a  special 
meeting  of  stockholders. 

Form  120.     Publication  Notice  of  Special  Meeting  of  Stockholders 


WESTERN  UTAH  RAILROAD  COMPANY 

Special  Meeting  of  Stockholders 


'  120  Broadway,  New  York, 

March  26,  1922 
To  the  Stockholders  of  the 

Western  Utah  Railroad  Company: 

Notice  is  hereby  given  that  a  special  meeting  of  the  stockholders  of  Western 
Utah  Railroad  Company  has  been  called  by  the  Board  of  Directors  to  convene  at 
the  office  of  the  Company  at  Salt  Lake  City,  in  the  State  of  Utah,  on  the  5th  day 
of  May,  1922,  at  10  a.m.,  for  the  purpose  of  considering  and  acting  upon  a  propjosi- 
tion  for  the  sale  of  the  Company's  entire  assets  to  the  Salt  Lake  City  Air  Line  as 
set  forth  below. 

(Purposes  here) 


Ch.  12]  NOTICES  OF  MEETINGS  153 1 

The  books  for  the  transfer  of  the  stock  (both  preferred  and  common)  will  be 
closed  for  the  purpose  of  the  meeting,  at  12  noon,  on  the  nth  day  of  April,  1922, 
and  will  be  reopened  at  10  a.m.  on  the  6th  day  of  May,  1922. 
By  order  of  the  Board  of  Directors. 

John  Hamilton, 

Secretary 


Notice  of  the  annual  meeting  must  be  sent  out  in  accordance 
with  the  requirements  of  the  by-laws. 

Form  121.    Notice  of  Annual  Meeting 

HARMON  PUBLISHING  COMPANY 

765  Main  St.,  Dover,  Delaware 

May  I,  1922 
Mr.  Francis  H.  Jamieson, 

336  Ocean  Ave.,  Atlantic  City,  N.  J. 

Dear  Sir: 

You  are  hereby  notified  that  the  annual  meeting  of  the  stockholders  of  the 
Harmon  Publishing  Company  will  be  held  at  the  office  of  the  Company  in  Dover, 
Delaware,  on  Tuesday,  May  15,  1922,  at  10  a.m.,  for  the  elections  of  five  Directors 
for  the  ensuing  year  and  for  the  transaction  of  such  other  business  as  may  come 
before  the  meeting. 

The  stock  transfer  books  of  the  Company  will  be  closed  at  3  p.m..  May  5, 1922, 
and  remain  closed  until  10  a.m.,  May  16,  1922. 

Respectfully, 

James  H.  Howard, 

Secretary 


In  a  number  of  states  the  statutes  require  the  publication 
of  the  notice  of  the  annual  meeting.  The  following  forms  are 
suitable  for  this  purpose.  Form  121  may  also  be  easily  modified 
to  serve  as  a  publication  notice. 

Form  122.    Publication  Notice  of  Annual  Meeting 


HARMON  PUBLISHING  COMPANY 
765  Main  St.,  Dover,  Delaware 

May  I,  1922 
Notice  is  hereby  given  that  the  annual  meeting  of  the  stockholders  of  the 
Harmon  Publishing  Company  will  be  held  at  the  office  of  the  Company  at  765  Main 


1S32  CORPORATE  FORMS  [Bk.  IV 

St.,  Dover,  Delaware,  May  15,  1922,  at  10  a.m.,  for  the  election  of  five  Directors 
and  for  the  transaction  of  such  other  business  as  may  be  brought  before  said 
meeting. 

The  stock  transfer  books  of  the  Company  will  be  closed  at  3  p.m.,  May  5,  1922, 
and  remain  closed  until  10  a.m.,  May  16,  1922. 

James  H.  Howard, 

Secretary 


Form  123.     Publication  Notice  of  Annual  Meeting 


THE  CORPORATION  TRUST  COMPANY 

(New  York) 

Notice  of  Annual  Meeting 

The  annual  meeting  of  the  stockholders  of  The  Corporation  Trust  Company 
will  be  held  on  the  i8th  day  of  January,  1922,  at  twelve  o'clock  noon,  at  the 
office  of  the  company.  No.  37  Wall  Street,  New  York,  N.  Y.,  for  the  purpose  of 
electing  two  Directors  of  the  Second  Class,  receiving  and  acting  upon  the  reports  of 
the  officers  and  for  the  transaction  of  such  other  business  as  may  properly  come 
before  the  meeting. 

Horace  S.  Gould, 

Secretary 
Dated,  December  20,  1921 


Form  124.     Publication  Notice  of  Annual  Meeting 

GREAT  WESTERN  RAILROAD  COMPANY 
Annual  Meeting 

120  Broadway,  New  York, 
August  13,  192 1 

The  annual  meeting  of  the  stockholders  of  the  Great  Western  Railroad  Com- 
pany will  be  held  at  the  office  of  the  Company  in  Chicago,  Illinois,  on  Tuesday, 
February  14,  1922,  at  twelve  noon,  for  the  following  purposes,  viz.:  (i)  To  elect 
fifteen  Directors;  (2)  To  consider  and  act  upon  an  amendment  to  Article  XVI  of 
the  Company's  By-laws;  (3)  To  transact  all  such  other  business  as  may  legally 
come  before  the  meeting,  including  the  approval  and  ratification  of  all  action  of  the 
Board  of  Directors  and  of  the  Executive  Committee  since  the  last  Annual  Meeting 
of  the  stockholders  of  the  Company. 

For  the  purposes  of  the  meeting  the  books  for  the  transfer  of  stock,  both  pre- 
ferred and  common,  will  be  closed  at  3  p.m.  on  Wednesday,  February  i,  1922,  and 
will  be  reopened  at  10  a.m.  on  Wednesday,  February  15,  1922. 

John  Hamilton, 

Secretary 


Ch.  12]  NOTICES  OF  MEETINGS  1 533 

Directors'  Meetings 2 

It  is  but  rarely  that  publication  notices  are  used  in  assembling 
directors'  meetings.  Either  of  the  following  notices  might  be 
readily  modified,  if  desired,  to  serve  as  a  publication  notice. 
Consent  meetings,  from  their  nature,  do  not  permit  of  any 
formal  notice. 

The  following  is  a  simple  form  for  notice  of  special  meet- 
ing of  directors.     It  would  either  be  mailed  or  delivered  in  person. 

Form  125.    Notice  of  Special  Meeting  of  Directors 

HYDRO-CARBON  STEEL  COMPANY 
134  West  23rd  St.,  New  York  City 

January  3,  1922 
Mr.  Walter  H.  Sinclair, 
Montclair,  New  Jersey 

Dear  Sir: 

You  are  hereby  notified  that  pursuant  to  call  of  the  President,  a  special  meet- 
ing of  the  Board  of  Directors  of  this  Company  will  be  held  in  its  office  at  3  p.m. 
on  the  1 8th  day  of  January,  1922,  to  act  ujx)n  a  proposition  to  purchase  the  plant 
of  the  Scranton  Foundry  Company  and  to  transact  such  other  business  in  connec- 
tion therewith  as  may  be  necessary  or  desirable. 

Respectfully, 

Milton  H.  Sanderson, 

Secretary 

This  notice  must  be  sent  to  every  member  of  the  board. 
The  time,  place,  and  purpose  of  the  meeting  must  be  stated, 
and,  unless  every  member  of  the  board  is  present  and  agrees 
thereto,  no  business  may  be  transacted  at  the  meeting  save 
that  so  specified. 

The  following  notice  is  the  usual  formal  notice  of  the  regular 
meeting  of  directors.  If  desired,  a  printed  form  might  be  used 
with  blanks  for  the  dates  and  addresses. 


'  For  general  discussion,  see  Book  I,  1}  286  424. 


1534  CORPORATE  FORMS  [Bk.  IV- 

Form  126.    Notice  of  Regular  Meeting  of  Directors 


HYDRO-CARBON  STEEL  COMPANY 
134  West  23rd  St.,  New  York  City 

■    March  15,  1922 
Mr.  Walter  H.  Sinclair, 
Montclair,  New  Jersey 

Dear  Sir: 

You  are  hereby  notified  that  the  regular  quarterly  meeting  of  the  Board  of 
Directors  of  the  Hydro-Carbon  Steel  Company  will  be  held  in  the  office  of  the 
Company,  No.  134  West  23rd  St.,  New  York,  on  Tuesday,  March  28,  1922,  at  3  p.m. 

Respectfully, 

Milton  H.  Sanderson, 

Secretary 


CHAPTER  XIII 

PROXIES  FOR  MEETINGS 

A  proxy  is  merely  a  special  power  of  attorney  and  may 
convey  any  authority  as  to  the  representation  of  his  stock  the 
maker  desires  up  to  the  limit  of  his  own.i 

The  powers  conferred  by  a  proxy  are  limited  strictly  to 
those  specified.  Thus  a  proxy  to  vote  on  a  proposed  amend- 
ment of  the  charter  at  a  certain  meeting  would  not  authorize 
the  holder  to  vote  also  upon  a  proposed  amendment  of  the 
by-laws  though  considered  at  the  same  meeting. 

The  time  for  which  a  proxy  runs  is  also  governed  strictly 
by  the  provisions  of  the  instrument  unless  sooner  terminated 
(i)  by  statutory  or  by-law  provisions,  (2)  by  the  death  of  the 
maker,  (3)  by  the  sale  of  his  stock,  (4)  by  his  formal  revocation 
filed  with  the  secretary,  or  (5)  for  the  meetings  at  which  he  ap- 
pears, by  the  presence  and  participation  thereat  of  the  maker. 
A  proxy  given  for  a  particular  meeting  holds  good  for  any 
meeting  adjourned  therefrom,  whether  so  specified  in  the  proxy 
or  not. 

A:  proxy  should  be  in  writing,  but  it  is  not  necessarily  in 
any  particular  form;  it  need  not  be  acknowledged  or  proved, 
but  it  must  be  in  such  a  shape  as  reasonably  to  satisfy  the  in- 
spectors of  election  of  its  genuineness  and  validity.  To  meet 
this  requirement  the  proxy  should  be  signed  and  sealed  by 
the  maker  and  be  witnessed  by  at  least  one  person,  but  does 
not  ordinarily  require  acknowledgment.  It  may  cover  all  or 
any  part  of  the  stock  owned  by  an  individual,  and  two  or  more 
proxies  may  be  given  by  a  single  stockholder,  each  proxy  cover- 

>For  general  discussion,  see  Book  I,  if  375,  401. 

t 

IS3S 


1536  CORPORATE  FORMS  IBk.  IV- 

ing  a  part  of  his  holding,  or  each  authorizing  action  on  different 
propositions. 

A  proxy  may  be  revoked  by  the  maker  at  any  time  even 
though  by  its  terms  the  proxy  is  irrevocable.  The  only  ex- 
ception to  this  rule  is  where  occasionally  a  proxy  is  coupled 
with  an  interest  in  the  stock  on  which  the  proxy  is  given.  The 
revocation  of  a  proxy  should  be  in  writing  and  be  filed  with 
the  secretary  of  the  meeting.  The  mere  presence  of  the  owner 
of  the  stock  at  any  meeting,  with  the  express  intention  of  voting 
his  stock  thereat,  has  the  effect  of  revoking  for  that  meeting  all 
outstanding  proxies  given  by  him.  If  a  proxy  is  issued  while  a 
prior  proxy  for  the  same  stock  is  outstanding,  a  revocation  of 
the  first  proxy  should  be  incorporated  in  the  second.  Should 
this  not  be  done,  the  more  recent  proxy  will  on  presentation 
revoke  the  first,  but  the  absence  of  formal  revocation  is  a  suspi- 
cious circumstance,  liable  to  provoke  inquiry  and  cause  trouble. 

Notices  of  the  annual  meetings  of  the  larger  corporations 
are  usually  accompanied  by  proxy  forms,  which  stockholders 
unable  to  be  present  at  the  meeting  in  person  are  requested  to 
sign  and  send  in  to  the  corporate  officials.  In  this  way  a  quorum 
is  often  secured  when  otherwise  it  would  fail.  The  plan  is  some- 
times utilized  with  much  effect  for  the  purpose  of  securing  a 
majority  for  some  measure  favored  by  the  directors  of  the  com- 
pany, or  to  secure  the  election  or  re-election  of  parties  desired 
as  directors  by  those  in  control. 

Proxies  sent  with  notices  of  meetings  sometimes  name  the 
party  or  parties  to  act,  but  are  frequently  sent  out  with  the  names 
omitted,  and  are  then  usually  returned  signed  in  blank;  i.e., 
while  duly  signed  and  witnessed,  the  name  of  the  person  who 
is  to  act  as  proxy  is  omitted.  The  name  of  the  secretary  or  some- 
one else  present  at  the  meeting  is  then  inserted  and  the  instru- 
ment so  completed  is  legally  effective. 

Proxies  signed  in  blank  are  usually  employed  in  any  case 
where  the  name  of  the  party  to  act  has  not  been  definitely 
decided  upon  or  where  it  is  immaterial.     In  this  shape  the 


Ch.  13]  PROXIES  FOR  MEETINGS  1537 

proxy  can  be  used  by  anyone  into  whose  hands  it  may  come. 
When  once  completed,  however,  by  the  insertion  of  the  name 
of  the  party  to  act,  it  can  be  used  only  by  the  specified  party, 
nor  can  this  party  authorize  anyone  else  to  vote  the  stock 
covered  by  the  proxy  unless  the  proxy  itself  distinctly  con- 
fers upon  him  full  rights  of  substitution. 

Directors  cannot  give  proxies  authorizing  others  to  repre- 
sent and  vote  for  them  at  directors'  meetings.  The  directors 
occupy  a  position  of  trust  and  they  cannot  as  individuals  dele- 
gate the  trust  vested  in  them  to  others.  This  is  a  settled 
principle  of  law. 

When  the  proxies  are  to  be  used  they  are  filed  with  the 
secretary  of  the  meeting.  If  the  holder  desires  to  retain  his 
original  proxy,  he  may,  after  exhibiting  the  original,  file  a  certified 
copy  with  the  secretary  of  the  meeting. 

Form  127.    Proxy — Simple  Form 

Proxy 

I  hereby  appoint  George  H.  Brewer  my  proxy  with  full  authority  to  vote  for 
me  and  in  my  place  at  any  and  all  stockholders'  meetings  of  the  Brewer  Plow 
Company. 

Witness  my  hand  and  seal  this  7th  day  of  May,  1922. 

Harold  J.  McCormick  [l.  s.] 
Witnessed  by 

Henry  F.  Simmons 

This  proxy  is  under  most  circumstances  legally  sufficient 
and  the  powers  it  conveys  are  broad.  A  more  formal  proxy  is, 
however,  desirable  when  important  matters  are  to  be  con- 
sidered. The  proxy  which  follows  is  still  simple  as  to  form 
but  more  specific  in  its  terms. 

Form  128.    Proxy — Unlimited 

Proxy 

I,  the  undersigned,  do  hereby  constitute  and  appoint  George  J.  McClelland 
my  true  and  lawful  attorney  to  represent  me  at  any  and  all  meetings  of  the  stock- 


1538  CORPORATE  FORMS  [Bk.  IV- 

holders  of  the  Carney  Falls  Spinning  Company,  and  for  me  and  in  my  name  and 
stead  to  vote  thereat  upon  the  stock  standing  in  my  name  on  the  books  of  said 
Company  at  the  times  of  said  meetings,  and  I  hereby  grant  my  said  attorney  all  the 
powers  that  I  should  myself  possess  if  personally  present  thereat. 

Witness  my  signature  and  seal  this  15th  day  of  January,  1922. 

Harold  B.  McClelland  [l.  s.] 
In  the  presence  of 

Alphonse  H.  DuRet 


At  the  expiration  of  the  specified  term  the  following  proxy 
becomes  null  and  void  without  formal  revocation  or  other 
action  on  the  part  of  the  maker. 

Form  129.     Proxy — Time  Limited 


Proxy 


I,  the  undersigned,  do  hereby  constitute  and  appoint  Henry  M.  Williams  my 
true  and  lawful  attorney  to  represent  me  at  all  meetings  of  the  stockholders  of  the 
Carney  Falls  Power  Company  held  on  or  prior  to  the  15th  day  of  June,  1923,  and 
do  hereby  authorize  and  empower  him  for  me  and  in  my  name  and  stead  to  vote 
at  such  meetings  upon  the  stock  now  standing  in  my  name  on  the  books  of  said 
Company,  and  I  hereby  grant  my  said  attorney  all  the  power  at  said  meetings  that 
I  should  myself  possess  if  personally  present  thereat. 

Witness  my  signature  and  seal  this  ist  day  of  February,  1922. 

Samuel  B.  Fremont  [l.  s.] 
In  the  presence  of 

J.  J.  Masterson 


It  should  be  noted  that  the  wording  of  the  foregoing  proxy 
authorizes  the  appointee  to  vote  only  upon  the  stock  "now 
standing  in  my  name."  Should  the  maker  dispose  of  this 
stock  prior  to  the  expiration  date  of  the  proxy,  the  proxy  would 
of  course  be  automatically  terminated  and  be  of  no  further  effect. 
Should  the  maker  acquire  additional  stock  of  the  company 
after  the  date  of  this  proxy  but  during  its  life,  such  additional 
stock  is  not  covered  by  the  proxy.  In  this  the  proxy  differs 
from  the  proxy  of  Form  128  which  covers  all  stock  owned  by  the 
maker  "at  the  times  of  said  meetings." 


Ch.  13]  PROXIES  FOR  MEETINGS  1539 

Form  130.    Proxy  for  Particular  Meeting 

Proxy 

Know  All  Men  by  These  Presents: 

That  I,  the  undersigned,  do  hereby  constitute  and  appoint  Kenneth  J.  Johnson 
my  true  and  lawful  attorney  with  full  powers  of  substitution  and  revocation,  to 
represent  me  at  the  special  meeting  of  stockholders  of  the  Graham  Navigation 
Company,  to  be  held  on  the  19th  day  of  June,  1922,  at  3  p.m.,  and  do  hereby 
authorize  and  empower  him  to  vote  at  said  meeting  and  at  any  adjournment  thereof, 
for  me  and  in  my  name  and  stead,  upon  the  stock  then  standing  in  my  name  on  the 
books  of  said  Company,  and  I  hereby  grant  my  said  attorney  all  the  powers  that  I 
should  possess  if  personally  present  at  said  meeting. 

Witness  my  signature  and  seal  this  ist  day  of  May,  1922. 

Melver  M.  McKim  [l.  s.] 
In  the  presence  of 

Henry  P.  Swenton 

Outside  its  limitation  as  to  time,  the  preceding  proxy  is 
broad.  It  not  only  covers  all  stock  held  in  the  name  of  the 
maker  at  the  time  of  meeting  and  empowers  the  appointee 
to  act  as  fully  and  with  the  same  authority  as  the  owner  might 
himself,  but  also  empowers  him  to  give  and  revoke  proxies 
conveying  similar  voting  powers  to  others.  If  it  is  not  desired 
to  convey  these  latter  powers,  the  words  "with  full  power  of 
substitution  and  revocation"  should  be  omitted. 

If  all  the  stock  covered  by  a  proxy  is  disposed  of  before 
the  date  of  meeting,  such  proxy  is,  as  already  stated,  thereby 
nullified.  If  part  of  the  stock  is  sold,  the  proxy  still  holds  for  the 
remaining  stock.  If  a  proxy  specifies  the  number  of  shares  of 
stock  to  be  voted  upon,  such  proxy  is  good  for  the  number  of 
shares  standing  in  the  maker's  name  up  to  the  specified  number. 

The  following  form  may  be  used  when  but  a  portion  of  the 
stock  owned  by  a  stockholder  is  to  be  represented  by  his  proxy. 
A  single  stockholder  may  give  several  such  proxies  to  cover  his 
entire  holding  of  stock,  the  object  being  to  admit  several  repre- 
sentatives to  the  proceedings  of  the  meeting. 

The  following  proxy  does  not  convey  any  greater  or  more 
complete  powers  than  the  shorter  forms  heretofore  considered, 


I540  CORPORATE  FORMS  [Bk.  IV- 

but  is  more  specific  and  conventional  and  therefore  preferable 
when  matters  of  importance  are  to  be  considered  and  acted  upon. 

Form  131.     Proxy— Limited  as  to  Stock 

Proxy 

I,  the  undersigned,  do  hereby  nominate  and  appoint  John  H.  McConnell  mj^ 
true  and  lawful  attorney,  for  me  and  in  my  name,  place,  and  stead  to  vote  at  all 
stockholders'  meetings  of  the  Fowler  Watch  Company  upon  Twenty-five  Shares  of 
the  stock  of  said  Company  standing  in  my  name,  and  I  hereby  grant  my  said 
attorney  all  the  powers  as  to  said  Twenty-five  Shares  of  stock  that  I  would  myself 
possess  if  personally  present  at  such  meetings. 

Witness  my  signature  and  seal  this  loth  day  of  March,  1922. 

Francis  P.  Sterling 
In  the  presence  of 

Harry  H.  French 


Form  132.     Proxy  for  Annual  Meeting — ^Formal 

Proxy 

Know  All  Men  by  These  Presents: 

That,  we,  the  undersigned,  stockholders  of  the  Carney  Falls  Power  Company, 
do  hereby  constitute  and  appoint  J.  Adam  McCall  our  true  and  lawful  attorney 
with  full  power  of  substitution  and  revocation,  for  us  and  in  our  names,  place,  and 
stead  to  vote  upon  the  stock  then  standing  in  our  respective  names  upon  the  books 
of  said  Company,  at  the  annual  meeting  of  the  stockholders  thereof  to  be  held  in 
the  ofl&ce  of  the  Company,  425  Fifth  Ave.,  New  York  City,  January  17,  1922,  at 
10  o'clock  in  the  forenoon,  and  at  any  meeting  postponed  or  adjourned  therefrom, 
hereby  granting  to  our  said  attorney  full  power  and  authority  to  act  for  us,  and  in 
our  names  and  stead  to  vote  thereat  upon  our  said  stock  in  the  election  of  directors 
and  in  the  transaction  of  such  other  business  as  may  be  brought  before  the  said 
meeting,  all  as  fully  as  we  might  or  could  do  if  personally  present,  and  we  hereby 
ratify  and  confirm  all  that  our  said  attorney  or  his  substitute  shall  lawfully  do  at 
such  meeting  in  our  names,  place  and  stead. 

In  Witness  Whereof,  we  have  hereunto  affixed  our  respective  signatures 
and  seals  this  2nd  day  of  November,  192 1. 

S.  S.   FOLSOM  [l.  s.] 

Henry  M.  Cleveland         [l.  s.j 
J.  B.  McLain  [l.  s.j 

Sargent  McLain  [l.  s.j 

In  the  presence  of 

William  J.  Hammond 
as  to  S.  S.  Folsom 
and  Henry  M.  Cleveland 
Jerry  T.  McAllister 
as  to  J.  B.  McLain 
and  Sargent  McLain 


Ch.  13I  PROXIES  FOR  MEETINGS  1 541 

If  corporate  stock  is  held  by  a  corporation  in  its  own  name, 
the  proxy  might  be  given  under  the  corporate  name  as  in  the 
following  general  form. 

Form  133.    Corporate  Proxy 


Proxy 


Know  All  Men  by  These  Presents  : 

That  the  Steel  Company  of  the  Republic,  a  corporation  organized  under  the 
laws  of  the  State  of  Pennsylvania,  owning  and  holding  Five  Hundred  Shares  of  the 
Capital  Stock  of  the  Howard  Welding  Company  of  New  York  City,  does  hereby 
constitute  and  appoint  Frederick  W.  Morton  of  New  York  City  its  true  and  lawful 
attorney  to  attend  the  annual  meeting  of  the  aforesaid  Howard  Welding  Company 
to  be  held  in  its  office.  No.  22  Broad  St.,  New  York,  on  Monday,  January  16,  1922, 
at  ID  o'clock  in  the  forenoon,  and  thereat  for  this  Company  and  in  its  name,  place, 
and  .stead  to  vote  upon  the  said  Five  Hundred  Shares  of  stock,  and  to  do  all  such 
other  things  competent  to  a  stockholder  of  said  Howard  Welding  Company,  as  may 
in  his  judgment  be  necessary  or  advantageous  for  the  interests  of  this  Company, 
and  to  that  end  the  said  Steel  Company  of  the  Republic  does  hereby  grant  to  its 
said  attorney  for  said  meeting,  and  for  any  meetings  adjourned  therefrom,  any  and 
all  powers  belonging  to  or  pertaining  to  this  Company  as  a  stockholder  of  the 
aforesaid  Howard  Welding  Company,  hereby  ratifying  and  confirming  all  that  its 
said  attorney  may  lawfully  do  at  said  meeting  in  its  name,  place  and  stead. 

In  Witness  Whereof,  the  President  and  Secretary  of  the  said  Steel 
Company  of  the  Republic,  duly  authorized  thereto,  have  hereunto 
affixed  the  signature  and  seal  of  their  said  Company,  all  being  done  in 
the  City  of  Philadelphia,  Pennsylvania,  on  this  3rd  day  of  January, 
1922. 

Steel  Company  of  the  Republic, 
CORPORATE  \  By  John  H.  Sherman, 

SEAL       /  President 

Attest  seal: 

William  M.  McDonald, 

Secretary 


In  some  states  the  statutes  empower  the  corporate  officials 
to  vote  the  stock  of  other  corporations  held  by  their  corpora- 
tion. In  such  case  no  proxy  is  necessary,  but  a  certification 
that  the  official  representing  the  company  is  its  official,  properly 
representing  the  company,  is  required. 


1542  CORPORATE  FORMS  [Bk.  IV- 

Form  134.    Revocatioii  of  Proxy 

Revocation  of  Proxy 


Know  All  Men  by  These  Presents: 

That  I,  the  undersigned,  do  hereby  revoke  and  annul  any  and  all  proxies  or 
powers  of  attorney  heretofore  given  by  me,  authorizing  or  empowering  any  person 
or  persons  to  represent  me,  or  vote  in  my  name  and  stead  or  act  for  me  in  any  way 
whatsoever  at  any  meeting  or  meetings  of  the  stockholders  of  the  Carney  Falls 
l^ower  Company. 

Witness  my  signature  and  seal  this  loth  day  of  May,  1922. 

Daniel  H.  Ronalds  [l.  s.] 
In  the  presence  of 
John  H.  Dunn 


The  foregoing  revocation  of  outstanding  proxies  is  sweeping 
in  its  terms.  If  some  particular  proxy  is  to  be  excepted  from 
the  general  revocation,  such  proxy  may  be  specifically  reserved, 
or  otherwise  the  revocation  may  itself  be  limited  by  its  terms 
to  the  one  or  more  proxies  to  be  revoked,  in  which  case  any  other 
outstanding  proxies  are  not  ajBfected. 


CHAPTER  XIV 

MOTIONS  AND  RESOLUTIONS 

In  the  course  of  corporate  meetings,  whether  of  stockholders 
or  directors,  anything  to  be  done  that  is  obviously  proper  and  of 
no  great  importance  may  be  merely  ordered  by  the  president, 
as  for  instance,  the  reading  of  the  minutes  of  the  previous 
meeting,  or  the  filing  of  some  paper  or  report,  and,  in  the  absence 
of  objection,  this  is  held  to  be  the  action  of  the  meeting.  Matters 
of  more  importance  are  sometimes  acted  upon  in  this  same  way, 
but  usually,  and  preferably,  action  is  then  taken  by  means  of 
either  a  motion  or  a  resolution. 

There  is  no  distinct  line  of  demarcation  between  these  two. 
They  differ  as  to  form  but  both  are  expressions  of  the  decisions 
of  the  meeting  and  are  of  the  same  legal  force.  The  motion  is 
the  simpler  in  form,  and,  though  there  is  no  well-established 
rule,  is  usually  employed  for  matters  of  minor  importance; 
while  resolutions,  which  are  formal  and  usually  go  further  into 
their  subject  matter,  are  employed  for  such  important  corporate 
actions  as  require  a  more  complete  statement  and  record. 

Motions  are  not  as  a  rule  submitted  in  writing.  The  secre- 
tary must  therefore  exercise  every  care  to  get  the  sense  of  what  is 
intended.  If  he  is  in  doubt  in  any  case  as  to  whether  he  has 
understood  the  motion,  or  if  its  subject  matter  is  of  unusual 
importance,  or  if  it  is  desirable  that  the  exact  wording  be  pre- 
served, the  presiding  officer  should  request  the  maker  of  the 
motion  to  repeat  it,  or,  better,  to  reduce  it  to  writing.  When 
this  is  done,  the  written  motion  is  turned  over  to  the  secretary, 
and,  if  carried,  is  incorporated  in  his  minutes  in  the  exact  form 
submitted. 

The  following  forms  show  motions  as  they  should  appear  in 

1543 


1544  CORPORATE  FORMS  [Bk.  IV- 

the   secretary's  minutes.    The   form  is   the  same  for  either 
stockholders'  or  directors'  minutes. 

Form  135.    Motion  Instructing  Secretary  to  Cast  Vote 

There  being  no  other  nominations,  the  Secretary  was  instructed  by  motion 
unanimously  carried,  to  cast  the  single  ballot  of  the  meeting  for  the  five  candidates 
for  Directors  already  named. 


Form  136.    Motion  Instructing  Secretary  to  Cast  Vote — Formal 

On  motion  unanimously  carried,  the  Secretary  was  instructed  to  cast  the  single 
ballot  of  the  meeting  as  follows : 

For  President John  H.  McNeil 

"    Vice-President Samuel  French 

"    Secretary Harry  McGill 

"    Treasurer Joseph  F.  Macklin 


An  amendment  to  the  by-laws  is  usually  acted  upon  by 
means  of  a  resolution.  In  the  following  instance,  as  the  amend- 
ment is  of  minor  importance  it  is  decided  by  motion. 

Form  137.    Motion  to  Amend  By-Laws 


By  motion  unanimously  carried.  Section  i  of  Article  II  of  the  By-laws  was 
amended  by  changing  the  hour  for  the  assembling  of  the  annual  meeting  of  the 
Company  from  1 2  o'clock  noon  to  3  p.m. 


Form  138.    Motion  to  Pay  Bills 

Upon  motion  duly  seconded  and  unanimously  carried,  the  Treasurer  was  in- 
structed to  pay  the  account  of  the  Meyer  Contracting  Companj'  for  One  Hundred 
and  Thirty-Five  Dollars,  due  for  repairs  on  roof  of  the  Franklin  Mill  as  per  state- 
ment submitted. 


Usually  the  secretary  uses  his  discretion  as  to  recording 
the  names  of  the  parties  making  and  seconding  motions.  They 
are  not  essential  in  the  case  of  routine  motions,  motions  covering 
matters  of  minor  importance,  or  motions  unanimously  carried. 


Ch.  14]  MOTIONS  AND  RESOLUTIONS  1545 

Under  other  circumstances  the  name  of  the  party  making  and 
also  the  party  seconding  a  motion  should  be  recorded.  The 
vote  on  important  motions  when  there  is  opposition,  is  sometimes 
recorded  as  well. 

Form  139.     Motion  to  Employ  General  Manager 
-f      ""' "'"' """ 

Mr.  Henry  Sheldon  moved  that  James  J.  McLain  be  employed  as  General 
Manager  of  the  Company  for  a  term  of  two  years  from  date,  at  the  annual  salary 
of  Four  Thousand,  Five  Hundred  Dollars  payable  in  monthly  instalments.  The 
motion  was  seconded  by  Mr.  Charles  H.  Corbett  and  carried;  Messrs.  Sheldon, 
McLemore,  Corbett,  and  Johnson  voting  in  the  affirmative,  and  Messrs.  Franklin, 
Hereford,  and  Trask  in  the  negative. 

A  motion  in  writing  should  appear  on  the  minutes  in  the 
exact  form  submitted,  as  in  the  following  example,  and  should  be 
introduced  by  an  explanatory  statement,  as  "The  following 
motion  offered  by  Mr.  Wilson  was  duly  seconded  and  carried 
by  unanimous  vote." 

Form  140.    Motion  to  Appoint  an  Investigating  Committee 

Moved,  that  the  President  be  authorized  and  directed  to  appoint  a  Committee 
consisting  of  three  Directors  of  this  Company,  to  investigate  the  books  and  accounts 
of  the  Treasurer  for  the  past  three  years,  such  Committee  to  have  full  access  to  the 
Company's  financial  records  and  to  have  authority  to  employ  an  Auditor  to  con- 
duct the  technical  work  of  their  examination,  the  compensation  of  said  Auditor 
not  to  exceed  the  sum  of  Three  Hundred  Dollars. 


Resolutions  should  be  submitted  in  writing.  They  are 
entered  in  the  minutes  prefaced  with  such  explanatory  remarks 
as  the  conditions  require  or  the  secretary  thinks  desirable,  as 
"Upon  motion  duly  made  and  seconded  the  following  resolution 
was  unanimously  adopted,"  or  "The  following  resolution  was 
presented  by  Mr.  Cassellton,  seconded  by  Mr.  Edwards  and 
adopted,  Messrs.  Cassellton,  Edwards,  Brice,  and  McNeil 
voting  in  the  affirmative,  and  Messrs.  Mack  and  Adams  voting 
in  the  negative."  A  preamble  to  a  resolution  is  always  ad- 
missible but,  if  its  subject  matter  is  simple,  is  not  necessary. 


1546  CORPORATE  FORMS  [Bk.  IV- 

There  is  no  difference  in  form  between  a  resolution  adopted 
by  the  stockholders  and  one  adopted  by  the  directors. 

Form  141.    Stockholders'  Resolution  for  Sale  of  Entire  Assets  1 

Whereas,  William  F.  Gaynor  and  James  G.  Reilly,  as  Trustees  before  organi- 
zation for  the  New  Hampshire  Granite  Company,  have  made  a  proposition  to 
purchase  the  entire  plant  and  business  of  this  Company  as  a  going  concern,  includ- 
mg  all  assets  and  liabilities,  save  cash  in  bank  and  on  hand,  for  Ten  Thousand  Dol- 
lars ($10,000)  in  cash  and  Forty  Thousand  Dollars  ($40,000)  par  value  of  the  stock 
of  said  New  Hampshire  Granite  Company: 

Now,  Therefore,  Be  It  Resolved,  That  the  said  proposition  be  hereby  ap- 
proved, and  that  the  Directors  of  this  Company  be  and  hereby  are  fully  authorized, 
instructed,  and  empowered  to  accept  the  said  proposition  for  the  sale  of  its  entire 
property  and  business,  and  to  do  all  things  necessary  to  carry  such  acceptance  into 
effect  according  to  the  terms  of  said  proposition. 


Form  142.    Stockholders'  Resolution  Authorizing  ConsoHdation 

Whereas,  A  consolidation  of  the  Midvale  Foundry  Company  and  the 
Wanaque  Steel  Company  under  the  name  of  the  New  Jersey  Steel  Foundry  Com- 
pany, has  been  proposed  by  the  Wanaque  Steel  Company  on  terms  and  conditions 
approved  by  the  Board  of  Directors  of  this  Company;  and 

Whereas,  Said  proposed  consolidation  on  the  terms  set  forth  meets  with  the 
approval  of  the  stockholders  of  the  Company: 

Now,  Therefore,  Be  It  Resolved,  That  the  Board  of  Directors  of  this  Com- 
pany be  and  hereby  is  fully  authorized,  empowered,  and  instructed  to  take  all 
such  steps  as  may  be  necessary  or  desirable  to  carry  said  consolidation  into  effect 
in  accordance  with  the  terms  submitted  by  the  said  Wanaque  Steel  Company. 


Form  143.     Stockholders'  Resolution  to  Amend  By-Laws 

Whereas,  Section  2  of  Article  IV  of  the  By-laws  of  this  Company  relating  to 
the  President  reads  and  provides  in  part  as  follows: 

"He  may  also,-  in  the  absence  or  disability  of  the  Treasurer,  indorse 

checks,  drafts,  and  other  negotiable  instruments  for  deposit  or  collection,  and 

shall,  with  the  Secretary,  sign  the  minutes  of  all  meetings  over  which  he  may 

have  presided." 

And  Whereas,  It  seems  to  the  stockholders  of  the  Company  that  the  interest 
of  the  Company  will  be  better  conserved  if  these  duties  are  assigned  to  the  Vice- 
President  of  the  Company,  save  as  to  the  signature  to  minutes: 

Now,  Therefore,  Be  It  Resolved,  That  said  Section  2  of  Article  IV  of  said 
By-laws  be  and  hereby  is  amended  as  to  the  part  above  set  forth  to  read  and  pro- 
vide as  follows: 


1  For  corresponding  directors'  resolution,  see  Form  159. 


Ch.  i\]  MOTIONS  AND  RESOLUTIONS  1547 

"He  shall,  with  the  Secretary,  sign  the  minutes  of  all  meetings  over  which 
he  may  have  presided." 
and  that  Section  3  of  Article  IV  of  said  By-laws  relating  to  the  Vice-President  be 
amended  by  the  addition  of  the  following  provision: 

"He  may,  in  the  absence  or  disability  of  the  Treasurer,  indorse  checks, 
drafts,  and  other  negotiable  instruments  for  deposit  or  collection." 


The  following  is  a  simple  form  of  resolution  authorizing 
the  treasurer  to  open  a  bank  account.  It  should  be  certified 
before  submission  to  the  bank. 

Form  144.    Directors'  Resolution  to  Open  Bank  Account 

Resolved,  That  the  Treasurer  be  and  hereby  is  authorized  and  instructed  to 
open  an  account  for  the  Company  with  the  Irving  National  Bank  of  New  York 
City,  and  to  deposit  therein  all  funds  of  the  Company  coming  into  his  possession, 
such  account  to  be  in  the  name  of  the  Company  and  funds  deposited  therein  to  be 
withdrawn  only  by  check  signed  by  the  Treasurer  and  countersigned  by  the 
President. 


In   some   cases   the   designated   bank   requires   a   certified  ' 
transcript  of  any  by-laws  giving  the  duties  and  powers  of  the 
officers  in  relation  to  the  funds.     Such  by-laws  may  be  certified 
separately,  or  may  be  included  in  the  resolution,  as  in  the 
following  example: 

Form  145.    Directors'  Resolution  Designating  Depositary  2 

Whereas,  Section  3,  Article  VII  of  the  By-laws  of  the  Standard  Milling  Com- 
pany is  as  follows: 

^'The  Moneys  of  the  Company  shall  be  deposited  in  the  name  of  the  Com- 
pany in  such  bank  or  banks  as  the  Board  of  Directors  shall  designate,  and  shall 
be  drawn  out  only  by  check  signed  by  the  Treasurer  and  countersigned  by  the 
President,  unless  otherwise  provided  by  resolution  of  the  Board." 
Now,  Therefore,  In  pursuance  of  said  By-law,  the  Board  of  Directors  of  the 
Standard  Milling  Company  hereby  designates  the  Sherman  Trust  Company  of 
New  York  City  as  a  depositary  of  this  Company,  and  authorizes  and  instructs  the 
Treasurer  to  open  an  account  with  said  Trust  Company  in  the  name  of  the  Com- 
pany, and  to  deposit  therein  all  funds  of  the  Company  coming  into  his  custody, 
save  as  may  be  otherwise  directed  by  the  Board,  said  funds  to  be  withdrawn  only 
by  check  signed  by  the  Treasurer  and  countersigned  by  the  President 


'  For  certification,  see  Form  335. 


IS48  CORPORATE  FORMS  (a/lW- 

In  many  cases,  as  already  stated,^  the  banks  have  their  own  ' 
forms  of  resolution  for  designation  of  the  corporate  depositary, 
which  they  supply  on  request  and  which  they  naturally  prefer 
should  be  used.  As  a  rule  these  forms  are  good,  though  occasion- 
ally the  latitude  and  power  they  confer  upon  the  officers  of  the 
corporation  are  somewhat  excessive.  If  this  is  the  case,  the 
resolution  may  be  so  modified  as  to  eliminate  these  undesirable 
provisions  while  still  preserving  its  general  form.  The  resolution 
which  follows  is  used  by  some  of  the  large  New  York  banks. 

Form  146.    Directors'  Resolution  Designating  Bank 

Resolved,  That  the  Sherman  National  Bank  of  the  City  of  New  York  be  and 
the  same  is  hereby  designated  as  the  depositary  of  the  funds  of  the  American  Tex- 
tile Company,  and  that  an  account  be  opened  with  such  Bank  in  the  name  of  said 
Company,  and  that  George  H.  Wahrman,  the  Treasurer  of  said  Company,  so  long 
as  he  shall  be  Treasurer  thereof,  is  hereby  authorized  to  sign  or  indorse  any  instru- 
ment for  or  on  behalf  of  said  Company  and  have  the  same  placed  to  the  credit  of 
said  account,  and  also  from  time  to  time  withdraw  or  transfer  by  check  or  draft 
or  other  instrument  signed  by  him  and  countersigned  by  Henry  G.  Maxim,  Presi- 
dent of  the  said  American  Textile  Company,  or  any  successor  President  of  said 
Company,  any  amount  or  parts  thereof  which  may  from  time  to  time  be  to  the 
credit  of  said  account;  and 

Resolved,  Further,  That  the  respective  powers  and  the  authority  conveyed 
by  this  present  resolution  shall  pass  to  any  duly  elected  and  qualified  successor 
Treasurer  or  President  of  the  said  American  Textile  Company  without  further 
action  of  this  Board,  and  as  fully  and  to  the  same  extent  as  if  said  successor  officer 
were  named  herein. 


Under  this  resolution,  if  a  new  treasurer  or  president  is 
elected,  nothing  is  necessary  save  for  the  election  and  acceptance 
of  the  new  official  to  be  certified  to  the  bank  by  the  secretary 
of  the  company.'* 

Form  147.    Directors'  Resolution  Authorizing  Issue  of  Stock 

Resolved,  That  the  President  and  Treasurer  be  and  hereby  are  authorized  and 
directed  to  issue  certificates  of  the  full-paid  Capital  Stock  of  this  Company  to  the 
aggregate  amount  of  Ten  Thousand  Dollars  ($10,000),  and  to  deliver  the  same  to 
the  written  order  of  Robert  H.  Stuart,  Fiscal  Agent  for  the  Company,  against  pay- 
ment into  the  treasury  of  the  Company  of  the  full  par  value  thereof. 


•  Ch.  IX,  "Organization  Meeting  of  Directors." 

*  See  Forms  227,  228. 


Ch.  14]  MOTIONS  AND  RESOLUTIONS  1549 

Form  148.    Directors'  Resolution  Authorizing  Contract 

Resolved,  That  the  President  and  Secretary  be  and  hereby  are  authorized 
and  instructed  to  enter  into  a  contract  with  the  Wilbur  Collins  Construction  Com- 
pany on  behalf  of  this  corporation,  for  the  erection  of  a  power  house,  the  construc- 
tion of  said  power  house  to  be  in  accordance  with  the  plans  and  specifications  on  file 
in  the  office  of  this  corporation,  and  the  cost  thereof  not  to  exceed  Twenty-Five 
Thousand  Dollars  ($25,000),  payment  thereof  to  be  made  as  set  forth  in  the  written 
proposition  heretofore  submitted  to  this  corporation  by  the  said  Wilbur  Collins 
Construction  Company. 

Form  149.    Directors'  Resolution  Declaring  Dividend 

Resolved,  That  the  sum  of  Ten  Thousand  Dollars  ($10,000)  be  and  hereby 
is  appropriated  and  set  aside  from  the  surplus  profits  of  this  Company  for  the  pay- 
ment of  the  regular  Two  Per  Cent  (2%)  quarterly  dividend  upon  its  outstanding 
stock,  said  dividend  to  be  due  and  payable  on  the  20th  day  of  May,  1922,  to  stock- 
holders of  record  as  shown  by  the  books  of  the  Company  at  the  close  of  business  on 
the  15th  day  of  May,  1922. 

Resolved  Fxjrther,  That  the  Treasurer  of  this  Company  be  hereby  author- 
ized and  instructed  to  give  notice  of  such  dividend  and  to  pay  the  same  when  due. 


Form  150.    Directors'  Resolution  Declaring  Dividend — Preferred 
Stock 


Resolved,  That  the  semiannual  dividend  of  Three  Per  cent  (3%)  upon  the 
outstanding  Preferred  Stock  of  the  Company  be  and  hereby  is  declared  from  sur- 
plus profits,  said  dividend  to  be  paid  on  the  loth  day  of  March,  1922,  and  to  be 
payable  to  stockholders  who  appear  of  record  on  the  i»t  day  of  March,  1922,  at 
3  P.M.,  and  that  the  Treasurer  of  this  Company  be  hereby  instructed  and  fully 
authorized  to  give  due  notice  of  such  dividend  and  to  .pay  the  same  on  the  date  set 
forth. 


Form  151.    Directors'  Resolution  Declaring  Dividend — Preferred 
and  Common  Stock 


Whereas,  The  surplus  profits  of  this  Company  now  exceed  the  sum  of  Ten 
Thousand  Dollars  ($10,000)  required  by  the  By-laws  of  this  Company  to  be  in 
reserve  before  dividends  may  be  paid  upon  either  the  preferred  or  common  stock 
of  this  Company,  and  such  excess  is  now  available  for  payment  of  dividends: 

Now,  Therefore,  Be  It  Resolved,  That  a  dividend  of  Five  Per  Cent  (5%) 
be  and  hereby  is  declared  upon  the  outstanding  Preferred  Stock  of  this  Company, 
and  a  dividend  of  Three  Per  Cent  (3%)  on  the  outstanding  Common  Stock  of  this 
Company,  said  dividends  to  be  payable  from  said  excess  surplus  profits  of  the 
Company  on  the  5th  day  of  March,  1922,  to  stockholders  appearing  of  record  at 
3  P.M.,  on  this  isth  day  of  February,  1922;  and  that  the  Treasurer  of  this  company 


I5SO  CORPORATE  FORMS  [Bk.  IV- 

be  hereby  fully  authorized  and  instructed  to  give  proper  notice  of  said  dividends, 
to  pay  the  same  when  due,  and  to  take  all  other  necessary  steps  to  carry  out  the 
intent  of  the  present  resolution. 


Form  152.     Directors'  Resolution  Appointing  Managing  Director 

Resolved,  That  Mr.  William  S.  Weston  be  hereby  appointed  Managing  Direc- 
tor of  this  Company  and  be  given  the  general  supervision  and  management  of  the 
Company's  affairs  and  business,  with  such  other  powers  and  duties  as  the  Board  of 
Directors  may  from  time  to  time  confer  upon  him ;  the  annual  salary  of  said  Man- 
aging Director  to  be  Forty-Eight  Hundred  Dollars  ($4,800),  payable  in  monthly 
instalments  of  Four  Hundred  Dollars  ($400)  each.  < 


Form  153.    Directors'   Resolution   Calling   Special  Meeting  of 
Stockholders 

Whereas,  The  authorized  Capital  Stock  of  this  corporation  is  One  Hundred 
Thousand  Dollars  ($100,000)  divided  into  One  Thousand  (1,000)  Shares  of  Com- 
mon Stock  of  the  par  value  of  One  Hundred  Dollars  ($100)  each,  of  which  Five 
Hundred  (500)  Shares  are  issued  and  Five  Hundred  (500)  Shares  are  unissued;  and 

Whereas,  It  is  deemed  advisable  by  this  Board  that  said  Capital  Stock  shall 
be  so  classified  and  divided  into  Common  and  Preferred  Stock  that  the  said  Five 
Hundred  (500)  Shares  of  outstanding  stock  shall  be  and  remain  Common  Stock, 
but  shall  be  of  no  par  value;  and  that  the  said  Five  Hundred  (500)  Sharesof  unissued 
stock  shall  become  and  be  non-voting  Preferred  Stock  of  the  par  value  of  One 
Hundred  Dollars  ($100)  each,  entitled  to  receive  a  cumulative,  preferred  dividend 
of  Seven  Per  Cent  (7%)  per  annum  and  redeemable  at  its  par  value  at  the  option 
of  the  Company  at  any  time  after  ten  years  from  the  date  of  its  issue,  and  upon 
the  liquidation  of  the  Company  to  be  redeemed  if  outstanding,  at  its  full  face  value 
from  the  assets  before  any  payment  is  made  upon  the  Common  Stock,  but  not  to 
participate  further  in  said  assets: 

Now,  Therefore,  Be  It  Resolved,  That  a  special  meeting  of  the  stockhold- 
ers of  this  Company  be  and  hereby  is  called  to  meet  in  the  office  of  the  Company 
on  the  loth  day  of  May,  1922,  at  10  o'clock  in  the  forenoon,  for  the  purpose  of 
considering  and  acting  upon  the  proposed  classification  of  the  stock  of  this  Com- 
pany as  afore  set  forth,  and  that  the  Secretary  of  the  Company  be  hereby  author- 
ized and  instructed  to  send  out  notices  of  said  meeting  as  required  by  law  and  by 
the  By-laws  of  this  Company. 

This  resolution  conforms  to  the  requirements  of  the  New 
York  laws,  classification  of  the  company's  stock  requiring 
authorization  by  the  stockholders. 

Form  154.    Directors'  Resolution  to  Sell  Bonds 

Resolved,  That  Howell  &  Wilkins  of  New  York  City  be  and  hereby  are 
authorized  and  empowered  to  sell  bonds  of  this  Company  to  the  aggregate  face 


Ch.  14]  MOTIONS  AND  RESOLUTIONS  1551 

value  of  One  Hundred  Thousand  Dollars  ($100,000),  and  to  deduct  from  the  price 
received  therefor  a  commission  of  Two  Per  Cent  (2%),  provided,  however,  that  the 
net  price  received  by  this  Company  for  each  One  Thousand  Dollar  ($1,000)  Bond 
shall  not  be  less  than  Nine  Hundred  and  Eighty  Dollars  ($980) ;  and 

Resolved,  Further,  That  the  Treasurer  of  this  Company  be  and  hereby  is 
authorized  and  instructed  to  deliver  said  bonds  in  whole  or  in  part  on  the  written 
order  of  the  said  Howell  &  Wilkins,  and  to  receive  and  receipt  for  all  amounts  paid 
by  them  into  the  treasury  of  the  Company  on  account  of  sales  of  said  bonds. 


Form  155.     Directors'  Resolution  to  Purchase  Property 

Resolved,  That  the  President  and  Treasurer  of  the  Company  be  and  hereby 
are  authorized  and  instructed  to  purchase  the  West  Valley  marl  beds  in  accordance 
with  the  terms  of  the  option  under  which  said  beds  are  now  held,  and  that  they 
be  further  authorized  and  empowered  to  do  all  such  things  for  and  on  behalf  of 
the  Company  and  in  its  name  as  may  be  necessary  to  the  consummation  of  said 
purchase. 


Form  156.    Directors'  Resolution  for  Settlement  of  Claim 

Resolved,  That  the  President  and  Secretary  of  this  Company,  acting  with  its 
Counsel,  be  hereby  instructed  to  use  their  best  efforts  to  arrive  at  some  favorable 
settlement  with  the  employees  of  this  Company  injured  in  the  recent  accident,  and 
that  said  officers  be  hereby  fully  authorized  and  empowered  to  agree  to  any  settle- 
ment deemed  by  them  satisfactory  and  approved  by  the  Counsel  of  the  Company, 
provided  that  the  total  payments  involved  therein  shall  not  exceed  the  sum  of 
Twenty -five  Hundred  Dollars  ($2,500). 

Form  157.    Directors'  Resolution  Ratifying  Sale  of  Property 

Whereas,  The  President  and  Treasurer  of  this  Company  have  heretofore  on 
the  2ist  day  of  January,  1922,  sold  and  disposed  of  the  machinery,  tools,  and  other 
apparatus  belonging  to  this  Company  and  then  in  the  premises  at  235  Main  St., 
Newark,  New  Jersey,  the  amount  realized  from  such  sale — Two  Thousand,  Seven 
Hundred  and  Fifty  E)ollars  ($2,750) — having  been  duly  paid  into  the  treasury  of 
this  Company;  and 

Whereas,  Said  sale  was  made  without  authorization  from  this  Board  owing 
to  the  absence  from  the  city  of  so  many  of  its  members  that  a  quorum  could  not 
be  secured;  and 

Whereas,  In  the  opinion  of  the  Board  such  sale  was  for  the  best  interests  of 
the  Company,  and  the  action  of  said  officers  in  consummating  the  same  therefore 
meets  with  its  approval: 

Now,  Therefore,  Be  It  Resolved,  That  the  action  of  the  said  officers  of 
this  Company  in  selling  and  disposing  of  the  aforementioned  property  as  aforesaid, 
be  and  hereby  is  ratified,  approved,  and  confirmed,  and  that  said  action  be  accepted 
as  the  action  of  the  Company,  and  the  bills  of  sale  and  assignments  thereof  be 
ratified,  confirmed,  and  accepted  as  the  duly  executed  assignments  of  this  Com- 
pany, of  the  same  force  and  effect  as  if  entered  into  under  direct  authorization  of 
this  Board. 


1552  CORPORATE  FORMS  [Bk.  IV- 

In  some  few  states  the  statutes  give  the  directors  power  to 
remove  an  objectionable  official.  The  following  resolution 
embodies  such  action  taken  in  accordance  with  the  statutes 

Form  158.    Directors'  Resolution  Removing  Officer  (New  York) 

Whereas,  In  the  opinion  of  this  Board  the  interests  of  the  Company  do  not 
permit  the  continuance  in  his  present  official  position  of  its  President,  John  Farra- 
day;  and 

Whereas,  The  said  John  Farraday  has  refused  to  resign  although  requested 
thereto  by  members  of  this  Board  duly  authorized  thereunto : 

Now,  Therefore,  Be  It  Resolved,  That  exercising,  its  statutory  power  the 
Board  of  Directors  of  the  Manly  Electric  Corporation  does  hereby  remove  the 
said  John  Farraday  from  his  official  position  as  President  of  this  Company,  and 
declares  said  office  vacant  and  said  John  Farraday  no  longer  authorized  to  act  on 
its  behalf  in  any  capacity;  and 

Resolved  'FtiRTHER,  That  the  Secretary  of  the  Company  be  and  hereby  is 
instructed  to  notify  at  once  the  said  John  Farraday  of  his  removal  from  the  presi- 
dency of  this  Company,  and  to  give  such  other  proper  and  public  notice  of  said 
removal  as  may  in  his  judgment  be  necessary  to  protect  the  interests  of  the  Com- 
pany. 


Form  159.     Directors'  Resolution  for  Sale  of  Entire  Assets  ^ 

Whereas,  A  proposition  has  been  made  by  the  Trustees  of  the  New  Hamp>- 
shire  Granite  Company  to  purchase  the  entire  property  and  business  of  this  Com- 
pany for  Ten  Thousand  Dollars  ($10,000)  in  cash  and  Forty  Thousand  Dollars 
($40,000)  in  stock  of  the  said  proposed  corporation  as  set  forth  in  their  written 
proposition  heretofore  ordered  to  be  spread  upon  the  minutes  of  this  meeting;  and 

Whereas,  The  stockholders  of  this  Company  in  duly  assembled  meeting  at 
which  all  the  voting  stock  of  the  Company  was  represented  in  person  or  by  proxy, 
did  by  resolution  unanimously  carried,  approve  said  sale  and  authorize  and  in- 
struct this  Board  to  accept  said  proposition: 

Now,  Therefore,  Be  It  Resolved,  That  the  said  proposition  be  and  the 
same  is  hereby  accepted  by  this  Company  on  the  terms  set  forth  in  said  written 
proposition  as  entered  upon  the  minutes  of  this  meeting,  and  the  President  and 
Secretary  of  the  Company  are  hereby  empowered  and  instructed  to  execute  all 
proper  instruments  to  carry  such  acceptance  into  effect,  and  on  behalf  of  this 
Company  to  receive  the  said  Ten  Thousand  Dollars  ($10,000)  in  cash  and  Forty 
Thousand  Dollars  ($40,000)  in  stock  of  the  said  New  Hampshire  Granite  Company, 
and  to  do  all  such  other  things  in  connection  with  such  sale  and  the  said  transfer 
of  property  as  may  be  found  necessary  for  its  proper  consummation. 


'  For  corresponding  stockholders'  resolution,  see  Form  141. 


rid'J.R  ,11' 


CHAPTER  XV 


FORMS  USED  IN  CONNECTION  WITH  MEETINGS 

The  secretary  will  find  a  list  of  stockholders,  giving  the 
stock  held  by  each  and  arranged  as  in  the  following  form,  of 
much  convenience  for  use  at  stockholders'  meetings.  This 
does  not  take  the  place  of  the  statutory  list  required  in  some 
states,  but  is  merely  for  use  in  calling  the  roll  or  noting  those 
present  and  absent,   and  ,th,e  proxies  for  ,.tho^:  jatjaent. 

Form  i6o.    Secretary's  List  of  Stockholders  ,      ,.  , 

_  .lilHi'Iiyi.liCU.J^iliij?^ 

INDUSTRIAL  SUPPLY  COMPANY 


List  of  Stockholders 
January  3,  1922 


Name 

Shares 
Owned 

Not 
Present 

Present 

IN 

Person 

Present 

BY 

Proxy 

Name  of  Proxy 

Adrian,  Henry  F. 

100 

100            H 

Ahrens,  Sam'l  T. 

50 

50 

Allison,  Daniel  H. 

75 

75 

George  T.  Foster 

Barry,  John  J. 

85 

85 

Belmont,  Maurice 

25 

25 

Colville,  Frederick 

100 

100 

Daniels,  E.  F. 

100 

50 

50 

Harry  H.  Winters 

Greenwald,  Martin 

80 

80 

William  Greenwald 

Hughes,  Cora  H. 

150 

150 

Lawrence,  Edw. 

25 

25 

McCabe,  Albert 

SO 

SO      ■ 

W.  B.  Wells 

MuUins,  Chas.  D. 

35 

35 

Price,  Harvey 

200 

200 

Rollins,  James  H. 

50 

50 

Henry  Siebert 

Shanley,  J.  J. 

25 

25 

Sherman,  B.  L. 

150 

150 

Wiley,  Edwin  H. 

100 

100 

Harry  T.  French 

Zimmer,  Henry  T. 

TOO 

'.'.'''■' 

'    100 

1,500 

ISO 

945 

405 

Mi.i,  ■tlf) 

1SS3 


1554  CORPORATE  FORMS  [Bk.  IV- 

The  list  as  shown  is  after  the  secretary's  notations  have  been 
made.  The  data  of  the  first  two  columns  are  taken  from  the 
stock  books  of  the  company  before  the  time  of  the  meeting. 
If  a  stockholder  is  not  represented  at  the  meeting,  a. check  mark, 
or,  better,  the  number  of  his  shares,  is  entered  in  the  third  column. 
If  present  in  person,  the  number  of  shares  owned  is  entered  in 
the  fourth  column.  If  represented  by  proxy,  the  number  of  his 
shares  is  entered  in  the  fifth  column,  and  the  name  of  the  person 
holding  the  proxy  in  the  last  column. 

It  will  be  noted  that  in  the  foregoing  list,  a  portion  of  the 
holding  of  one  stockholder  is  entered  in  the  column  "Not  Pres- 
ent" and  a  portion  is  entered  in  the  column  "Present  by  Proxy." 
This  shows  that  the  party  gave  a  proxy  for  a  portion  of  his 
stock  and  that  the  person  to  whom  this  was  given  was  present, 
while  the  remaining  stock  was  not  represented,  this  latter  stock 
losing  its  vote. 

The  list,  when  the  secretary's  notations  are  finished,  gives  a 
complete  record  of  the  attendance  at  the  meeting.  The  com- 
bined footing  of  columns  four  and  five  give  the  number  of  shares 
represented,  which  added  to  the  footing  of  column  three  should 
give  the  total  stock  outstanding. 

At  the  annual  meeting  routine  work  is  apt  to  be  gone  through 
with  some  rapidity  and  the  secretary  does  not  always  have 
time  for  its  proper  record  unless  provision  is  made  therefor  prior 
to  the  meeting.  For  this  purpose,  in  addition  to  the  list  of 
stockholders,  outline  minutes  as  shown  below  are  frequently 
prepared. 

These  outline  minutes  are  best  arranged  on  sheets  of  loose 
paper  with  ample  room  between  the  items  for  the  interpolation 
of  any  comments  or  additional  matter.  They  are  merely 
intended  to  afford  memoranda  from  which  the  secretary  may 
later  write  out  the  complete  minutes.  If,  through  unexpected 
changes  or  omissions,  any  portion  of  the  outline  minutes  cannot 
be  used,  the  secretary  has  merely  to  draw  his  pencil  through 
the  part  to  be  eliminated. 


Ch.  15]  FORMS  USED  IN  MEETINGS  1555 

Form  161.     Outline  Minutes  for  Annual  Meeting 


INDUSTRIAL  SUPPLY  COMPANY 

OF  New  York 


Minutes  of  Annual  Meeting 
Held  January  16,  1922 

Meeting  called  to  order  at a.m.,  by 

who  presided  over  meeting.    Officiating  Secretary 

Present  at  meeting  in  person Shares.  By 

Proxy Shares.   Total Shares.    Necessary 

for  quorum,  751  Shares. 

Copy  of  notice  of  meeting  submitted  with  secretary's  certificate  of  due  service 
attached.     Ordered  spread  upon  minutes. 

Minutes  of  previous  meeting  read  and 

Annual  Reports: 

President's 

Treasurer's 

Special 

Election  of  Directors.     Nominated: 


Inspectors  of  Election: 


,^      Results: 

1  ;    New  business: 


*  In  some  states  the  statutes  require  that  the  election  of 
Clirectors  must  be  conducted  by  inspectors.  Elsewhere  they  or 
similar  officers  designated  as  tellers,  are  employed  as  a  matter 
of  convenience. 

Usually  inspectors  are  not  sworn,  but  in  some  states  this 
is  required  by  the  statutes  or  is  a  matter  of  custom.  The  oaths 
and  certificates  of  inspectors  of  election  in  the  general  form 
employed  in  New  York  follow.  They  may  be  easily  modified 
to  meet  the  statutory  requirements  of  other  states  where  oaths 
and  certificates  are  required. 


1556  CORPORATE  FORMS  [Bk.  IV- 

Form  162.    Oath  of  Inspectors  of  Election — ^New  York 


'I  im<'>li 


Oath  of  Inspectors  of  Election 

State  of  New  York    \         , 
County  of  New  York/ 

We,  the  undersigned,  duly  appointed  to  act  as  Inspectors  of  Election  at  the 
annual  meeting  of  the  stockholders  of  the  Alvin  Auto  Car  Company,  held  in  the 
office  of  the  Company,  No.  72  Broadway,  New  York,  on  the  2nd  day  of  February, 
1922,  being  severally  duly  sworn,  depose  and  say  and  each  for  himself  deposes  and 
says  that  he  will  faithfully  execute  the  duties  of  Inspector  of  Election  at  such 
meeting  with  strict  impartiality  and  according  to  the  best  of  his  ability. 

Frank  H.  Astor 
David  J.  McKane 
Severally  sworn  to  before  me  this 
2nd  dav  of  February,  1922 

Allen  T.  Bauvelt, 

Notary  Public  in  and  for 
/notarial!  New  York  County 

\      SEAL      / 

The  oath  of  the  inspectors  of  election  and  their  certificate 
as  to  the  election  results — as  given  in  the  form  which  follows 
— are  usually  written,  as  a  matter  of  convenience,  on  one  sheet 
of  paper,  the  oath  preceding  the  certificate. 

Form  163.     Certificate  of  Inspectors  of  Election — ^New  York 

Certificate  of  Inspectors  of  Election 

We,  the  undersigned,  duly  appointed  Inspectors  of  Election  of  the  Alvin  Auto- 
Car  Company  of  New  York  City,  New  York,  do  hereby  certify  that  at  the  regular 
annual  meeting  of  said  corporation,  held  in  the  office  of  the  Company,  No.  72  Broad- 
way, New  York  City,  on  the  2nd  day  of  February,  1922,  a  quorum  being  present; 
we  being  first  duly  sworn  by  oath  hereunto  annexed,  did  conduct  the  election  for 
Directors  of  said  corporation  and  that  the  result  of  the  vote  taken  thereat  was  the 
election  by  the  plurality  vote  set  opposite  their  respective  names,  of  the  following 
Directors: 

names  votes  received 

Charles  E.  Shepherd 2,135 

Frank  J.  Piatt 2,000 

Harry  P.  Tucker i  •  •  ^1.  •  • , i.970 

Edward  T.  Bowles. .  f. .:.  W! 1,875 

Henry  P.  Moody.  .  . .  .  ;  . . 1,825 

George  McDonald 1,825 

Albert  T.  Calkins 1,800 

In  Testimony  Whereof,   we  have  executed  this  certificate  this  2nd 
day  of  February,  1922. 

Frank  H.  Astor 
David  J.  McKane 


Ch.  15]  FORMS  USED  IN  MEETINGS  1557 

In  New  York  the  inspectors'  oath  and  certificate  must 
be  filed  in  the  county  clerk's  office. 

Form  1 64.    Acknowledgment  of  Inspectors'  Certificate 

State  of  New  York  ) 
CotTNTY  OF  New  York/    ^'^■' 

On  this  2nd  day  of  February,  1922,  before  me  personally  came  Frank  H.  Astor 
and  David  J.  McKane,  to  me  known  to  be  the  persons  described  in  and  who 
executed  the  foregoing  certificate  and  severally  acknowledged  that  they  executed 
the  same  for  the  use  and  purposes  therein  set  forth. 

Allen  T.  Bauvelt, 
fNOTARiALl  Notary  Public  in  mid  for 

\     seal     J  New  York  County 

When  not  required  by  statute,  the  formality  of  swearing 
inspectors  is  usually  dispensed  with.  An  inspectors'  report  is, 
however,  a  convenient  method  of  preserving  the  results  of 
an  election,  and  the  written  report  is  therefore  desirable.  Its 
form  under  such  circumstances  might  be  as  follows: 

Form  165.    Certificate  of  Inspectors  of  Election — General 

Certificate  of  Inspectors  of  Election 

We,  the  undersigned,  duly  appointed  Inspectors  of  Election  of  the  Hamilton 
Machine  Company  of  Philadelphia,  Pennsylvania,  to  conduct  the  election  of 
Directors  of  said  Company  held  this  14th  day  of  March,  1922,  at  3  p.m.,  in  the 
office  of  the  Company,  No.  15  Chestnut  St.,  Philadelphia,  Pa.,  do  hereby  certify 
and  report  that  said  election  was  conducted  by  us  in  due  and  proper  form,  and 
that  the  result  of  the  vote  taken  thereat  by  ballot  was  the  election  by  the  plurality 
vote  set  opposite  their  respective  names  of  the  following  directors: 

NAMES  votes  RECEIVED 

E.  L.  Lambert 200 

John  C.  Robinson 200 

Walter  S.  Hall 200 

William  H.  Sloane 200 

Alvah  H.  Marshall 200 

In  Witness  Whereof,  we  hereunto  affix  our  respective  signatures  this 
14th  day  of  March,  1922. 

Arthur  T.  Newman 
George  Haywood 

A  simple  form  of  ballot  for  the  annual  meeting  is  shown 
below.  This  is  prepared  before  the  time  of  the  meeting,  com- 
plete— when  the  candidates'  names  are  known  in  advance — 


I5S8  CORPORATE  FORMS  [Bk.  IV- 

save  as  to  signature  and  the  number  of  shares  voted.  If  there 
are  more  candidates  than  the  number  of  directors  to  be  elected, 
the  space  where  the  names  are  to  appear  would,  of  course,  be 
left  blank. 

Form  i66.    Ballot  at  Annual  Meeting 

MAXIM  WATCH  COMPANY 

Ballot 
Annual  Meeting,  January  io,  1922 

I,  the  undersigned,  hereby  vote  125  shares  of  stock  for  the  following  named 
persons  to  serve  as  Directors  for  the  ensuing  year: 

John  H.  Brown  Frank  T.  Jones 

Howard  McCall  Fowler  McVeigh 

Marvin  H.  Smith 

Signature, 

Harold  McKain, 

Proxy  for  Samuel  H.  Hilton 

Where  a  more  formal  ballot  is  desired  the  following  will 
serve : 

Form  167.    Ballot  at  Annual  Meeting — Formal 

UNITED  STATES  POTTERIES 

Ballot 
Sixteenth  Annual  Meeting,  April  20,  1922 

The  undersigned  votes  the  number  of  shares  noted  in  the  subscription  hereto 
as  follows: 

1.  In  favor  of  approving  and  ratifying  all  purchases,  contracts,  acts,  pro- 
ceedings, elections,  and  appointments  by  the  Board  of  Directors  or  the  Finance 
Committee,  since  the  fifteenth  annual  meeting  of  the  stockholders  of  the  Corpora- 
tion on  April  15,  1921,  as  set  forth  in  the  minutes  of  the  Board  of  Directors,  or  of 
the  Finance  Committee,  or  in  the  Fifteenth  Annual  Report. 

2.  For  the  following  named  persons,  as  Directors  for  the  three  years  ending 
in  1925: 

name  number  of  shares 

preferred  common 

in  person 


proxy  for 

3.  For  the  firm  of  Jones,  Williams  &  Company,  as  independent  auditors,  to 
audit  the  books  and  accounts  of  the  Corporation  at  the  close  of  the  fiscal  year 
ending  December  31,  1922 


CHAPTER  XVI 

MINUTES    OF    CORPORATE    MEETINGS 

The  general  form  in  which  minutes  are  kept  is  a  matter 
of  custom.  The  details  are  determined  by  the  secretary  of 
the  particular  company.  The  headings  should,  however, 
always  be  sufficiently  full  and  explicit  to  show  at  a  glance 
whether  the  meeting  is  of  stockholders  or  directors  and  whether 
it  is  a  regular,  special,  or  adjourned  meeting.  The  date  of  the 
particular  meeting,  though  always  stated  in  the  body  of  the 
minutes,  should  also  appear  in  the  heading  as  a  matter  of  con- 
venience. 

The  name  of  the  corporation  is  frequently  brought  in  at  the 
head  of  every  set  of  minutes.  When  this  is  not  done  the  minute 
book  itself  should  be  very  plainly  stamped  or  marked  with 
the  name  of  the  company,  which  should  also  appear  on  the 
title  page  of  the  book  and  again  at  the  top  of  the  first  written 
page  of  minutes. 

Form  i68.    Minutes  of  Annual  Meeting  of  Stockholders ' 

MIDVALE  FOUNDRY  COMPANY 
of  New  Jersey 

Minutes  of  Regular  Meeting  of  Stockholders 
Held  March   2,    1922 

The  stockholders  of  the  Midvale  Foundry  Company  met  in  annual  meeting 
in  the  office  of  the  Company  at  Midvale,  New  Jersey,  at  10  o'clock  in  the  forenoon, 
March  2,  1922. 

The  meeting  was  called  to  order  and  presided  over  by  Frederick  H.  Colgate, 
President  of  the  Company.  The  Secretary  of  the  Company,  W.  A.  Thompson, 
acted  as  Secretary  of  the  meeting. 

•  See  Ch.  XLII,  "Annual  Meeting  of  Stockholders.  " 

1559 


1560  CORPORATE  FORMS  [Bk.  IV- 

The  Secretary  after  noting  the  stockholders  present,  reported  that  out  of  a 
total  of  5,000  shares  of  stock  outstanding  and  entitled  to  vote  at  the  meeting, 
4,900  shares  were  represented  at  the  meeting;  3,500  shares  in  person,  and  1,400 
shares  by  proxies  filed  with  the  Secretary. 

The  Secretary  then  read  a  copy  of  the  notice  of  the  meeting,  with  his  certificate 
attached  showing  that  a  copy  thereof  had  been  mailed  to  each  stockholder  of  record 
on  or  before  the  17th  day  of  February,  1922.  He  Jilso  presented  copies  of  the 
Newark  Advertiser  and  the  Jersey  City  Journal  under  date  of  February  18  and  25, 
1922,  containing  due  advertisement  of  the  meeting.  The  proof  of  notice  as  pre- 
sented was  ordered  received  and  filed. 

The  Secretary  produced  the  stock  and  transfer  books  of  the  Company,  together 
with  an  alphabetical  list  giving  the  name,  residence,  and  number  of  shares  of  stock 
held  by  every  stockholder  entitled  to  vote  in  the  election  of  directors.  This  list 
remained  open  to  inspection  during  the  election  of  directors  and  for  the  entire  time 
of  the  meeting. 

The  minutes  of  the  preceding  annual  meeting  were  then  read  and  approved. 
The  minutes  of  the  special  meeting  of  stockholders  held  December  10,  1921,  were 
also  read  and  approved. 

Upon  motion  duly  seconded  and  carried,  Messrs.  W.  B.  Johnson  and  D.  L. 
Boyd  were  appointed  Inspectors  of  Election,  were  duly  sworn,  and  the  meeting 
then  proceeded  to  the  election  of  Directors.  The  election  was  held  by  ballot  and 
the  polls  were  opened  at  10:15  o'clock  a.m.  and  closed  at  11:15  o'clock  a.m. 

The  Inspectors  thereupon  presented  their  report  in  writing  showing  that 
Frederick  H.*  Colgate,  Benson  R.  Vale,  William  R.  Buchanan,  Malcolm  R.  Rigby, 
and  Robert  H.  McCarter  had  received  a  plurality  of  all  the  votes  cast,  and  the  said 
parties  were  thereupon  declared  to  be  the  duly  elected  Directors  of  the  Company 
for  the  ensuing  year  and  until  the  election  of  their  successors. 

The  annual  report  of  the  President  was  then  presented  and  upon  request  was 
read  by  him.     The  report  was  by  unanimous  motion  ordered  received,  and  filed. 

The  Treasurer's  annual  report  was  submitted,  and,  no  objection  being  offered, 
was  ordered  received  and  filed. 

The  report  of  the  committee  appointed  at  the  special  meeting  of  stockholders 
held  December  10,  1921,  to  examine  the  accounts  of  the  Company,  was  received, 
and  by  motion  its  findings  were  approved  and  the  report  ordered  received  and  filed. 

Upon  motion  duly  made  and  unanimously  adopted,  the  Board  of  Directors 
were  authorized  to  secure  plans  and  estimates  for  enlarging  the  plant  of  the  company. 

There  being  no  further  business  before  the  meeting,  a  motion  to  adjourn  was 
unanimously  adopted. 

Frederick  H.  Colgate,  W.  A.  Thompson, 

President  Secretary 


Form  169.    Minutes  of  Special  Meeting  of  Stockholders  ^ 

MIDVALE  FOUNDRY  COMPANY 
of  New  Jersey 

Minutes  of  Special  Meeting  of  Stockholders 
Held   March   20,    1922 

The  stockholders  of  the  Midvale  Foundry  Company  assembled  in  special 
meeting  in  the  ofl&ce  of  the  Company  at  Midvale,  New  Jersey,  at  10  o'clock  in  the 

J  See  Ch.  XLIII,  "Special  Meetings  of  Stockholders.  " 


Ch.  i6]  MINUTES  OF  MEETINGS  1561 

forenoon  on  the  20th  day  of  March,  1922,  pursuant  to  call  of  the  President  followed 
by  due  notice  thereof  to  the  stockholders. 

The  Meeting  was  called  to  order  by  Frederick  H.  Colgate,  President  of  the 
Company;  the  Secretary  of  the  Company,  W.  A.  Thompson,  officiating  as  recording 
officer. 

The  entire  capital  stock  of  the  Company  was  represented  at  the  meeting,  either 
in  person  or  by  proxy  filed  with  the  Secretary. 

"The  Secretary  presented  the  Call  and  Notice  pursuant  to  which  the  meeting 
was  held,  with  his  certificate  that  said  notice  had  been  sent  out  not  less  than  twenty 
days  before  the  date  of  meeting.  The  Call  and  Notice  were  ordered  spread  upon 
the  Minute  Book  immediately  following  the  minutes  of  the  meeting. 

The  President  then  stated  briefly  that  the  meeting  was  assembled  to  consider 
a  proposition  from  the  Wanaque  Steel  Company  for  the  consolidation  of  the  two 
companies  under  the  general  name  of  the  New  Jersey  Steel  Foundry  Company,  the 
new  company  to  have  a  capitalization  of  One  Million,  Five  Hundred  Thousand 
Dollars  ($1,500,000)  and  stock  in  both  companies  to  be  exchanged  for  stock  of  the 
new  company,  share  for  share. 

A  discussion  of  the  proposition  disclosed  considerable  opposition  mainly  on  the 
ground  that  the  financial  conditions  of  the  Wanaque  Steel  Company  were  not  such 
as  to  make  the  desired  consolidation  advantageous. 

Replying  to  this  objection,  the  President  stated  that  the  financial  statement 
of  the  Wanaque  Steel  Company  as  presented  in  the  proposition  from  that  Company, 
apparently  misrepresented  its  real  condition,  and  suggested  that  an  adjournment 
of  the  meeting  be  taken  until  10  a.m.  on  the  following  day,  in  order  to  permit  the 
officers  of  the  Wanaque  Steel  Company  to  furnish  authoritative  information  on  this 
point. 

No  objection  being  offered  to  this  suggestion,  the  President  declared  the 
meeting  adjourned  to  assemble  again  in  the  office  of  the  Company  at  10  a.m., 
March  21,  1922. 

Frederick  H.  Colgate,  W.  A.  Thompson, 

President  Secretary 


Form  170.    Minutes  of  Adjourned  Meeting  of  Stockholders 


MIDVALE  FOUNDRY  COMPANY 
of  New  Jersey 

Minutes  of  Adjourned  Special  Meeting  of  Stockholders 
Held  March  21,  1922 
(Adjourned  from  meeting  of  March  20,  1922) 

The  stockholders  of  the  Midvale  Foundry  Company  met  in  adjourned  meeting 
in  the  office  of  the  Company. at  Midvale,  New  Jersey,  at  10  o'clock  in  the  forenoon 
on  the  2ist  day  of  March,  1922. 

Frederick  H.  Colgate  called  the  meeting  to  order  and  presided.  W.  A. 
Thompson  acted  as  Secretary  of  the  meeting.  * 

The  stockholders  of  the  Company  were  all  present  in  person  or  by  proxy. 

The  minutes  of  the  special  meeting  of  stockholders  held  on  the  preceding  day 
and  from  which  the  present  meeting  was  adjourned,  were  read  for  the  information 
of  those  present. 


1562  CORPORATE  FORMS  [Bk.  IV- 

The  President  (hen  presented  and  read  to  the  meeting  a  letter  from  the 
Treasurer  of  the  Wanaque  Steel  Company,  explaining  satisfactorily  the  financial 
condition  of  that  Company. 

The  President  further  stated  that  the  proposed  consolidation  had  already  been 
authorized,  on  the  terms  set  forth,  by  the  stockholders  of  the  Wanaque  Steel 
Company,  and  that  if  it  were  also  authorized  by  the  Midvale  Foundry  Company, 
the  proper  action  would  be  taken  by  the  Boards  of  Directors  and  officials  of  the 
respective  companies  to  consummate  the  consolidation  at  the  earliest  possible 
moment. 

The  following  resolution  was  then  offered  by  Charles  H.  Curtis: 

Whereas,  A  consolidation  of  the  Midvale  Foundry  Company  and  the 
Wanaque  Steel  Company  under  the  name  of  the  New  Jersey  Steel  Foundry 
Company,  has  been  proposed  by  the  Wanaque  Steel  Company  on  terms  and 
conditions  approved  by  the  Board  of  Directors  of  this  Company;  and 

Whereas,  Said  proposed  consolidation  on  the  terms  set  forth  meets  with 
the  approval  of  the  stockholders  of  the  Company : 

Now,  Therefore,  Be  It  RES^LVED,  that  the  Board  of  Directors  of  this 
Company  be  and  hereby  is  fully  authorized,  empowered,  and  instructed  to  take 
all  such  steps  as  may  be  necessary  or  desirable  to  carry  said  consolidation  into 
effect  in  accordance  with  the  terms  submitted  by  the  said  Wanaque  Steel 
Company. 

After  a  short  discussion,  D.  W.  Jackson  moved  that  the  resolution  be  adopted. 
The  motion  was  thereupon  seconded  by  Henry  B.  Vale,  and  was  carried  by 
unanimous  vote. 

Frederick  W.  Howard  stated  that  the  conditions  made  prompt  action  im- 
portant and  asked  that  the  Board  be  instructed  to  complete  the  pending  con- 
solidation at  the  earliest  possible  moment.  A  m.otion  to  this  effect  was  there- 
upon made  and  unanimously  carried. 

There  being  no  further  business  before  the  meeting,  the  President  declared  it 
adjourned. 

Frederick  H.  Colgate,  W.  A.  Thompson, 

President  Secretary 


The  proposition  for  consolidation  presented  at  the  special 
meeting  of  the  stockholders  of  the  Midvale  Foundry  Company, 
does  not  appear  in  connection  with  the  foregoing  minutes  of  that 
meeting,  as  it  would  properly  appear  in  the  minutes  of  the 
directors'  meeting  at  which  final  action  upon  it  is  taken.  The 
proposal  does  not  have  to  be  brought  into  the  minutes  of  both 
meetings. 

The  general  form  of  directors'  minutes  is  the  same  as  for 
minutes  of  stockholders'  meetings.  It  is,  however,  customary 
to  enter  the  names  of  those  present  at  the  directors'  meeting. 
Such  an  entry  is  not  usually  made  in  the  case  of  stockholders' 
meetings. 


Ch.  i6]  MINUTES  OF  MEETINGS  1563 

Form  171.    Minutes  of  Regular  Meeting  of  Directors  * 


FAIRFIELD  CEMENT  COMPANY 
of  New  York 

Minutes  of  Regular  Meeting  of  Directors 
Held  December  15,  1921 

The  Board  of  Directors  of  the  Fairfield  Cement  Company  of  New  York 
assembled  in  regular  meeting  in  the  office  of  the  Company,  Fairfield,  New  York,  at 
,5  P.M.  on  Wednesday,  December  14,  1921. 

The  meeting  was  called  to  order  and  presided  over  by  William  A.  Pierce, 
President  of  the  Company.  Morris  H.  Goodrich,  Secretary  of  the  Companj', 
acted  as  Secretary  of  the  meeting. 

Present:  Messrs.  William  A.  Pierce,  John  H.  Pickering,  Walter  S.  Laighton 
John  K.  Bates,  Fred  N.  fiarney,  and  Morris  H.  Goodrich,  constituting  a  quorum 
of  the  Board. 

The  minutes  of  the  preceding  meeting  of  September  9,  192 1,  and  of  the  meet- 
ings of  September  15  and  of  September  18  and  September  25  adjourned  therefrom, 
were  read  and  approved. 

The  President  reported  that  the  new  plant  of  the  Company  at  the  West  Valley 
marl  beds  was  progressing  rapidly  and  should  be  completed  on  or  before  March  i, 
1922.  He  also  stated  that  arrangements  had  been  made  for  the  installation  of  the 
necessary  machinery  and  for  the  general  equipment  of  the  plant,  and  that  it  was 
hoped  it  would  be  in  full  operation  before  the  first  of  June,  1922. 

The  President  also  reported  that  the  Deering  Construction  Company  was 
alx)ut  to  contract  for  a  large  amount  of  cement,  aggregating  nearly  One  Hundred 
Thousand  (100,000)  barrels,  with  deliveries  extending  over  a  year,  and  that  he  felt 
confident  that  if  the  Company  would  make  the  proper  concessions  as  to  price  that 
the  contract  could  be  secured,  and  asked  that  the  Board  authorize  him  to  make  such 
concessions — not  exceeding  fifteen  cents  per  barrel — as  might  be  necessary  to  secure 
said  contract. 

The  President  further  reported  that  additional  funds  amounting  to  about 
Forty  Thousand  Dollars  ($40,000)  would  be  required  for  the  completion  of  the 
West  Valley  plant  not  later  than  February  15,  1922,  and  asked  the  Board  to  take 
such  action  as  might  be  necessary  to  secure  these  needed  funds. 

The  Treasurer  then  submitted  a  report  giving  the  receipts  and  expenditures 
for  the  past  month  and  showing  a  present  cash  balance  on  hand  of  $15,525.25. 
The  report  was  ordered  received  ana  filed. 

.Xrthur  Hurd,  Counsel  for  the  Company,  who  was  present  by  request,  reported 
verbally  that  his  investigations  of  the  titles  of  the  marl  beds  lying  to  the  north  of 
the  Company's  West  Valley  beds  had  disclosed  some  apparent  imperfections,  and 
he  therefore  advised  the  Board  to  postpone  the  consummation  of  the  purchase  of 
these  beds  until  further  investigation  should  show  definitely  that  either  the  titles 
were  or  were  not  in  satisfactory  shape. 

The  President's  recommendations  were  then  taken  up,  and  after  some  discus- 
sion the  President  was  authorized  by  motion  unanimously  carried  to  make  such 
discounts  to  the  Deering  Construction  Company — not  exceeding  fifteen  cents  per 
barrel — as  might  be  necessary  to  secure  the  contract  mentioned. 

The  matter  of  finance  for  the  West  Valley  plant  was  by  unanimous  consent 
deferred  until  the  next  meeting  of  the  Board. 

'  See  Ch.  XLIV,  "Meetings  of  Directors." 


1564  CORPORATE  FORMS  [Bk.  IV- 

The  report  of  the  Company's  Counsel  in  regard  to  the  marl  beds  north  of  the 
West  Valley  beds  was  then  taken  up  for  discussion.  Walter  S.  Laighton  urged  that 
no  lengthy  delay  should  be  permitted,  stating  that  he  was  personally  cognizant  of 
the  fact  that  other  parties  were  desirous  of  securing  these  same  marl  beds,  and  that 
the  present  option  under  which  the  beds  were  held  would  expire  in  three  weeks 
from  date  and  he  was  positive  could  not  be  renewed  at  anything  like  the  present 
option  price.  Arthur  Hurd,  Counsel  for  the  Company,  in  answer  to  an  enquiry 
from  the  presiding  officer,  stated  that  his  investigations  could  be  completed  inside 
a  week,  and  thereupon  on  motion  duly  carried,  the  meeting  was  adjourned  to  assem- 
ble again  in  the  office  of  the  Company,  December  22,  at  3  p.m. 

William  A.  Pierce,  Morris  H.  Goodrich, 

President  Secretary 


Form  172.     Minutes  of  Adjourned  Meeting  of  Directors 

FAIRFIELD  CEMENT  COMPANY 

of  New  York 

Minutes  of  Adjourned  Meeting  of  Directors 

Held  December  22,  1921 
(Adjourned  from  regular  meeting  of  December  15,  1922) 

The  Board  of  Directors  of  the  Fairfield  Cement  Company  met  in  adjourned 
meeting  in  the  office  of  the  Company  at  Fairfield,  New  York,  at  3  o'clock  in  the 
afternoon  on  Thursday,  December  22,  1921. 

The  meeting  was  called  to  order  and  presided  over  by  the  President,  William 
A.  Pierce.  The  Secretary  of  the  Company,  Morris  H.  Goodrich,  acted  as  Secretary 
of  the  meeting. 

There  were  present:  Messrs.  William  A.  Pierce,  John  H.  Pickering,  Walter  S. 
Laighton,  John  K.  Bates,  Fred  N.  Barney,  Silas  H.  Harvey,  and  Morris  H.  Good- 
rich, constituting  a  quorum  of  the  Board. 

The  minutes  of  the  board  meeting  of  December  15,  1921,  were  read  for  the 
information  of  those  present. 

After  the  reading  of  the  minutes,  Arthur  Hurd,  Counsel  for  the  Company,  re- 
ported that  his  investigation  of  the  titles  of  the  marl  beds  lying  north  of  the  West 
Valley  beds  had  been  completed,  that  the  apparent  defects  to  which  he  had  referred 
in  his  previous  report  had  been  explained  satisfactorily,  that  he  believed  the  titles 
to  be  in  good  shape,  and  that  in  his  opinion  the  purchase  of  the  beds  could  be  safely 
consummated. 

Thereupon  on  motion  of  John  H.  Pickering,  seconded  by  Walter  S.  Laighton 
and  carried  by  unanimous  vote,  the  following  resolution  was  adopted: 

Resolved,  That  the  President  and  Treasurer  of  the  Company  be  and 
hereby  are  authorized  and  instructed  to  purchase  the  West  Valley  marl  beds 
in  accordance  with  the  terms  of  the  option  under  which  said  beds  are  now 
held,  and  that  they  be  further  authorized  and  empowered  to  do  all  such  things 
for  and  on  behalf  of  the  Company  and  in  its  name  as  may  be  necessary  to  the 
consummation  of  said  purchase. 

There  being  no  further  business  before  the  meeting,  it  was  adjourned. 
William  A   Pierce,  Morris  H.  Goodrich, 

President  Secretary 


Ch.  i6]  MINUTES  OF  MEETINGS  1565 

Form  173.     Minutes  of  Special  Meeting  of  Directors 

NORWICH  METAL  SPINNING  COMPANY 

MiNuras  OF  Special  Meeting  of  Directors 
Wednesday,  February  16,  1922 

The  Directors  of  the  Norwich  Metal  Spinning  Company  met,  pursuant  to  Call 
and  Waiver  of  Notice  signed  by  all  the  Directors  of  the  Company,  in  the  offices  of 
the  Company  at  2  p.m.,  February  16,  1922. 

William  S.  Dickenson,  Chairman  of  the  Board,  presided,  and  Henry  B.  Horton 
acted  as  Secretary  of  the  meeting. 

There  were  present:  Henry  B.  Horton,  John  Harrison,  Philip  G.  Sanderson, 
William  S.  Dickenson,  and  Howard  Dickenson,  constituting  the  entire  membership 
of  the  Board. 

The  Chairman  stated  that  the  special  business  before  the  meeting  was  a  propo- 
sition to  increase  the  capitalization  of  the  -Company  from  Four  Thousand  Shares 
of  no  par  value,  to  Ten  Thousand  Shares  of  no  par  value,  this  in  order  to  give  a 
margin  of  common  stock  that  could  be  sold  to  provide  the  capital  needed  for  the 
Company's  rapidly  expanding  business.  He  also  stated  that  if  the  suggested  in- 
crease of  capitalization  were  carried  out,  it  was  proposed  to  issue  Five  Thousand 
Shares  of  the  new  no-par-value  stock  to  the  present  holders  of  common  stock,  these 
stockholders  receiving  for  each  share  of  common  stock  now  held  by  them  one  and 
one-quarter  shares  of  the  new  stock.  This  would  leave  Five  Thousand  Shares  of 
the  new  stock  unissued  to  meet  the  future  requirements  of  the  Company.  He  also 
stated  that  the  plan  contemplated  a  sale  of  so  much  of  the  unissued  stock  as  might 
be  authorized  by  the  Board  at  Fifty  Dollars  a  share,  and  the  exchange  of  the  new 
common  stock  for  the  outstanding  preferred  stock  of  the  Company  of  the  par  value 
of  One  Hundred  Dollars  at  the  option  of  the  preferred  holder  on  the  basis  of  two 
shares  of  no-par-value  common  stock  for  each  share  of  preferred. 

After  a  full  discussion  of  the  suggested  plan,  the  following  resolution  was 
moved  and  adopted  by  the  unanimous  vote  of  all  present. 

Resolved,  That  the  Board  of  Directors  does  hereby  approve  the  increase 
of  the  common  capital  stock  of  the  Company  from  Four  Thousand  Shares  of 
no  par  value,  to  Ten  Thousand  Shares  of  no  par  value,  and  does  hereby 
authorize  the  proper  officers  of  the  Company  to  take  all  such  steps  as  may  be 
necessary  to  secure  the  consent  of  the  stockholders  of  the  Company  to  such 
increase,  and,  this  consent  being  secured,  to  take  such  further  steps  as  may  be 
necessary  to  make  the  proposed  increase  effective. 

The  Board  also  passed  the  following  resolution  as  a  statement  of  the  plan  to 
be  carried  out  when  and  if  the  common  stock  of  the  company  is  increased  as  con- 
templated. 

Resolved,  That  in  event  of  the  proposed  increase  of  common  stock  being 
effected,  the  Board  approves  the  retirement  of  the  present  outstanding  cer- 
tificates of  common  stock,  and  the  issue  to  the  holders  thereof,  in  exchange 
therefor,  of  new  certificates  on  the  basis  of  one  and  one-quarter  shares  of  the 
new  common  stock  for  each  one  share  of  the  old  common  stock; 

And  in  event  of  said  increase  being  effected,  the  Board  also  approves  the 
sale  of  Two  Thousand  Shares  of  said  new  common  stock  at  the  rate  of  Fifty 
Dollars  a  share,  preference  in  said  sale  of  common  stock  to  be  given  first  to 
officers  and  to  the  employees  of  the  Company,  and  then  to  outsiders  friendly 


1566  CORPORATE  FORMS  [Bk.  IV- 

to  the  Company,  no  more,  however,  than  Five  Hundred  Shares  of  stock  to  be 
sold  to  any  one  individual. 

And  in  event  of  said  increase  of  common  stock  being  effected,  the  Board 
further  approves  the  exchange  of  two  shares  of  said  common  stock  for  each  one 
share  of  the  preferred  stock  of  the  Company  now  outstanding,  said  exchange 
to  be  made  at  the  option  of  the  holder  of  such  preferred  stock  and  upon  his 
written  request;  said  preferred  stockholders  to  be  notified  of  such  proposed 
exchange  as  soon  as  the  increase  of  the  common  stock  shall  have  been  effected, 
and  their  written  request  to  be  made  and  their  option  exercised  within  sixty 
days  after  such  notice  has  been  mailed. 

The  Chairman  of  the  Board  then  presented  the  following  communication: 

To  the  Board  of  Directors  of 

Norwich  Metal  Spinning  Company 

Gentlemen: 

Recognizing  the  disturbed  industrial  conditions  now  existing  and  the  depress- 
ing effect  this  has  had  and  is  likely  to  have  for  some  months  to  come  on  the  business 
of  the  Norwich  Metal  Spinning  Company,  we,  the  undersigned  executive  officers  of 
the  Company,  do  hereby  suggest  and  rec'ommend  that  all  salaries  paid  by  the  Com- 
pany be  reduced  as  far  as  practicable,  and  that  the  operating  expenses  of  the  Com- 
pany be  cut  in  every  way  consistent  with  real  economy  and  the  preservation  of  the 
organization,  and,  looking  to  this  end,  we  hereby  recommend  that  said  reduction 
begin  with  the  salaries  of  the  executive  officers  of  the  Company,  said  salaries  being 
reduced  not  less  than  st,}/^  per  cent,  and  such  reduction  of  salaries  to  continue  in 
effect  until  the  status  of  the  Company  justifies  their  reinstatement. 

Respectfully  submitted, 

John  Harrison 
Philip  G.  Sanderson 
Henry  B.  Horton 
William  S.  Dickenson 
Howard  Dickenson 

After  the  reading  of  this  communication,  the  following  resolution  was  passed 
by  the  unanimous  vote  of  all  present: 

Resolved,  That  the  salaries  of  the  five  executive  officers  of  the  Company 
— John  Harrison,  Philip  G.  Sanderson,  Henry  B.  Horton,  William  S.  Dicken- 
son, and  Howard  Dickenson — be  reduced  from  Nine  Thousand  Dollars  per 
annum  to  Six  Thousand  Dollars  per  annum,  payable  in  monthly  instalments 
of  Five  Hundred  Dollars  each,  said  reduction  being  effective  from  March  i, 
1922,  and  continuing  until  in  the  opinion  of  the  Board  the  finances  of  the  Com- 
pany justify  the  reinstatement  of  the  executive  salaries  to  their  former  figure. 

The  Chairman  of  the  Board  reported  that  in  accordance  with  the  authoriza- 
tion already  given,  the  Metal  Polish  Corporation  had  been  formed  under  the  laws 
of  the  State  of  New  York  with  a  capital  stock  of  Five  Hundred  Shares  of  no  par 
value;  that  all  this  stock  had  been  issued  to  the  Norwich  Metal  Spinning  Company 
in  payment  for  the  patents,  machinery,  and  equipment  belonging  to  the  Norwich 
Company  and  used  m  connection  with  the  manufacture  and  sale  of  metal  polish, 
and  that  in  accordance  with  authority  given  them  at  the  meeting  of  the  Board  of 
Directors  of  November  25,  1921,  the  officers  of  the  Company  had  transferred  the 
ownership  of  said  patents,  machinery,  and  equipment  to  the  Metal  Polish  Cor- 
poration. 


Ch.  i6]  MINUTES  OF  MEETINGS  1567 

Philip  G.  Sanderson,  Treasurer  of  the  Company,  then  called  attention  to  the 
fact  that  the  existing  method  of  writing  off  depreciation  on  the  machinery  belong- 
ing to  the  Company  was  unsatisfactory  in  its  operation,  and  asked  authority  to 
modify  the  present  plan  so  that  an  arbitrary  write-off  of  Fifteen  Per  Cent  would 
be  made  annually,  any  corrections  necessary  to  be  made  as  to  any  particular 
mechanism  at  the  time  it  was  replaced  or  otherwise  disposed  of. 

Upon  motion  carried  by  unanimous  vote  of  all  present,  the  Treasurer  was 
authorized  to  adopt  this  method  of  writing  off  depreciation. 

There  being  no  further  business  before  the  meeting,  it  was  adjourned. 

Henry  B.  Horton, 
William  S.  Dickenson,  Secretary 

Chairman  of  the  Board 


Part  III — Forms  Relating  to  General  Procedure 


CHAPTER  XVII 

MISCELLANEOUS  NOTICES  * 

Subscription  and  Assessment  Notices 

The  following  form  of  mailing  notice  is  suitable  when  sub- 
scriptions to  stock  are  payable  in  instalments  as  called  for  by 
the  board. 

Form  174.    Instalment  Notice 

HILBERT  DESK  COMPANY 
225  Main  St.,  Grand  Rapids,  Mich. 

0   

Instalment  Notice 

Mr.  Howard  Burns, 
Sparta,  Mich. 

Dear  Sir: 

You  are  hereby  notified  that  by  due  resolution  of  the  Board  of  Directors,  an 
instalment  of  Ten  Per  Cent  on  subscriptions  to  the  stock  of  this  Company  has  been 
called  for,  the  amount  thereof  to  be  paid  to  the  Treasurer  of  the  Company  on  or 
before  the  15th  day  of  January,  1922. 

Henry  H.  Hilbert, 

Treasurer 
Grand  Rapids,  Mich., 
January  3,  1922 
Shares  subscribed,  25. 
Amount  of  Assessment,  $250. 

Draw  checks  payable  to  Treasurer. 


>  See  also  Ch.  XII,  "Notices  of  Meetings." 

1569 


1570  CORPORATE  FORMS  [Bk.  IV- 

The  following  form  of  assessment  notice  may  be  used  as 
either  a  mailing  or  publication  notice. 

Form  175.    Notice  of  Stock  Assessment 


BURNS  REFRIGERATING  COMPANY 

Assessment  Notice 


Notice  is  hereby  given  that  assessment  No.  2  of  Fifteen  Per  Cent  on  the 
subscribed  Capital  Stock  of  this  Company  has  been  called  for  by  due  resolution 
of  the  Board  of  Directors,  and  is  payable  to  the  Treasurer  of  the  Company  on  or 
before  the  i8th  day  of  January,  1922. 

Newark,  New  Jersey,  Francis  H.  Wilson, 

December  15,  192 1  Secretary 

Make  checks  payable  to  Treasurer. 


In  some  states  the  directors  have  statutory  power  to  levy 
assessments  under  certain  conditions.  In  several  of  the  western 
states  the  statutes  prescribe  the  form  of  notice  for  such  assess- 
ments.    This  is  substantially  as  follows: 

Fonn  176.    Notice  of  Stock  Assessment — Statutory 

* 

RED  GULCH  MINING  COMPANY 

Sacramento,  California 

Notice  is  hereby  given  that  at  a  meeting  of  the  Directors  held  on  the  loth  day 
of  December,  1921,  an  assessment  of  Ten  Dollars  per  share  was  levied  upon  the 
Capital  Stock  of  th^  corporation,  payable  on  the  12th  day  of  January,  1922,  to 
the  Treasurer  of  said  Red  Gulch  Mining  Company  at  its  principal  ofl&ce.  No.  584 
J.  Street,  Sacramento,  California.  Any  stock  upon  which  this  assessment  shall 
remain  unpaid  on  the  27th  day  of  January,  1922,  will  be  delinquent  and  adver- 
tised for  sale  at  public  auction,  and  unless  payment  is  made  before,  will  be  sold  on 
the  nth  day  of  February,  1922,  to  pay  said  delinquent  assessment  together  with 
costs  of  advertising  and  expenses  of  sale. 

John  H.  McClelland, 

Secretary 

December  10,  192 1 


This  notice  must  be  served  upon  each  stockholder  either 
personally  or  by  mail,  and  must  also  be  published, 


Ch.  17]  MISCELLANEOUS  NOTICES  1571 

In  case  assessments  are  not  paid  when  due,  public  notice 
must  be  given  before  the  deUnquent  stock  can  be  sold.  A  gen- 
eral form  of  assessment  notice  that  may  be  used  where  the 
specific  form  is  not  prescribed  by  statute,  is  as  follows: 

Form  177.    Notice  of  Sale  of  Delinquent  Stock 

BURNS  REFRIGERATING  COMPANY 

Notice  of  Sale  of  Delinquent  Stock 

Notice  is  hereby  given  that  the  undersigned,  Treasurer  of  the  Burns  Re- 
frigerating Company,  will  on  order  of  the  Board  of  Directors  and  pursuant  to  the 
statutes  in  such  case  made  and  provided,  sell  at  public  auction  on  the  2nd  day  of 
June,  1922,  at  2  o'clock  in  the  afternoon  at  the  office  of  the  Company,  345  Broad 
St.,  Newark,  New  Jersey,  Twenty  (20)  Shares  of  the  stock  of  said  Company  now 
standing  in  the  name  of  Howard  T.  Carleton,  or  so  many  of  said  shares  as  may  be 
sufficient  to  satisfy  the  unpaid  assessment  on  said  shares  amounting  to  Three 
Hundred  Dollars  ($300),  and  also  the  interest  thereon  from  the  19th  day  of  Septem- 
ber, 1921,  to  the  date  of  sale,  and  all  necessary  incidental  charges. 

Fifty  Dollars  ($50)  per  share  has  already  been  paid  the  Company  on  said 
stock. 

Howard  W.  Bronson, 

Treasurer 

Newark,  N.  J., 
May  I,  1922 


Notices  Relating  to  Dividends 

In  the  smaller  corporations  dividend  notices  are  usually 
sent  only  by  mail.  In  the  larger  corporations  they  are  almost 
invariably  published  and  are  usually  also  sent  by  mail. 

Form  178.    Dividend  Notice — Mailing 

CHARLESTON  MILLING  COMPANY 
785'Grand  St.,  New  York 

December  i,  192 1 
Dear  Sir: 

You  are  hereby  notified  that  the  Directors  of  the  Charleston  Milling  Company 
have  this  day  declared  the  regular  semiannual  dividend  of  Three  Per  Cent  on  the 
Capital  Stock  of  the  Company,  payable  January  15,  1922,  to  stockholders  who 
appear  of  record  at  the  close  of  business  January  10,  1922. 

Harry  H.  McCallum, 

Treasurer 


1572  CORPORATE  FORMS  [Bk.  IV- 

If  the  transfer  books  are  closed  preparatory  to  payment 
of  dividends,  the  dates  of  closing  and  reopening  should  appear 
as  in  the  following  notice,  which  may  be  used  either  for  pub- 
lication or  for  mailing. 

Form  179.     Dividend  Notice — Publication 

MARTIN  FOUNDRIES  COMPANY 

New  York,  February  i,  1922 
Dividend  No.  25 
The  Directors  of  the  Martin  Foundries  Company  have  this  day  declared  a 
quarterly  dividend  of  One  and  One-Half  Per  Cent  on  the  Capital  Stock  of  the 
Company,  payable  March  i,  1922,  to  stockholders  of  record  at  the  close  of  business 
February  10,  1922. 

Transfer  books  will  close  February  10,  1922  and  reopen  February  20,  1922. 
Checks  will  be  mailed. 

John  H.  Martin 

Treasurer 


When  notice  of  dividends  is  by  publication  alone,  an  explan- 
atory statement  usually  accompanies  the  dividend  check.  An 
announcement  of  this  nature  used  by  some  of  the  larger  cor- 
porations is  given  in  the  following  form: 

Form  180.     Notice  Accompanying  Dividend  Check 

MARTIN  FOUNDRIES  COMPANY 

New  York,  March  i,  1922 
On  February  i,  1922,  the  Directors  declared  quarterly  dividend  No.  25  of 
One  and  One-half  Per  Cent  upon  the  Preferred  Stock  of  the  Company,  payable 
this  day  to  stockholders  of  record  of  February  10,  1922. 

In  accordance  with  permanent  order  on  file,  enclosed  please  find  check  for 
above  dividend  on  the  Preferred  Stock  standing  in  your  name.  No  acknowledg- 
ment is  necessary. 

Kindly  advise  John  J.  Hart,  Assistant  Secretary,  No.  575  Broadway,  New 
York,  of  any  change  in  your  address,  giving  your  old  address  as  well  as  the  new. 

John  H.  Martin, 

Treasurer 

Dividend  check  enclosed  which  please  cash  immediately. 


Ch.  17]  MISCELLANEOUS  NOTICES  1 5 73 

The  following  publication  notice  is  somewhat  informal  but 
sufficient. 

Form  181.     Dividend  Notice 


THE  CORN  EXCHANGE  BANK 
New  York 

At  a  regular  meeting  of  the  Board  of  Directors  of  The  Corn  Exchange  Bank 
held  January  11,  1922,  a  quarterly  dividend  of  $5.00  per  share  was  declared,  pay- 
able February  i,  1922,  to  stockholders  of  record  at  the  close  of  business  January  31, 
1922. 

Edward  S.  Malmar, 
Cashier 

1 

This  notice  is  signed  by  the  cashier  of  the  corporation. 
Usually,  though  not  necessarily,  dividend  notices  are  signed 
by  the  treasurer. 

Form  182.    Dividend  Notice — Common  Stock 

;)iiia.>i  ) 

Office  of 
AMERICAN  DREDGING  COMPANY 

No.  145  Broadway,  New  York  City, 
April  4,  1922 

Quarterly  Common  Stock  Dividend  No.  23 

The  Directors  of  the  American  Dredging  Company  have  this  day  declared  a 
dividend  of  Two  Per  Cent  on  the  Common  Capital  Stock  of  the  Company,  payable 
May  15,  1922,  to  stockholders  of  record  April  28,  1922.  The  books  of  the  Com- 
pany for  the  transfer  of  Common  Stock  will  be  closed  at  3  p.m.,  April  28,  1922, 
and  will  be  reopened  May  2,  1922. 

M.  W.  Erickson, 

Treasurer 


The  following  publication  notice  covers  the  dividend  on 
both  common  and  preferred  stock.  This  inclusion  is  not  in 
any  way  objectionable,  but  at  tim^s,  for  the  sake  of  greater 
emphasis  and  publicity,  a  separate  notice  for  each  dividend  is 
preferred. 


1574  CORPORATE  FORMS  [Bk.  IV- 

Forin  183.    Dividend  Notice — Common  and  Preferred  Stock 

AMERICAN  RADIATOR  COMPANY 

Preferred  Dividend  , .   .-,         «> 

Common  Dividend      "^  fcn^bmCT     .t8i  Jtno 

A  dividend  of  one  and  three-quarters  per  cent.,  being  the  92nd  consecutive 
quarterly  dividend,  has  been  declared  on  the  Preferred  Stock,  payable  February 
15,  1922,  to  stockholders  of  record  close  of  business  February  i,  1922. 

A  dividend  of  One  Dollar  per  share,  being  the  70th  consecutive  quarterly 
dividend,  has  been  declared  on  the  Common  Stock,  payable  March  31,  1922,  to 
stockholders  of  record  close  of  business  March  15,  1922. 
The  Transfer  Books  will  not  close. 

Wetmore  Hodges 

Secretary 

Form  184.     Dividend  Notice — Mailing  Orders  Requested 

SOUTHERN  NAVIGATION  COMPANY 
Dividend  No.  95 

A  Quarterly  Dividend  of  One  Dollar  and  Fifty  Cents  ($1.50)  per  share  on  the 
Capital  Stock  of  this  Company  has  been  declared  payable  at  the  Treasurer's 
Office,  No.  165  Broadway,  New  York,  N.  Y.,  on  July  2,  1922,  to  stockholders  of 
record  at  3  p.m.,  on  Thursday,  May  31,  1922.  The  stock  transfer  books  will  not 
be  closed  for  the  payment  of  this  dividend.  Cheques  will  be  mailed  only  to 
stockholders  who  have  filed  permanent  dividend  orders. 

A.  K.  Van  Deventer, 

May  10,  1922  Treasurer 

The  mailing  order  referred  ^to,  in  the  foregoing  dividend 
notice  is  shown  below :  , , 

Form  185.    Mailing  Order  for  Dividends 

No  Check  Mailed  Without  an  Order 

To  the  Treasurer  of  Southern  Navigation  Company, 
165  Broadway,  New  York,  N.  Y. 

Until  this  order  shall  be  revoked  in  writing,  please  send  by  mail,  in  cheque 

payable  to  the  order  of 

See  printed         Address w  . ;.  i ; .  j. .  j : ;; .  jij.  .j.  jl 

instructions.  in ^^j-fj;^ .  .j.j.  .ii^{ . . .,l*l..«*^> 

(Please  write         Full  ^^^. . . .-... .,: . ..... .j.i, .».'^ 

distinctly.)  ^^.':'^!!:'^.^}!^^^.'].{^ 

all  dividends  now  due,  or  which  may  hereafter  become  due,  on  all  stock  now  stand- 


Ch.  17]  MISCELLANEOUS  NOTICES  1575 

ing  or  which  may  hereafter  stand,  on  the  books  of  your  Company  in.  . .  .  •xrH-yytfi-j  • 
name.  > 

(Sign  here   ';-'.  ;s,'.vi  .■....:. 

(Date)        exactly  as ; 

pears  on      

stock.)  

When  payment  is  to  be  made  to  other  than  the  stockholder,  signature  of  the  latter  MUST 
be  acknowledged  before  a  Notary  Public  on  the  back  of  this  order,  and  if  signed  by  an  Attorney, 
Administrator,  Executor,  Guardian  or  Trustee,  it  MUST  be  accompanied  by  satisfactory 
evidence  of  the  signer's  authority. 


On  the  back  of  this  mailing  notice  appears  form  for  notarial 
acknowledgment.  >,i^  y^.^i^i. 

irti  a  it. 

Notices  of  Appointment         a'^''  "»/ 

When  an  election  is  held,  it  devolves  upon  the  secretary 
to  notify  the  ofhcials-elect. 

Form  186.    Notice  of  Election  as  Director 

ORVELLE  MACHINE  WORKS 

Trenton,  New  Jersey       '"i    '"^  >..■  n  ,-oi  j  jmi^ 
»t;^  rri  •^i.'^  to  ,f>iuooo 


January  10,  iQ^fnti 
Mr.  George  W.  Bromleigh,  \  ' 

236  Greenwood  Ave.^ji  lo   IjjJjjIj   .  ^    .il 

Trenton,  N.  J.       '      .        ,  , 

Dear  Sir: 

You  are  hereby  notified  that  at  the  annual  meeting  of  the  Orvelle  Machine 
Works  held  this  day,  you  were  elected  a  member  of  its  Board  of  Directors. 

The  next  regular  meeting  of  the  Board  will  be  held  in  the  office  of  the  Com- 
pany, February  5,  1922,  at  3  p.m.,  for  the  election  of  officers  and  for  the  trans- 
action of  such  other  business  as  may  come  before  the  meeting. 

You  are  requested  to  be  present  and  participate  in  that  meeting. 

Respectfully, 
Martin  B.  Hereford, 

Secretary 


Usually  before  the  election  of  a  director,  those  interested 
assure  themselves  that  he  will  serve  if  elected.  In  such  case 
the  notification  need  not  ask  his  acceptance  of  the  position. 
If,  however,  there  is  any  uncertainty,  the  notification  of  election 
should  request  a  formal  acceptance  of  the  position.    If  the 


1576  CORPORATE  FORMS  [Bk.  IV- 

director-elect  refuses  to  accept,  his  election  is  void,  as  he  cannot 
be  forced  into  office  against  his  will. 

Form  187.    Notice  of  Election  as  Director — Acceptance  Requested 

BLACK  DIAMOND  DRILL  COMPANY 

23  State  St.,  Boston,  Massachusetts 

January  10,  1922 
Mr.  Horace  H.  Fleming, 
1716  State  St., 
Boston,  Mass. 
Dear  Sir: 

At  a  meeting  of  the  Directors  of  this  Company  held  this  loth  day  of  January 
1922,  you  were  elected  a  member  of  the  Board  to  fill  the  vacancy  caused  by  the 
death  of  Mr.  Frederick  Colwell.  Will  you  kindly  indicate  your  acceptance  of  the 
position  at  your  early  convenience. 

Respectfully, 

Howard  B.  Ives, 

Secretary 


As  a  rule,  when  corporate  officials  are  elected,  either  the 
officers-elect  are  present  at  the  meeting  at  which  their  election 
occurs,  or  are  in  such  close  personal  touch  with  the  corporate 
proceedings  that  formal  notice  of  their  election  is  unnecessary. 
If,  however,  a  stranger  is  elected  or  appointed  to  an  official 
corporate  position,  notice  must  be  given. 

Form  188.     Notice  of  Appointment  as  General  Manager 

WILLIS  OIL  WELL  COMPANY 
265  Madison  Avenue,  New  York 

January  17,  1922 
Mr.  Henry  P.  Simpson, 

445  Greenwood  Ave., 

Newark,  New  Jersey 

Dear  Sir: 

At  a  meeting  of  the  Board  of  Directors  of  this  Company  held  this  day,  you 
were  appointed  General  Manager  of  the  Company  at  a  salary  of  Forty-Eight 
Hundred  Dollars  per  annum,  payable  in  monthly  instalments  of  Four  Hundred 
Dollars  each,  your  employment  and  duties  to  begin  on  the  ist  day  of  February, 
1922,  and  the  first  instalment  of  your  salary  to  be  due  and  payable  on  the  loth 
day  of  the  following  month. 


Ch.  17]  MISCELLANEOUS  NOTICES  1 57 7 

Will  you  kindly  notify  me  without  delay  of  your  acceptance  of  the  position 
and  report  for  duty  on  the  day  above  designated. 

Yours  very  truly, 

Gerald  E.  Conway, 

Secretary 


If  the  acceptance  of  the  party  elected  is  doubtful,  his  appoint- 
ment and  the  notice  thereof  are  usually  made  tentative  as  in 
the  following  example. 

...  .lAii'n 
Form  189.     Tender  of  Position  as  Sales  Manager  r  .  r; 

HOWARD  DESK  COMPANY 

25  Stone  St.,  New  York 

December  10,  1921 
Mr.  Willis  H.  Walters, 

225  Broadway,  New  York. 

Dear  Sir: 

I  am  instructed  by  the  Board  of  Directors  to  tender  you  the  position  of  Sales 
Manager  of  this  Company  at  a  salary  of  Six  Thousand  Dollars  per  annum,  payable 
in  monthly  instalments  of  Five  Hundred  Dollars  each,  your  employment  and  duties 
to  begin  in  case  of  your  acceptance,  on  the  3d  day  of  January,  1922. 
Your  early  action  in  the  matter  will  greatly  oblige, 

Yours  very  truly, 

Sherwin  F.  Hamilton, 

Secretary 


no  I 


CHAPTER  XVIII 

RESIGNATIONS 


nt  i'.R  'i'/iiniii'ji 

Resignations  may  be  divided  into  two  general  classes — those 
which  are  so  phrased  as  to  be  effective  without  an  acceptance, 
which  may  be  termed  peremptory  resignations,  and  those  which 
are  tentative  in  their  nature  and  therefore  not  effective  until 
accepted.     The  following  form  is  of  the  latter  nature. 

Form  190.     Resignation  of  Director 


To  the  Board  of  Directors  of  the 
Howard  Scale  Company 

Gentlemen: 

On  account  of  my  continued  ill  health,  which  prevents  my  proper  attention 
to  the  duties  of  the  position,  I  hereby  tender  my  resignation  as  a  member  of  your 
body. 

Very  respectfully, 

Henry  H.  Gale 
New  York  City, 

January  10,  1922 


If  a  resignation  of  this  kind  is  accepted  without  qualification, 
its  effect  is  immediate  and  the  resigning  director,  though  present 
at  the  meeting,  ceases  to  be  a  director  at  the  moment  the  resolu- 
tion or  motion  of  acceptance  is  adopted.  If  it  is  desired  to  avoid 
this,  acceptances  may  be  phrased  "to  take  effect  at  the  close  of 
the  meeting."  It  may  be  noted  in  this  connection  that  a  director 
retiring  by  resignation  cannot  legally  vote  on  his  own  successor. 
The  vacancy  does  not  exist  until  his  resignation  is  effective  and 
thereafter  he  is  not  a  director. 

Dummy  directors  are  sometimes  elected  to  fill  a  position  or 
vacancy  in  the  board  until  a  permanent  incumbent  is  elected. 
In  such  case  the  dummy  director's  resignation  in  tentative  form 

1578 


Ch.  i8]  RESIGNATIONS  1579 

is  usually  secured  at  the  time  of  his  election  and  is  placed  on  file. 
Then  when  a  suitable  person  for  permanent  director  has  been 
found,  the  resignation  on  file  is  accepted  and  the  successor  is  at 
once  elected.  The  following  form  of  resignation  is  commonly 
used  under  such  circumstances. 

Form  191.     Resignation  of  Director — Efifective  on  Acceptance 

To  the  Board  of  Directors  of  the 

Harvard  Publishing  Company 

Gentlemen: 

I  hereby  tender  my  resignation  as  a  member  of  your  body,  to  take  effect  upon 
acceptance. 

Respectfully, 

Frank  McClelland 
New  York  City, 

March  i,  1922                                 .— ■  »    V!  *     '   . .» 
_ JiilUirrrAQi.QyJiG.iQ.luD/lflll.'^^^^ .lJi}.1... 

This  resignation  holds  good  until  acceptance  or  until  the 
party's  term  as  director  expires,  unless  sooner  withdrawn.  If 
the  party  is  again  elected  as  a  director,  his  old  resignation  is  of 
no  further  eflfect  and  must  be  renewed  if  his  same  uncertain  ten- 
ure of  office  is  to  be  maintained.  It  must  be  remembered,  how- 
ever, that  a  party  tendering  such  a  resignation  has  the  right  to 
withdraw  it  or  to  revoke  it  at  any  time  prior  to  its  acceptance. 

The  final  clause  of  the  foregoing  resignation,  while  con- 
ventional, is  of  no  direct  effect.  A  "tendered"  resignation  can- 
not take  effect  until  accepted. 

The  following  form  terminates  the  official  status  of  the  party 
signing  the  same  as  soon  as  the  document  is  filed  with  the  secre- 
tary of  the  company.  No  action  of  the  board  is  required  nor 
can  the  board  in  any  way  prevent  its  effect.  This  peremptory 
form  of  resignation  is  often  employed  in  cases  where  a  director 
wishes  to  escape  responsibility  for  some  proposed  action  of  the 
board  or  wishes  to  express  his  disapproval  of  some  action  already 
taken.  It  does  not  in  any  way  relieve  him  from  responsibility 
for  past  actions  but  does  relieve  him  from  responsibility  for  any 
future  board  actions.       '"''^'"^  ^^  ismq^ao  ,  .1  j  iliiv/  noUjyiinoj 


1580  CORPORATE  FORMS  [Bk.  IV- 

Form  192.    Resignation  of  Director — Peremptory         vlir tj>tt 

To  the  Board  of  Directors  of  the 

Franklin  Electric  Corporation 

Gentlemen: 

I  hereby  resign  my  position  as  a  director  of  the  Franklin  Electric  Corporation, 
my  resignation  to  take  immediate  effect. 

Respectfully, 
9onjslq90:>A  no  9Vi  William  H.  Collins  ftno*? 

New  Brighton,  Pa., 
January  21,  1922 


A  resignation  may  be  made  effective  at  a  future  date  as  in  the 
following  form.  The  object  of  such  a  deferred  resignation  is 
usually  to  give  time  for  the  selection  of  a  suitable  successor. 

Form  193.    Resignation  of  Director — Future  Date 

To  the  Board  of  Directors  of  the 
CooPERSTOWN  Tannery 

Gentlemen  : 

I  hereby  resign  my  membership  in  your  body,  such  resignation  to  be  effective 
May  21,  1922. 

Respectfully, 

Howard  McCall 
Cooperstown,  New  York, 
May  I,  1922 


When,  as  occasionally  happens,  some  difficulty  has  arisen 
between  the  directors  and  an  official,  and  this  latter  wishes  a  vote 
of  confidence  or  an  expression  of  the  feeling  of  the  board  towards 
him,  he  will  hand  in  a  tentative  resignation  as  in  the  form  given 
below. 

If  a  majority  of  the  board  wish  to  retain  the  president,  they 
either  vote  that  the  resignation  be  not  accepted  or  vote  against 
a  motion  for  its  acceptance.  In  either  case  the  president's 
resignation  is  of  no  effect  and  the  incident  is  merely  an  indorse- 
ment of  him  and  his  position.  If,  however,  those  opposed  to  the 
president  are  in  a  majority  and  accept  the  resignation,  his  official 
connection  with  the  company  is  peremptorily  terminated. 


Ch.  i8]  RESIGNATIONS  1581 

Form  194.    Resignation  of  President — Conditional 

To  the  Board  of  Directors  of  the 
Standard  Milung  Company 

Gentlemen: 

I  hereby  tender  my  resignation  as  President  and  Director  of  your  Company 
and  request  your  immediate  action  thereon. 

Very  respectfully, 

Henry  H.  Maxwell 
Franklin,  Pa., 

January  21,  1922 

A  more  friendly  resignation  is  given  in  the  following  form. 

Form  195.    Resignation  of  Treasurer 

New  York,  June  28,  1922 
To  the  Board  of  Directors  of  the 
Otis  Machine  Company, 
43  Dey  St.,  New  York 

Gentlemen: 

I  am  offered  the  position  of  Treasurer  of  the  Los  Angeles  Fruit  Company  of 
Los  Angeles,  California,  and  on  account  of  the  condition  of  my  health  am  very 
desirous  of  accepting  the  same.  Therefore,  I  hereby  tender  my  resignation  as 
Treasurer  of  the  Otis  Machine  Company  and  ask  your  acceptance  of  same  at  the 
earliest  possible  date.  I  would  also  request  the  early  appointment  of  a  committee 
to  audit  my  accounts;  also  the  due  authorization  of  my  successor  to  take  over  and 
receipt  for  the  moneys  and  other  property  of  the  Company  now  in  my  charge. 

Regretting  the  termination  of  my  pleasant  official  relations  with  the  Company 
and  thanking  you  for  the  uniformly  kind  consideration  accorded  me  by  your  body, 
I  remain, 

Resp)ectfully, 

James  H.  McDonald 

Resignations  and  other  communications  for  the  board  of 
directors  are  frequently  addressed  to  the  secretary  or  even  to 
the  president  of  the  company.  The  better  practice  is  to  address 
the  communication  to  the  board,  enclosing  it  in  an  envelope 
addressed  to  the  secretary  or  the  president  of  the  company,  as 
the  case  may  be.  It  is  then  the  duty  of  the  officer  receiving  the 
communication  to  present  it  to  the  board.  Such  service  on, 
or  delivery  to,  the  president  or  secretary  is  legally  sufficient. 


CHAPTER  XIX 
CORPORATE  AND  OFFICIAL  SIGNATURES 

The  signature  of  a  corporate  official  followed  by  his  official 
designation  is  usually  referred  to  as  an  "official"  signature.  The 
name  of  a  corporation  duly  affixed  and  evidenced  by  the  signature 
of  the  affixing  officer  or  officers  is  known  as  a  "corporate" 
signature. 

Speaking  generally,  the  corporate  signature  is  affixed  to  all 
important  instruments  by  which  the  corporation  itself  is  to  be 
directly  and  legally  obligated,  while  the  official  signatures  are 
employed  by  the  corporate  officials  in  matters  pertaining  par- 
ticularly to  their  respective  departments,  in  which  the  contract 
relations  of  the  corporation  do  not  enter  in,  or,  if  otherwise,  the 
authority  of  the  officer  signing  the  contract  is  sufficient  to  sustain 
his  action. 

Thus,  the  president  signs  reports,  letters,  instruments,  etc., 
with  his  official  signature ;  the  treasurer  signs  notices  of  dividends 
or  assessments,  financial  statements,  and  even  corporate  checks 
and  reports  in  the  same  manner;  while  the  secretary  affixes  his 
official  signature  to  the  minutes  of  meetings,  to  reports,  notices, 
certificates,  etc. 

In  regard  to  letter  signatures,  practice  varies  widely.  In 
perhaps  the  majority  of  corporations  the  qorporate  signature  is 
attached  to  every  letter  pertaining  to  the  business  of  the  corpora- 
tion unless  there  is  some  specigil  reason  for  a  different  signature. 
In  many  corporations,  however,  this  practice  is  exactly  reversed, 
the  official  signature  of  the  writer  being  always  employed  unless 
there  is  some  special  reason  for  the  corporate  signature.  The 
former  is  the  preferable  plan. 

1582 


Ch.  19]  CORPORATE  AND  OFFICIAL  SIGNATURES  1583 

Form  196.     Official  Signature — Informal 

HOLLISTER  PIANO  COMPANY 

63  State  Street,  Chicago,  111. 


January  3,  1922 
Mr.  William  Holcomb 

155  Broadway,  New  York 

Dear  Sir: 

Your  ofifer  to  supply  this  Company  with  mahogany  veneer  has  been  accepted- 
The  matter  will  be  formally  closed  as  soon  as  the  necessary  papers  can  be  prepared. 

Yours  very  truly, 

Joseph  H.  McPherson, 

President 


This  is  the  simplest  form  of  official  signature.  It  should  be 
used  only  when  the  letter  or  other  instrument  to  which  it  is 
appended  shows  plainly  and  unmistakably,  by  heading  or  subject 
matter,  of  what  company  the  person  signing  is  an  official.  If  this 
is  not  the  case,  the  official  signature  should  be  written  in  full  as  in 
the  following  form : 

Form  197.    Official  Signature — Formal 

Joseph  H.  MacPherson 

President  Hollister  Piano  Co. 


The  corporate  signature  is  shown  below  in  its  simplest  form. 

Form  198.    Corporate  Signature — Informal 

(i)  Ramsay  Water  Company, 

By 

President 

(2)  Ramsay  Water  Company, 

By  Howard  Ramsay, 

President 


The  first  of  these  forms  shows  a  partial  corporate  signature — 
usually  afl&xed  by  means  of  a  rubber  stamp — awaiting  completion 


1584  CORPORATE  FORMS  [Bk.  IV- 

by  the  insertion  of  the  president's  signature  as  shown  in  the 
second  form. 

The  word  "By"  as  given  in  the  preceding  form  is  sometimes 
omitted  from  the  corporate  signature.  The  word  is,  however, 
employed  by  a  majority  of  the  best  conducted  corporations  of  the 
country  and  its  omission-may,  under  some  circumstances,  involve 
the  officer  whose  name  is  affixed  in  a  personal  liability. 1  The 
form  as  given  is  therefore  regarded  as  distinctly  preferable. 

When  the  corporate  signature  is  affixed  to  important  instru- 
ments, usually,  though  not  necessarily,  two  or  more  official 
signatures  are  employed.  The  seal  is  also  usually  affixed  even 
when  not  legally  necessary.  It  is  to  be  remembered  that  seals 
were  used  before  signatures  and  for  many  years  corporations  used 
seals,  unaccompanied  by  written  signatures,  in  attestation  of 
their  acceptance  of  the  instruments  to  which  their  seals  were 
affixed. 

Form  199.    Corporate  Signature — Formal 

Western  Chemical  Company, 
By  Joseph  H.  McCleary, 
/  CORPORATE  \  President 

\       SEAL       /  Frederick  Wellman, 

Secretary 

The  corporate  signature  may  be  legally  affixed  by  any 
corporate  official  or  agent  authorized  thereto  by  the  directors  or 
by-laws.  In  all  current  business,  however,  where  but  one  signing 
officer  is  desired,  the  president  is  usually  designated,  unless  the 
transaction  pertains  specially  to  the  department  of  some  other 
official. 

When  the  secretary's  name  is  employed  in  a  corporate 
signature,  as  in  the  foregoing  form,  no  specific  attestation  of  the 
seal  is  usual  or  necessary.  If  otherwise,  the  seal  should  be 
formally  attested  as  in  the  following  form  which  gives  the 
corporate  signature  usually  employed. 

•  See  comment  on  Form  217, 


Ch.  19]  CORPORATE  AND  OFFICIAL  SIGNATURES  1585 

Signatures  affixed  to  formal  instruments  are  customarily 
preceded  by  an  explanatory  statement  termed  a  "testimoniujn 
clause."     Common  forms  of  testimonium  clauses  follow. 

Form  200.    Testimonium    Clauses — Corporate    Signature — Seal 
Attested 

(i)  In  Witness  Whereof,  the  said  Powell  Steel  Company  has  caused 

its  corporate  name  to  be  hereunto  subscribed  by  its  President 
and  its  duly  attested  corporate  seal  to  be  hereunto  affixed  by  its 
Secretary,  all  in  the  City  of  Hartford,  State  of  Connecticut,  on 
the  12th  day  of  January,  1922. 
/  CORPORATE  \  Powell  Steel  Company, 

\       seal       j  By  Alexander  H.  McDowell, 

President 
Attest  seal: 

Franklin  B.  Lord, 

Secretary 

(2)  In  Witness  Whereof,  the  said  corporation  has  hereunto  affixeo  its 

corporate  signature  and  seal,  acting  through  its  President  and 
Treasurer,  duly  authorized  thereunto,  all  being  done  in  the  City, 
County,  and  State  of  New  York,  this  ist  day  of  February,  1922. 
HoRLiCK  Carpet  Corporation, 
By  Howard  Horlick, 
/  corporate  \  President 

\       seal       J  William  Johnson, 

Secretary 


Form  201.    Testimonium  Clause — Two  Corporate  Signatures 

In  Witness  Whereof,  the  said  parties  of  the  first  and  second  parts 
have  caused  their  respective  corporate  signatures  and  seals  to  be 
hereunto  affixed  by  their  duly  authorized  officers,  in  the  City, 
County,  and  State  of  New  York,  on  the  day  and  year  first  above 
written, 
f  corporate  1  ,  Arlington  Brass  Works, 

\       seal       /  By  Henry  Brierly, 


Attest  seal: 

John  H.  Savage, 

Secretary 


President 


(  corporate  1        .  Newark  Castings  Company, 

\       seal       j  By  Horace  D.  Powers, 

President 


Attest  seal : 

Henry  M.  Sunthein, 
Secretary 


1586  .    CORPORATE   FORMS  [Bk.  IV- 

The  foregoing  is  a  convenient  form  of  testimonium  clause 
when  the  instrument  is  to  be  signed  by  two  or  more  corporations. 

An  informal  but  effective  testimonium  clause  for  a  corporate 
and  individual  signature  is  as  follows : 


Form    202.    Testimonium    Clause— Corporate    and    Individual 
Signatures 


In  Witness  Whereof,  the  parties  hereunto  have  affixed  their  legal 
signatures  and  seals,  all  being  done  in  the  City  of  Trenton,  State 
of  New  Jersey,  on  this  3rd  day  of  January,  1922. 
(  CORPORATE  \  Trenton  Chain  Company, 

\       SEAL       /  By  Howard  Markham, 

President 
Attest  seal:  ' 

Henry  Jordan, 

Secretary  John  H.  Patterson  [l.  s.] 


A  more  formal  testimonium  clause  for  a  corporate  and  in- 
dividual signature  is  given  below : 

Form  203.    Testimonium  Clause — Corporate  and  Individual  Sig- 
natures 


In  Witness  Whereof,  the  Little  Falls  Carpet  Company,  said  parly 
of  the  first  part,  has  caused  its  corporate  seal  to  be  affixed  to  this 
indenture  and  its  corporate  signature  to  be  subscribed  hereunto 
by  its  President  and  Secretary  duly  authorized  thereunto,  and  the 
said  Harrison  H.  Spellman,  party  of  the  second  part,  has  affixed 
his  signature  and  seal  hereunto,  all  being  done  in  the  City  of 
Trenton,  State  of  New  Jersey,  on  the  day  and  year  first  above 
written. 
/  corporate  )  Little  Falls  Carpet  Company, 

\       seal       /  By  Willis  H.  Shelley, 

President 
James  H.  McClelland, 

Secretary 
Harrison  H.  Spellman     ^    [l.  s.] 

If  a  contract  is  signed  by  an  agent,  the  corporate  seal  is  not 
usually  affixed. 


Ch.  19]  CORPORATE  AND  OFFICIAL  SIGNATURES  1587 

Form  204.     Testimonium  Clause — Signature  by  Agent 

In  Witness  Whereof,  the  said  Milton  Smelting  Corporation,  party 
of  the'  first  part,  acting  through  its  duly  appointed  agent, 
Mortimer  H.  Shepherd,  authorized  thereunto  by  resolution  of  its 
Board  of  Directors  (certified  copy  of  which  resolution  under  the 
corporate  seal  is  hereunto  annexed),  has  caused  its  corporate 
signature  to  be  hereunto  afiixed,  and  Samuel  Jaros,  party  of  the 
second  part,  has  hereunto  afiixed  his  signature  and  seal,  all  on  the 
day  and  year  first  above  written. 

Milton  Smelting  Corporation, 

By  Mortimer  H.  Shepherd, 

Agent 
Samuel  Jaros  [l.  s.] 

A  copy  of  the  resolution  which  authorizes  the  agent  to  execute 
the  instrument  on  behalf  of  the  corporation,  duly  certified  under 
the  corporate  seal,  should  be  attached  to  the  signed  instrument. 


CHAPTER  XX 
CHECKS,  RECEIPTS,  AND  NOTES 

Corporate  Checks 

The  form  of  signature  to  a  corporate  check  is  not  material. 
Its  purpose  is  merely  to  identify  and  authenticate  the  instru- 
ment, and  any  signature  duly  prescribed  by  the  by-laws  or 
by  resolution  of  the  directors  and  recognized  by  the  company's 
bank  is  sufficient.  Consequently,  while  the  corporate  signature 
is  usually  to  be  preferred,  there  is  in  practice  much  variation  as 
shown  in  the  forms  which  follow. 

The  corporate  seal  is  seldom  if  ever  used  on  corporate  checks, 
though  its  use  does  not  affect  the  check  in  any  way.  When  the 
corporate  funds  are  material  in  amount,  the  names  of  two 
officials,  the  president  and  treasurer,  are  usually  required  upon 
the  check. 

The  forms  of  corporate  checks  which  are  given  below  are  in 
common  use. 

Form  205.    Check — Corporate  Signature 


o 

H 
< 
S   > 

<  z 

9  s 
a  o 


No.  1754  New  York,  May  i,  1922 

SEABOARD  NATIONAL  BANK 
of  the  City  of  New  York 

Pay  to  the  order  of  John  H.  Wilkins $425.75 

Four  Hundred  and  Twenty-five   75/100 Dollars 

.  .  Standard  Radiator  Company, 

Samuel  S.  Steigel, 

President 
Stewart  H.  Wilson, 

Treasurer 


Ch.  20] 


CHECKS,  RECEIPTS,  AND  NOTES 


1589 


Frequently  the  number  is  placed  in  the  upper  right-hand 
corner  of  a  check,  the  date  line  coming  in  above  or  below. 
Such  an  arrangement,  with  the  other  details  as  shown  in  the 
form  given,  is  highly  approved  by  bank  officials,  as  it  brings 
the  essential  features  of  the  check — number,  date,  amount, 
payee,  and  signature — all  well  over  to  the  right-hand  side 
of  the  check  in  the  position  that  is  most  convenient  for  rapid 
reference. 

If  the  by-laws  or  a  directors'  resolution  require  that  the 
corporate  name  be  affixed  by  the  treasurer  and  the  check  be 
countersigned  by  the  president  of  the  company,  as  is  frequently 
found  to  be  the  case,  the  following  is  an  approved  form  of  such 
a  check.  u  «i  iinot  an 


Form  206.     Check — Countersigned 

""■" ■imrjuT-- "■TriTivT" 

No.  244 


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New  York,  June  8,  1922 


STANDARD  NATIONAL  BANK  ''    "'  '     '    ' 

of  the  City  of  New  York 

Pay  to  the  order  of  Howard  P.  Huntington $475.00 

Four  Hundred  and,,  Seventy i-fiye  fto/ioo. Dollars. 

Countersigned:     '••T')r|T<o  ^nrnf-MERRiVALE  Coal  Company, 
James  J.  McLane,                                By  Horace  P.  Wisner, 
President                                                          Treasurer 
lLIi^.JJii:L:.ij::^^^lL.:_ . 


Form  207.     Check — Official  Signatures 

No.  1582  New  York,  January  3,  1922 

THE  PEOPLE'S  NATIONAL  BANK 

of  New  York  '  •'-'  <-"  •-'■' 

Pay  to  the  order  of  Jesse  Claire .$125.45 

One  Hundred  and  Twenty-five  45/100 Dollars. 


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Wallace  McComb, 
President 


Perry  H.  Ducroix, 

Treasurer  <  oT 


159©  -  "    CORPORATE  FORMS  [B|^.  IV- 

Form  208      Check — Official  Signatures — Purpose  Stated 


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No.  745  New  York,  May  i,  1922 

BANK  OF  MANHATTAN 
of  New  York  City- 
Pay  to  the  order  of  James  &  Oliver $125.75 

One  Hundred  and  Twenty-five  75/100 Dollars 

Rudolf  Hessler, 
President 
In  full  for 

September  printing.  Jasper  H.  McMeis, 

Treasurer 


Where  the  official  signatures  of  the  treasurer  and  the  president 
are  affixed,  the  form  is  usually  as  above. 

There  is  no  objection,  legal  or  practical,  to  the  entry  on  a 
check  of  the  purpose  for  which  it  is  issued,  if  so  placed  as  not 
to  obscure  or  interfere  with  its  essential  details.  The  advantage 
in  the  use  of  such  a  check  is  apparent.  Duly  indorsed,  as  it 
must  be  before  payment  is  made,  the  check  itself  affords  the  best 
possible  evidence  of  the  settlement  effected  thereby,  and  saves 
the  expense  and  trouble  of  a  more  formal  receipt. 

A  form  of  check  much  in  favor  because  of  the  prominence 
given  to  the  name  of  the  issuing  corporation,  is  as  follows: 

Form  209.     Check — Draft  Form 

ALLIS-WILKINS  COMPANY 
1675  Broadway,  New  York 
No.  1728  .  March  10,  1922 

Pay  to  the  order  of  Jesse  H.  Sinclair $35-25 

Thiri^-iive  25/100 Dollars. 

Allis-Wilkins  Company, 
By  Francis  H.  Whitman, 

Treasurer 

To  the 

Seaboard  National  Bank, 
New  York 


Ch.  20]  CHECKS,  RECEIPTS,  AND  NOTES  1 591 

In  the  smaller  corporations  dividends  are  usually  paid  by 
means  of  the  ordinary  corporate  check,  the  words  "Dividend 
Check"  being  stamped  or  written  across  its  face.  In  the  larger 
corporations  special  checks  are  employed  for  the  purpose,  as  in 
the  following  form: 

Form  210,    Dividend  Check 


AMERICAN  WOOL  EXPORT  COMPANY 

New  York,  February  3,  1922  No.  1482 

AMERICAN  NATIONAL  BANK 

of  New  York 
Pay  to  the  order  of 

Henry  H.  McCall $125.00 

One  Hundred  and  Twenty-five  00/100 Dollars. 

Countersigned: 

Stock  Transfer  Department,  Frank  S.  Jordan, 

John  Frenckel,  Transfer  Agent  Treasurer 


No  receipt  is  usually  required  when  this  form  of  dividend 
check  is  employed,  the  duly  indorsed  check  in  itself  affording 
the  best  possible  evidence  that  payment  of  the  dividend  has 
been  made. 

The  ordinary  indorsement  of  a  corporate  check  is  given 
in  the  following  form: 

Form  211.     Indorsement  of  Corporate  Check 

.Eg 
b  a  2 

a< 


1592  CORPORATE  FORMS  [Bk.  IV- 

This  indorsement  is  usually  afl&xed  by  the  treasurer  or 
cashier,  though  the  president  is  frequently  authorized  thereto. 

The  following  form  of  indorsement  is  usually  affixed  in 
its  entirety — corporate  name,  official  signature,  and  all — with 
a  rubber  stamp.  Such  an  indorsement  is  approved  by  the 
banks  and,  on  account  of  the  rapidity  and  convenience  with 
which  it  may  be  affixed,  is  generally  employed. 

Form  212.    Indorsement  of  Check  for  Deposit 


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The  following  is  a  common  form  of  corporate  draft,  signed 

by  one  official. 

;(fnol  1' 

Form  213.     Corporate  Draft 

..._ _iu:fijjl3_lQ.±aafa.fi. ,... 

No.  745  'New  York,  May  15,  1922 

Three  days  after  sight  pay  to  the  order  of 

Seaboard  National  Bank  of  New  York $1,245.25 

Twelve  Hundred  and  Forty-five  25/100 Dollars 

payment  of  account  as  per  our  statement  of  April  10,  1922. 
Value  received.     Charge  same  to  account  of 

Car  Equipment  Company, 
By  Howard  James, 

Treasurer 
To  North  Wheeling  Car  Co., 
Wheeling,  West  Virginia 


Ch.  20]  CHECKS,  RECEIPTS,  AND  NOTES  1 593 

Corporate  Receipts  ^ 
A  common  form  of  corporate  receipt  is  as  follows: 

:0'1 

Form  214.    Corporate  Receipt 


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K       ^ 
«        J? 


$250.00    '    no'^sbni  jsje^v  York,  July  15,  1922 

Received  from  Edward  M.  Blair  Two  Hundred  and  Fifty  Dollars, 
rental  of  Store  at  No.  65  Vesey  St.  for  the  month  of  July,  1922. 

Metropolitan  Realty  CompanV, 
By  Samuel  F.  Watkins, 

Treasurer 


It  would  seem  preferable  that  all  receipts  foremoney  received 
by  a  corporation  should  be  given  in  the  corporate  name.  In 
practice,  however,  corporate  receipts  are  commonly  signed 
by  the  treasurer.  In  such  case  the  name  of  the  corporation 
should  appear  prominently. 

Form  215.     Corporate  Receipt — Official  Signature 

'"~^-~t"V)"~\Tori''')Til^<'~fv' 

$725.25  March  15,  1922 

WELLMAN  SUPPLY  CORPORATION 

265  Chambers  St.,  New  York 

Received  from  the  Jackson  Hardware  Company  Seven  Hundred  and  Twenty- 
five  25/100  Dollars  in  full  of  account. 

1^5  Ji  Ashton,  ^ 

* ,  ; ,        Treasurer 

-■'  The  larger  corporations,  when  dividends  are  to  be  paid, 
employ  dividend  checks,  which,  when  properly  indorsed  and 
deposited,  are  usually  regarded  as  all-sufficient  receipts.  It  is 
easy  to  devise  some  form  of  voucher  check  which  will  satis- 
factorily meet  the  situation. 


'  See  Forms  73,  74,  for  receipts  for  instalment  payments 


1 594  CORPORATE  FORMS  'Bk.  IV- 

If,  however,  formal  receipts  are  desired,  the  following  form 
will  serve: 

Fonn  216.    Dividend  Receipt 


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$25.00  Boston,  Mass.,  March  i,  192 

Received  of  the  Howard  Foundation  Company  Twenty-five 
Dollars,  payment  in  full  of  quarterly  dividend  No.  37,  of  One  and 
One-half  Per  Cent  on  the  stock  of  said  corporation  standing  in  my  name 

Henry  J.  Pollock  «  . 


This  receipt  is  sent  out  with  the  dividend  check  to  be  signed 
and  returned  by  the  recipient.     ,1*  . » f 

When  payment  of  dividends  is  made  at  the  office  of  the 
company  or  at  the  office  of  some  specified  trust  company  or 
bank,  the  parties  receiving  payment  usually  sign  the  dividend 
register  and  no  other  receipt  is  necessary. 

,  - ,      Corporate  Notes  ^^  ■  ^^^  ^^.^ ., 

A  corporate  note  does  not  require  to  be  sealed.  It  may 
be  signed  by  any  officer  or  officers  properly  authorized  thereto. 
Such  authority  is  usually  conferred  by  by-law  provisions  or 
by  resolution  of  the  board  of  directors,  but  otherwise  may 
be  given  by  custom.  For  large  amounts  or  special  trans- 
actions outside  the  usual  routine,  the  officer's  authorization 
should  always  be  specific  and  usually  by  resolution  of  the  board 
of  directors.  In  such  cases  the  parties  accepting  the  corporate 
note  will  usually  require  a  certified  copy  of  the  resolution  author- 
izing the  issuance  of  the  note. 

The  signature  of  a  corporate  note  should  always  be  the 
corporate  signature.  Any  other  signature  may  not  only  fail 
to  bind  the  corporation,  but  has  been  held  in  some  states  to 
involve  the  official  signing  the  note  in  a  personal  liability  as 
its  maker  or  indorser. 


Ch.  20]  CHECKS,  RECEIPTS,  AND  NOTES  1595 

Form  217.     Corporate  Note — By  President 


$500.00  New  York,  April  5,  1922 

Ninety  days  after  date  the  Hillman  Dredging  Company  promises  to  pay  to 
the  order  of  Howard  P.  Hunt  the  sum  of  Five  Hundred  Dollars. 

Value  Received. 

Hillman  Dredging  Company, 
By  Nathaniel  Potter, 

President 
Payable  at 

Irving  National  Bank, 
New  York 


Form  218.     Corporate  Note — By  Treasurer 


$2,500.00  Boston,  Mass.,  December  i,  1921 

Four  months  after  date  the  Hanover  Securities  Company  promises  to  pay  to 
the  order  of  James  C.  Bennett  the  sum  of  Twenty-five  Hundred  Dollars,  with 
interest  from  date  until  paid,  at  the  rate  of  Six  Per  Cent  per  annum,  at  the  Sedgwick 
National  Bank  of  Boston. 
Value  Received. 

Hanover  Securities  Company, 
By  William  Curtiss, 
No.  725  Treasurer 

Due  April  i,  1922 


The  preceding  notes  are  in  the  simplest  form.  The  corporate 
signature  is  affixed  by  one  officer  or  by  two  as  may  be  customary 
or  required  by  by-law  provision  or  directed  by  the  board. 

Form  219.    Collateral  Note — On  Demand 

Collateral  Note 

$4,000.00  New  York,  February  3,  1922 

On  Demand  the  Hanover  Power  Company  promises  to  pay  to  the  Seaboard 
National  Bank  of  the  City  of  New  York,  or  order,  at  its  Bankmg  House,  No.  18 
Broadway,  New  York,  N.  Y.,  Four  Thousand  Dollars  ($4,000)  for  value  received, 
with  interest  at  the  rate  of  Six  Per  Cent  (6%)  per  annum  from  the  date  hereof, 
said  corporation  having  deposited  with  said  Bank  as  collateral  security  for  payment 
of  this  or  any  other  liability  or  liabilities  of  the  undersigned  to  said  Bank,  due  or 
to  be  due  or  which  may  be  hereafter  contracted  or  exist,  the  following  property 
or  securities,  viz.:   Seventy-five  (75)  Shares  of  the  Preferred  Stock  of  the  United 


1 50  CORPORATE  FORMS  [Bk.  IV- 

States  Steel  Corporation  of  the  par  value  of  One  Hunilred  Dollars  ($ioo)  each,  the 
certificate  for  said  stock  standing  in  the  name  of  John  H.  Howard,  Treasurer  of  the 
said  Hanover  Power  Company,  and  being  indorsed  by  him  in  blank  on  the  back  of 
said  certificate. 

The  market  value  thereof  is  today  $6,225,  ^.nd  full  power  and  authority  is 
hereby  given  to  said  Bank  to  sell,  assign,  and  deliver  the  whole  or  any  part  thereof, 
or  any  substitutes  therefor,  or  any  additions  thereto,  at  any  Brokers'  Board,  or  at 
public  or  private  sale,  at  the  option  of  said  Bank  or  its  assigns  on  the  non-perform- 
ance of  this  promise  or  the  non-payment  of  any  of  the  liabilities  above  mentioned, 
or  at  any  time  or  times  thereafter,  without  advertisement  or  notice,  which  are  here- 
by expressly  waived;  and  upon  such  sale  the  holder  hereof  may  purchase  the  whole 
or  any  part  of  such  securities  discharged  from  any  right  of  redemption,  and  after 
deducting  all  legal  or  other  costs  and  expenses  for  collection,  sale  and  delivery, 
shall  apply  the  residue  of  the  proceeds  of  such  sale  or  sales  so  to  be  made  to  pay 
any,  either,  or  all  of  said  liabilities  to  said  Bank  or  its  assigns  as  said  Bank  or  its 
assigns  shall  deem  proper,  returning  the  overplus,  if  any,  to  the  undersigned.  And 
the  undersigned  gives  to  said  Bank  a  lien  to  secure  this  note.^nd  all  said-  other 
liabilities  now  existing  or  hereafter  arising,  and  whether  at  any  time  due  or  not 
upon  all  property  and  securities  of  the  undersigned  now  or  hereafter  deposited  with 
or  left  in  the  possession  of  said  Bank,  either  as  collateral  for  any  other  obligation 
or  otherwise,  and  also  upon  any  balance  at  any  time  of  the  deposit  account  of  the 
undersigned  with  said  Bank.  Other  collaterals  may  be  substituted  or  added  from 
time  to  time  with  the  bank's  consent,  all  representations,  conditions,  and  agree- 
ments as  to  original  collaterals  applying  to  those  so  substituted  or  added. 

In  Witness  Whereof,  the  said  corporation  has  hereunto  afl&xed  its 

corporate   signature   and   seal,    acting   through   its   President   and 

Treasurer  duly  authorized  thereunto. 
fcoRPORATEl  Hanover  Power  Company, 

\       SEAL     j  By  John  H.  Henderson, 

President 
Harry  F.  Sinclair, 
Treasurer 


Another  form  of  collateral  note  is  as  follows: 

Form  220.    Corporate  Note — Collateral  Security 
.^^^.^.^.^.^j^„.^_^„^.^.„.^_^^^ — .„.„..„._.^ 

•  Collateral  Note 

$10,000.00  •  New  York,  January  15,  1922 

Ninety  days  after  date,  the  Berwick  Mercantile  Company  promises  to  pay  to 
the  order  of  the  Guardian  Trust  Company  of  New  York  City,  at  No.  170  Broadway, 
New  York  City,  the  sum  of  Ten  Thousand  Dollars  ($10,000),  with  interest  from 
date  until  paid  at  the  rate  of  Six  Per  Cent  (6%)  per  annum,  and  the  said  Berwick 
Mercantile  Company  doth  herewith  deposit  with  the  Guardian  Trust  Company  as 
collateral  security  for  the  due  payment  of  the  foregoing  promissory  note,  Two 
Hundred  (200)  Shares  of  its  stock  in  one  Certificate  No.  325,  said  Certificate  stand- 
ing in  the  name  of  Mark  Baldwin,  Treasurer  of  the  said  Berwick  Mercantile  Com- 
pany, and  indorsed  by  him  in  blank. 

And  in  the  event  that  this  note  or  the  interest  thereon  shall  not  be  paid  when 
due,  the  said  Berwick  Mercantile  Company  hereby  appoints  and  constitutes  the 


Ch.  2oJ  CHECKS,  RECEIPTS,  AND  NOTES  1 597 

said  Guardian  Trust  Company  its  attorney  in  fact  and  irrevocably,  with  power 
of  substitution,  to  sell  at  any  time  after  this  said  note  or  anj'  interest  thereon  is  due 
and  unpaid,  with  or  without  notice,  and  either  at  public  or  private  sale,  the  whole 
or  any  part  of  said  securities,  the  proceeds  thereof  to  be  applied  to  the  payment  of 
the  said  promissory  note,  any  interest  due  thereon,  and  any  commissions  properly 
payable  on  the  sales  of  said  securities  so  sold,  and  any  surplus  remaining  thereafter, 
either  of  cash  or  of  the  said  securities  to  belong  to  and  be  subject  to  the  order  of  the 
said  Berwick  Mercantile  Company;  and  should  said  securities  not  bring  the  full 
amount  of  this  present  note,  together  with  any  interest  accrued  thereon,  said 
Berwick  Mercantile  Company  undertakes  and  agrees  to  pay  the  amount  still  due 
to  the  holder  hereof  on  demand. 

Should  any  such  sale  be  made,  the  holder  hereof  shall  directly  or  in  the  name 
of  any  other  person,  have  the  right  to  purchase  the  security  aforesaid.  In  case  the 
market  value  of  the  same  shall  decrease,  the  said  Berwick  Mercantile  Company 
hereby  promises  and  agrees  to  proportionately  reduce  the  amount  of  its  indebted- 
ness hereunder,  or  otherwise  increase  the  security  in  proportion  to  said  decrease  of 
value. 

In  Witness  Whereof,  the  said  Berwick  Mercantile  Company  has  caused 
its  name  to  be  subscribed  hereunto  by  its  President,  and  its  duly 
attested  seal  to  be  afiixed  hereto  by  its  Secretary,  on  the  day  and  year 
first  above  written. 

fcoRPORATE   1  Berwick  Mercantile  Company, 

\       SEAL       /  By  Henry  S.  Corbin, 

President 
Attest  seal: 

Amos  C.  Hallock, 
Secretary 


9obo  W  I0  aamsB  oJ  ©tBoftehs  mo  ♦! 


CHAPTER  XXI 

CERTIFICATIONS 

The  certifications  so  frequently  required  in  corporate  pro- 
cedure are  never  made  in  the  corporate  name.  Certificates  and 
affidavits  to  corporate  instruments  are  made  over  their  own 
names  by  the  officers  directly  concerned.  Acknowledgments  are 
made  for  and  on  behalf  of  the  corporation — but  not  in  its  name — 
by  such  corporate  officials  or  agents  as  may  be  prescribed  by 
statute  or  be  authorized  thereto  by  the  by-laws  or  resolutions 
of  the  board. 

The  following  is  a  simple  form  of  certificate  to  service  of 
notice,  more  especially  to  service  of  notice  of  a  corporate 
meeting. 

Form  221.    Certificate  to  Service  of  Notice 


I,  the  undersigned,  Secretary  of  the  Atlantic  Machine  Works,  do  hereby  certify 
that  in  accordance  with  the  by-law  requirements  of  said  Company,  a  copy  of  the 
foregoing  notice,  properly  enclosed  and  directed,  and  with  postage  prepaid,  was  by 
me  on  the  21st  day  of  December,  192 1,  mailed  to  each  stockholder  of  record  of  said 
Company  at  his  address  as  it  appeared  on  the  books  of  the  Company. 

Henry  H.  Linden 
New  York  City, 

January  3,  1922 


This  certificate  usually  appears  on  the  same  sheet  with,  and 
below  a  copy  of,  the  notice,  though  sometimes  written  separately 
and  attached  to  a  copy  of  the  notice.  In  this  latter  case  the 
wording  of  the  certificate  must  be  changed  to  correspond  with 
the  facts. 

An  affidavit,  as  in  the  case  of  the  certification,  may  appear  on 
the  same  sheet  as  the  copy  of  the  notice,  or  be  attached  thereto. 

1598 


Ch.  2i]  CERTIFICATIONS  1^99 

Form  222.    Affidavit  to  Service  of  Notice  -  ,1 


State  of  New  York 
County  of  New  York 

On  this  3rd  day  of  January,  1922,  before  me  personally  appeared  Henry  H. 
Linden,  Secretary  of  the  Atlantic  Machine  Works,  who  being  duly  sworn,  did  depose 
and  say  that  on  the  21st  day  of  December,  1921,  a  copy  of  the  attached  notice  of 
meeting,  properly  enclosed  and  directed  and  with  postage  prepaid,  was  by  him 
mailed  to  each  stockholder  of  record  of  said  corporation  at  his  address  as  shown 
by  the  books  of  the  Company. 

Henry  H.  Linden 
Sworn  to  and  subscribed  before  me 
the  day  and  year  aforesaid. 

John  H.  Anderson, 
/  notari.^l  \  Notary  Public  for 

\      SEAL      J  County  of  New  York, 

No.  16 


The  best  evidence  of  notice  by  publication  is  furnished  by- 
complete  copies  of  the  papers  in  which  the  notice  appeared. 
When  these  are  supplied,  no  certification  as  to  publication  of  the 
notice  is  usually  required.  If,  however,  the  notice  is  clipped 
from' the  paper  and  so  preserved,  an  affidavit  is  sometimes  con- 
sidered desirable.  The  larger  city  papers,  on  request,  furnish 
affidavits  of  publication  for  notices  appearing  in  their  columns. 

i  Form  223.    Affidavit  to  Publication  of  Notice 


State  of  New  York 
County  of  New  York 

On  this  3rd  day  of  January,  1922,  before  me  personally  appeared  Henry  H. 
Linden,  Secretary  of  the  Atlantic  Machine  Works,  who  being  duly  sworn,  did 
depose  and  say  that  the  annexed  notice  was  published  in  the  New  York  Times  on  the 
22nd  and  29th  days  of  December,  1921. 

Henry  H.  Linden 
Sworn  to  and  subscribed  before  me 
the  day  and  year  aforesaid. 

{Notarial  acknowledgment  as  in  Form  222.) 


In  the  following  form  of  certified  resolution  the  resolution 
appears  on  the  upper  part  of  the  sheet  followed  by  the  certifica- 
tion, the  general  arrangement  being  the  same  as  in  Form  229. 


l6oo  CORPORATE  FORMS  [Bk.  IV- 

Form  224.     Certified  Resolution  Designating  Bank  ^ 

{Resolution  here.) 

I,  Sherman  H.  Rogers,  Secretary  of  the  AUis  Drug  Company,  do  hereby 

certify  that  the  foregoing  is  a  full  and  true  transcript  of  a  resolution  duly  adopted 

at  a  regular  meeting  of  the  Board  of  Directors  of  the  said  Company  held  in  the 

City  of  New  York  on  the  loth  day  of  November,  192 1,  as  it  appears  on  the  minutes 

of  said  meeting,  and  I  do  further  certify  that  Charles  Allis  is  the  duly  elected 

President  of  said  Company,  and  Jasper  T.  Huntington  is  its  duly  elected  Treasurer, 

In  Witness  Whereof,  I  have  hereunto  affixed  my  official  signature 

and  the  corporate  seal  of  said  Company,   this   25th  day  of 

November,  192 1. 

Sherman  H.  Rogers, 
(  CORPORATE  \  Secretary 

\  SEAL  / 

The  following  certification  is  employed  in  connection  with  the 
resolution  given  in  Form  145. 

Form  225.     Certification  of  Resolution  Designating  Bank 


I,  John  H.  Farwell,  Assistant  Secretary  of  the  Standard  Milling  Company,  do 
hereby  certify  that  the  foregoing  resolution  was  duly  adopted  at  a  regular  meeting 
of  the  Board  of  Directors  of  said  Company  held  on  Tuesday,  February  7,  1922,  in 
the  office  of  the  Company,  225  Fifth  Avenue,  New  York,  all  as  shown  by  the  minutes 
of  said  meeting,  and  that  the  transcript  of  Section  3,  Article  VII,  of  the  By-laws  of 
said  Company  appearing  in  the  preamble  of  said  resolution  is  a  true  and  accurate 
transcript  thereof  from  the  duly  adopted  By-laws  of  the  Company,  and  I  do  further 
certify  that  Henry  F.  Farrand  is  the  duly  elected  Treasurer  of  said  Company  and 
Howard  C.  Malcolm  is  its  duly  elected  President. 

Witness  my  official  signature  and  the  corporate  seal  of  said  Company, 
this  1 8th  day  of  February,  1922. 

John  H.  Farwell, 
f  corporate  \  Assistant  Secretary 

\  SEAL  / 


If  the  bank  requires  certified  signatures  of  the  signing  officials, 
these  signatures  might  be  written  on  the  same  sheet  between  the 
resolution  and  certification,  and  the  following  phrase  be  added 
to  the  certification:  "and  that  the  signatures  above  written  are 
respectively  the  signatures  of  the  said  Henry  F.  Farrand  and 
Howard  C.  Malcolm." 


1  See  Forms  144-146. 


Ch.  2i]  CERTIFICATIONS  1601 

A  different  form  of  certification  employed  in  connection  with 
the  resolution  of  Form  J46  is  as  follows: 

Form  226.     Certification  of  Resolution 

The  undersigned,  Secretary  of  the  American  Textile  Company,  does  hereby 
certify  that  the  foregoing  resolution  was  duly  adopted  on  the  loth  day  of  January, 
1922,  at  a  meeting  of  the  Board  of  Directors  of  said  Company  regularly  called  and 
duly  constituted  and  at  which  a  quorum  was  present. 

Witness  my  hand  and  the  seal  of  said  corporation  this  12th  day  of 
January,  1922. 

Alfred  Dilworth, 
r  CORPORATE  \  Secretary 

I  SEAL  J 


Form  227.    Certificate  of  Election  of  Treasurer 


I,  Horace  B.  Elkins,  Secretary  of  the  EUwood  Creamery  Company,  hereby 
certify  that  at  a  regular  and  duly  constituted  meeting  of  the  Board  of  Directors  of 
said  Company  held  in  the  City  of  Albany  on  the  ist  day  of  March,  1922,  Henry 
Howells  was  elected  Treasurer  of  said  Company  to  fill  the  vacancy  in  said  office 
caused  by  the  death  of  J.  J.  McAUen,  and  that  the  said  Henry  Howells  is  now  the 
duly  qualified  and  authorized  Treasurer  of  the  said  EUwood  Creamery  Company 
Witness  my  hand  and  the  seal  of  the  Company  this  loth  day  of  March, 
1922. 

Horace  B.  Elkins, 
(  corporate  "I  Secretary 

\       seal       J 


Form  228.    Certificate  of  Election  of  Officers 


I,  Emory  Hardin,  Secretary  of  the  Dyett-King  Leather  Company,  do  hereby 
certify  that  the  Directors  of  said  Company  being  duly  assembled  in  lawful  meeting 
in  the  office  of  the  Company,  No.  75  Dey  St.,  New  York  City,  on  the  9th  day  of 
March,  1922,  and  a  quorum  being  present,  did  then  and  there  elect  Frederick 
Myers,  President,  and  Walter  C.  Jackson,  Treasurer  of  said  corporation,  to  serve 
for  the  ensuing  year  and  until  the  due  election  and  qualification  of  their  successors, 
and  that  said  Frederick  Myers  and  Walter  C.  Jackson  are  now  duly  and  fully 
quaUfied  and  empowered  to  act  for  said  corporation  in  their  respective  official 
capacities. 

In  Testimony  Whereof,  I  have  hereunto  affixed  my  official  signature  and 
the  corporate  seal  of  said  Company  this  15th  day  of  March,  1922. 

Emory  Hardin, 
f  corporate  \  ^  Secretary 

\       seal       j 


l6o2  CORPORATE  FORMS  [r,k.  IV- 

The  foregoing  certificate  of  the  election  of  corporate  officials 
may  be  used  when  greater  formality  is  desired. 

Forms  for  certifications  of  transcripts  of  various  kinds  are 
given  below. 

In  ths  transaction  of  corporate  business  transcripts  from  the 
by-laws  are  frequently  required.  When  the  matter  is  of  any 
considerable  importance  these  transcripts  must  be  certified. 

Form  229.     Certification  of  Transcript  from  By-Laws 

CONSOLIDATED  CRACKER   COMPANY 
Transcript  from  By-Laws 


"Article  IV — Officers 
"Sec.  2.     The  President 

"The  President  when  present  shall  preside  at  all  meetings  of  the  stockholders 
and  of  the  Board  of  Directors;  shall  sign  all  certificates  of  stock;  shall  sign  or 
countersign  as  may  be  necessary  all  such  bills,  notes,  checks,  drafts,  and  other 
instruments  as  may  pertain  to  the  ordinary  course  of  the  Company's  business;  and 
shall  sign  when  duly  authorized  thereto  all  contracts,  orders,  deeds,  licenses,  and 
other  instruments  of  a  special  nature. 

"He  may  also  in  the  absence  or  disability  of  the  Treasurer,  indorse  checks, 
drafts,  and  other  negotiable  instruments  for  deposit  or  collection,  and  shall  with  the 
Secretary  sign  the  minutes  of  all  meetings  over  which  he  presides." 

I,  James  T.  Howard,  Secretary  of  the  Consolidated  Cracker  Company,  i]r\ 
hereby  certify  that  the  above  is  a  true  and  correct  copy  of  Section  2,  Article  IV  of 
the  duly  adopted  by-laws  of  this  Company,  and  in  testimony  thereof  I  have  here- 
unto affixed  my  official  signature  and  the  seal  of  the  Company,  in  the  City  of 
Brooklyn,  on  this  21st  day  of  March,  1922. 

James  T.  Howard, 
CORPORATE  \  Secretary 

seal       / 


Form  230.    Certification  of  By-Laws  as  a  Whole 

I,  the  undersigned.  Secretary  of  the  General  Auto  Supply  Company,  do  hereby 
certify  that  the  foregoing  is  a  true  and  complete  copy  of  the  By-laws  of  said  corj)0  ra- 
tion, including  all  amendments,  and  as  the  same  are  in  force,  at  the  date  hereof. 

In  Witness  Whereof,  I  have  hereunto  subscribed  my  name  and  affixed 
the  seal  of  said  corporation,  this  2nd  day  of  March,  1922. 

William  H.  Sanford, 
r  CORPORATE  \  •  Secretary 

\        seal       j 


Ch.  2i]  CERTIFICATIONS  1603 

The  following  is  a  convenient  form  when  the  transcript  from 
the  minutes  of  either  stockholders'  or  directors'  meetings  must 
be  certified. 

Form  231.     Certification  of  Transcript  from  Minutes 

WESTON  MANUFACTURING  CORPORATION 

Transcript  from  Minutes  of 

Regular  Meeting  of  Directors 

Held  February  15,  1922 

{Transcript  from  minutes  appears  here.) 

I,  the  undersigned,  Secretary  of  the  Weston  Manufacturing  Corporation,  do 
hereby  certify  that  the  above  and  foregoing  is  a  true  and  accurate  transcript  from 
the  minutes  of  a  regular  meeting  of  the  Board  of  Directors  of  said  Company  held  in 
the  office  of  the  Company  on  the  isth  day  of  February,  1922,  and  recorded  on 
pages  85  to  87  of  the  Minute  Book  of  said  Company. 

Witness  my  hand  and  seal  of  the  Company  this  14th  day  of  April,  1922. 

Horace  Potter, 
corporate  \  Secretary 

SEAL 

The  president  occasionally  joins  with  the  secretary  in  the 
certification  of  any  specially  important  transcript.  In  such  case 
the  certificate  is  changed  as  follows : 

Form  232.    Certification  of  Minutes — President  and  Secretary 


We,  the  undersigned.  President  and  Secretary  respectively  of  the  Weston 

Manufacturing  Corporation,  do  hereby  certify  that  the  above  and  foregoing  is  a 

true  and  accurate  transcript  from  the  minutes  of  a  regular  meeting  of  the  Board  of 

Directors  of  said  Company  held  in  the  office  of  the  Company  on  the  15  th  day  of 

February, 1 922,  and  recorded  on  pages  85  to  87  of  the  Minute  Book  of  said  Company. 

In  Witness  Whereof,  we  have  hereunto  affixed  our  official  signatures 

and  the  seal  of  the  Company  in  the  City  of  New  York  on  this  14th  day 

of  April,  1922. 

Henry  J.  Randall, 
r  corporate  \  President 

\       SEAL       /  Horace  Potter, 

Secretary 


l6o4  CORPORATE  FORMS  [Bk.  IV- 

Affidavits  take  the  place  of  the  secretary's  certificate  when 
corporate  records  or  transcripts  therefrom  are  required  for  use  in 
legal  proceedings. 

Form  233.     Secretary's  Affidavit  to  Minutes 

State  of  New  York 
County  of  New  York 

On  this  14th  day  of  April,  1922,  before  me  personally  appeared  Horace  Potter, 
who  being  duly  sworn,  did  depose  and  say  that  he  is  the  Secretary  of  the  Weston 
Manufacturing  Corporation;  that  he  was  present  at  the  regular  meeting  of  the 
Directors  of  that  Company  held  on  the  15th  day  of  February,  1922,  that  he  recorded 
the  proceedings  of  said  meeting  in  th*^  Minute  Book  of  the  corporation,  and  that  the 
above  and  foregoing  is  a  true  and  correct  transcript  from  the  minutes  so  recorded- 

HoRACE  Potter 
Sworn  to  and  subscribed  before  me 
on  the  day  and  year  above  stated . 

{Notarial  signature  and  seal.)  ,;    hsnaim^bn ■ 


Notarial  exemplifications  of  certified  transcripts  from  the 
corporate  records  are  sometimes  required,  as  follows: 

Form  234.     Notarial  Exemplification  of  Minutes 

State  of  New  York 
County  of  New  York 

Personally  appeared  before  me  this  14th  day  of  April,  1922,  Horace  Potter, 
to  me  well  known,  and  acknowledged  that  he  signed  the  foregoing  certification  of  a 
transcript  from  the  minutes  of  the  Weston  Manufacturing  Corporation,  and  afhxed 
the  seal  of  said  Company  thereto  as  Secretary  of  the  said  Company  for  the  purposes 
therein  set  forth,  and  I  have  personhUy  examined  the  minutes  of  said  Company 
under  date  of  February  15,  1922,  and  certify  that  the  foregoing  transcript  is 
correctly  transcribed  therefrom. 

Morris  Manning, 
r  notarial  \  Notary  Public  for 

\      seal      /  County  of  New  York, 

No.  765 
Term  expires  December  i,  1922. 


Form  235.    Treasurer's  Affidavit  to  Corporate  Statement 

State  of  New  York  "1         . 
County  of  New  York  / 

On  this  29th  day  of  March,  1922,  personally  appeared  before  me,  a  Notary 
Public  in  and  for  the  County  of  New  York,  Walter  L.  Hood,  Treasurer  of  the  Hood 


Ch.  2i]  CERTIFICATIONS  1605 

Scale  Company,  who,  being  duly  sworn,  did  depose  and  say  that  he  has  full  charge 
and  control  of  the  books  and  accounts  of  the  said  Company;  that  the  above  and 
foregoing  statement  is  taken  from  said  books  and  accounts;  that  it  is  a  true  and 
accurate  transcript  therefrom,  and  that  to  the  best  of  his  knowledge  and  belief  it  is 
a  just  and  correct  presentation  of  the  financial  condition  of  said  Company  on  this 
date. 


Sworn  to  before  me  the 
day  and  year  aforesaid. 

James  H.  Steele, 
(  NOTARIAL  (^  Notary  Public  for 

\      SEAL      J  New  York  County, 

No.  gQ4 
Term  expires  Feb.  15,  1923. 


Walter  L.  Hood 


The  treasurer's  certifications  to  matters  relating  to  the 
corporation's  finances  are  usually  in  the  form  of  affidavits.  The 
affidavit  should  follow  the  statement  on  the  same  sheet  or  on  the 
last  sheet  if  the  statement  extends  over  several  pages. 

When  a  corporate  acknowledgment  is  taken,  the  notary 
should  not  be  an  officer  or  stockholder  of  the  corporation.  The 
form  of  acknowledgment  is  usually  regulated  by  statute  and 
therefore  varies  in  almost  every  state.  The  following  form  of 
corporate  acknowledgment  is  that  prescribed  by  the  statutes  of 
New  York. 

Form  236.    Notarial  Acknowledgment — New  York 

State  of  New  York  \ 
County  of  New  York  j     ^^" 


On  this  i6th  day  of  March  in  the  year  1922,  before  me  personally  came  John 
J.  Kerry,  to  me  known,  who,  being  by  me  duly  sworn,  did  depose  and  say  that  he 
resided  in  the  City  of  New  York;  that  he  is  the  President  of  the  Kerry  Machine 
Works,  the  corporation  described  in  and  which  executed  the  above  instrument; 
that  he  knew  the  seal  of  said  corporation;  that  the  seal  affixed  to  said  instrument 
was  such  corporate  seal;  that  it  was  so  affixed  by  order  of  the  Board  of  Directors  of 
said  corporation,  and  that  he  signed  his  name  thereto  by  like  order. 

John  J.  Kerry 
Sworn  to  before  me  the 

day  and  year  aforesaid. 

(Notarial  signature  and  seal.) 


CHAPTER  XXII 

POWERS  OF  ATTORNEY,  CONTRACTS,  AND 
ASSIGNMENTS 

Powers  of  Attorney 

The  execution  of  a  power  of  attorney  varies  according  to  the 
powers  conveyed  and  the  ccnditions  under  which  it  is  given. 
The  instrument  which  follows  does  not  require  acknowledgment 
if  the  parties  signing  the  power  of  attorney  are  known  to  the 
corporate  officials.  If  this  is  not  the  case  a  notarial  acknowl- 
edgment is  usually  required. 

Form  237.     Power  of  Attorney— To  Receive  Dividends 

Power  of  Attorney 


I,  the  undersigned,  do  hereby  constitute  and  appoint  George  H.  Williams  of 
New  York  City,  my  true  and  lawful  attorney,  for  me  and  in  my  place  and  stead  to 
receive  any  and  all  dividends  now  due  or  which  may  hereafter  become  due  on  the 
I'if ty  Shares  of  Preferred  Stock  o  the  Howard  Bank  Note  Company  now  standing 
in  my  name  on  the  books  of  said  Company,  and  to  receipt  for  the  same,  and  to  do 
all  other  things  that  may  be  necessary  to  enable  him  to  receive  my  said  dividends; 
and  I  hereby  ratify  and  confirm  all  that  my  said  attorneymay  properly  do  by  virtue 
of  the  authority  herein  conferred. 

In  Witness  Whereof,  I  have  hereunto  affixed  my  signature  and  seal 
this  7th  day  of  January,  1922. 

George  H.  Lane  [l.  s.] 

Witnessed  by: 

Howard  Lansing 


A  corporate  power  of  attorney  differs  from  the  ordinary  form 
only  in  those  details  directly  incident  to  its  corporate  origin.  It 
should  either  be  accompanied  by  a  certified  copy  of  the  resolution 
which  authorizes  it,  or  otherwise  be  acknowledged. 

1606 


Ch.  22]  POWERS  OF  ATTORNEY  1607 

Form  238.     Power  of  Attorney — To  Collect  Money 

Power  of  Attorney 

Know  All  Men  by  These  Presents: 

That  the  Tucson  Cattle  Company,  a  corporation  duly  organized  under  the 
laws  of  Arizona,  does  hereby  make,  constitute,  and  appoint  Howard  H.  McComb 
of  the  State  of  New  York,  its  true  and  lawful  attorney,  for  it  and  in  its  name,  place, 
and  stead  to  collect  and  receive  from  the  New  York  Drovers'  Association  of  New 
York  City  the  sum  of  Three  Thousand  Dollars  ($3,000)  with  interest  thereon  at  the 
rate  of  Six  Per  Cent  (6%)  per  annum  from  the  ist  day  of  January,  1922,  said 
amount  being  due  and  payable  to  the  Tucson  Cattle  Company  for  and  on  account 
of  cattle  shipped  the  said  New  York  Drovers'  Association  during  the  month  of 
December,  192 1,  and  the  said  Howard  H.  McComb  is  hereby  fully  authorized  and 
empowered  for  and  on  account  of  the  said  Tucson  Cattle  Company  and  in  its  name, 
to  collect,  receive,  and  receipt  for  the  said  Three  Thousand  Dollars  ($3,000),  and 
the  interest  thereon  as  aforesaid,  in  whole  or  in  part,  but  without  prejudice  to  any 
portion  thereof  unpaid,  and  to  incur  and  pay  on  behalf  of  the  said  Tucson  Cattle 
Company  all  reasonable  expenses  incident  to  the  collection  of  said  amount,  includ- 
ing all  proper  costs  of  any  suit  or  other  legal  proceedings  necessary  thereto,  and 
generally  to  do  all  such  other  things  in  connection  therewith  as  may  be  necessary 
and  proper  in  the  premises. 

In  Witness  Whereof,  the  said  Tucson  Cattle  Company  has  caused  its 
corporate  name  to  be  signed  hereunto  by  its  President  and  its 
corporate  seal  to  be  affixed  and  attested  by  its  Secretary,  all  being 
done  in  the  City  of  Tucson,  Arizona,  on  this  the  2nd  day  of  March, 
1922. 

(  CORPORATE  \  TtrCSON   CaTTLE   COMPANY, 

\       SEAL       J  By  George  M.  Price, 

President 
Attest  seal: 

Wilson  M.  Burney,  ' 
Secretary 

The  foregoing  power  of  attorney  would  usually  be  ac- 
knowledged in  order  to  give  it  greater  weight  and  more  ready 
recognition. 

Form  239.    Power  of  Attorney — To  Deliver  Deed 

Power  of  Attorney 

Know  All  Men  by  These  Presents: 

That  the  Albany  Flouring  Mills,  a  corporation  duly  organized  under  the  laws 
of  the  State  of  New  York,  and  having  its  principal  office  and  place  of  business  in 
Albany,  New  York,  has  made,  constituted,  and  appointed  and  by  these  presents 
does  make,  constitute,  and  appoint,  George  H.  McCall  of  Philadelphia,  Pennsyl- 
vania, its  true  and  lawful  attorney,  for  it  and  in  its  name  and  stead,  to  deliver  to  the 


l6o8  CORPORATE  FORMS  [Bk.  IV- 

Adams  Foundation  Company  of  Philadelphia,  Pennsylvania,  a  certain  deed  duly 
executed  by  the  said  Albany  Flouring  Mills  and  transferring  to  the  said  Adams 
Foundation  Company  the  property  therein  described  at  Nos.  1534,  1536,  and  1538 
West  Side  Avenue,  Philadelphia,  and  to  receive  payment  for  the  property  trans- 
ferred by  said  deed;  and  the  said  George  H.  McCall  is  hereby  fully  authorized  and 
empowered  for  and  on  behalf  of  this  Company  to  make  good  and  valid  delivery  of 
the  said  deed  and  to  receive  from  the  said  Adams  Foundation  Company  the  sum  of 
Nineteen  Thousand,  Two  Hundred  and  Fifty  Dollars  ($19,250)  in  cash,  payment 
for  the  property  transferred  by  said  deed,  and  to  receipt  for  said  payment,  and  to 
do  all  such  other  things  as  may  be  necessary  and  proper  in  the  premises. 

In  Witness  Whereof,  the  said  Albany  Flouring  Mills  has  caused  its 

corporate  seal  to  be  affixed  hereunto  by  its  Secretary  and  its  name  to 

be  subscribed  hereto  by  its  President,  all  being  done  in  the  City  of 

Albany,  and  State  of  New  York,  on  this  first  day  of  February,  1922. 

f  CORPORATE  \  Albany  Flouring  Mills, 

\       seal       J  By  Jesse  H.  Blanchard, 

President 
Attest  seal: 

Julian  Hurndon, 

Secretary 

{A  cknowledgment) 


The  power  of  attorney  which  follows  authorizes  the  sale  of 
land  and  the  execution  and  delivery  of  the  deeds,  and  therefore 
requires  the  same  formal  execution  as  a  deed.  Without  this  it  is 
ineffective.  The  form  of  execution  must  comply  with  the  law 
of  the  state  in  which  the  land  is  located. 

Form  240.     Power  of  Attorney — To  Manage,  Sell,  and  Deed  Land 

Power  of  Attorney 


Know  All  Men  by  These  Presents  : 

That  the  Berwell  Investment  Company,  a  corporation  duly  organized  and 
existing  under  and  by  virtue  of  the  laws  of  the  State  of  New  York,  and  having  its 
office  and  principal  place  of  business  at  No.  30  Broad  Street,  in  the  City  of  New 
York,  has  made,  constituted,  and  appointed,  and  by  these  presents  does  make, 
constitute,  and  appoint,  Horace  M.  Maxwell  of  Houston,  Texas,  its  true  and 
lawful  attorney,  for  it  and  in  its  name,  place,  and  stead  to  bond,  grant,  bargain,  sell, 
contract,  lease,  exchange,  give  options  on,  sell  timber  from,  sell  or  lease  oil,  coal  or 
other  mineral  rights  in  or  on,  or  handle  or  dispose  of  in  such  other  way  as  may  by 
him  be  deemed  advantageous  and  advisable,  and  for  such  considerations  and  on 
such  terms  as  he  may  approve,  and  in  whole  or  in  part,  that  certain  tract  or  parcel 
of  land,  owned  by  said  Berwell  Investment  Company,  in  Brazos  County,  Texas, 
consisting  of  the  east  half  of  the  league  of  land  known  as  the  J.  J.  Oliver  League,  and 
containing  Two  Thousand  Two  Hundred  and  Fourteen  (2,214)  Acres,  more  or  less, 
said  land  being  part  of  the  Headright  granted  to  J.  J.  Oliver  by  the  Mexican 
Government  and  surveyed  by  the  County  Surveyor  in  1838,  and  conveyed  to  the 


Ch.  22]  POWERS  OF  ATTORNEY  1609 

Berwell  Investment  Company  by  deed  from  the  said  J.  J.  Oliver,  dated  July  i,  1856, 
and  recorded  in  the  office  of  the  County  Clerk  of  Brazos  County,  D.  B.  15,  page  225; 
and  the  said  Berwell  Investment  Company  grants  to  its  said  attorney  full  power 
and  authority  to  collect  and  receive  for  said  Company  all  rents,  royalties,  and  other 
considerations  or  payments  derived  from  the  said  property  in  any  way;  and  for  the 
said  Berwell  Investment  Company  and  in  its  name  and  stead,  either  alone  or 
jointly  with  others,  as  may  be  requisite  and  necessary,  to  make,  execute,  acknowl- 
edge, and  deliver  good  and  sufficient  deeds,  conveyances,  option  contracts  or  leases 
for  the  said  property,  or  for  any  parts  thereof,  or  for  any  rights  therein  or  thereon, 
giving  and  granting  its  said  attorney  full  power  and  authority  to  do  and  perform 
any  and  every  act  and  thing  whatsoever  requisite  and  necessary  to  be  done  in  the 
premises,  the  said  Company  hereby  ratifying  and  confirming  all  that  its  said 
attorney  shall  lawfully  do  or  cause  to  be  done  by  virtue  of  this  present  indenture. 
In  Witness  Whereof,  the  said  Berwell  Investment  Company  has  caused 
its  corporate  name  to  be  signed  by  its  President  and  its  corporate  seal 
to  be  affixed  by  its  Secretary,  all  being  done  in  the  City  of  New  York 
on  this  the  i8th  day  of  January,  1922. 

r  CORPORATE  \  RWELL  INVESTMENT  COMPANY, 

\       SEAL       /  By  James  Warren, 

President 
Attest  seal: 

Willis  Baker, 

Secretary 

(A  cknowledgment) 


This  instrument  is  sweeping,  giving  the  agent  practically 
every  power  over  the  lands  covered  by  the  power  of  attorney, 
that  the  company  has  itself.  The  acknowledgment  must  in  this 
case  follow  the  Texas  form. 

When  a  power  of  attorney  is  given  for  some  special  act,  it 
expires  automatically  as  soon  as  that  act  is  performed.  When, 
however,  it  is  desired  to  terminate  the  powers  prior  thereto,  or 
where  the  power  is  a  continuing  one,  a  formal  revocation  is 
necessary.  Notice  of  this  revocation  should  be  sent  to  the  parties 
directly  interested,  and,  in  case  of  a  general  power  of  attorney, 
should  also  be  published. 

Form  241.    Revocation  of  Power  of  Attorney 

Know  All  Men  by  These  Presents  : 

That  the  Berwell  Investment  Company,  a  corporation  duly  organized  and 
existing  under  and  by  virtue  of  the  laws  of  the  State  of  New  York,  and  having  its 


l6io  CORPORATE  FORMS  Bk.  IV- 

office  and  principal  place  of  business  at  No.  30  Broad  Street  in  the  City  of  New 
York,  has  for  good  cause  and  consideration  revoked,  recalled,  annulled,  and  made 
void,  and  by  these  presents  does  revoke,  recall,  annul,  and  make  void  a  certain 
power  of  attorney  given  under  the  corporate  signature  and  seal  on  the  i8th  day  of 
January-,  1922,  to  Horace  M.  Maxwell  of  Houston,  Texas,  and  authorizing  and 
empowering  him  to  handle  for  and  in  behalf  of  this  Company  the  east  half  of  the 
league  of  land  in  Brazos  County,  Texas,  known  as  the  J.  J.  Oliver  League,  and 
the  said  Berwell  Investment  Company  does  hereby  withdraw,  deny,  and  cancel  any 
and  all  powers  and  authorities  whatsoever  therein  expressed  and  conveyed. 

In  Witness  Whereof,  the  said  Berwell  Investment  Company  has  caused 
its  corporate  signature  and  seal  to  be  hereunto  affixed  by  its  President 
and  Secretary  in  the  City  of  New  York  on  this  29th  day  of  March, 
1922. 

f  CORPORATE  \  Berwell  Investment  Company, 

\       SEAL       /  By  James  Warren, 

President 
Willis  Baker, 

Secretary 


Corporate  Contracts  and  Assignments 

Corporate  contracts  differ  in  nowise  from  contracts  between 
individuals,  save  in  the  verbiage  necessary  to  adapt  them  to  the 
corporate  form.  The  forms  which  follow  are  included  to  illus- 
trate this  adaptation. 


Form  242.     Corporate  Contract 


Contract 


An  Agreement,  made  and  entered  into  this  25th  day  of  June,  A.  D.  1922, 
by  and  between  the  Atlas  Lithographing  Company,  a  corporation  duly  organized 
under  the  laws  of  the  State  of  Maine  and  having  its  usual  place  of  business  in 
Boston,  Massachusetts,  party  of  the  first  part,  and  the  Selby  Lithographing  Com- 
pany, a  corporation  organized  under  the  laws  of  the  State  of  New  York,  and  having 
its  principal  office  and  place  of  business  at  No.  265  Center  Street,  in  the  City  of 
New  York,  party  of  the  second  part. 

For  and  in  consideration  of  the  sum  of  One  Dollar  and  of  other  valuable  con- 
siderations passing  between  the  parties  hereto,  the  receipt  whereof  is  hereby 
respectively  acknowledged,  it  is  agreed  as  follows: 

I.  That  the  said  party  of  the  first  part  shall  employ  one  John  H.  Bernard  of 
Boston,  Massachusetts,  for  account  of  both  the  parties  hereunto,  to  work  upwn  and 
perfect  as  far  as  may  be,  a  certain  improvement  in  lithography  known  as  the  "Silver 
Plate  Process,"  said  process  being  now  the  joint  property  of  the  said  parties  to  this 
present  agreement. 


Ch.  22]  CORPORATE  CONTRACTS  AND  ASSIGNMENTS  161 1 

2.  That  said  party  of  the  first  part  shall  pay  the  said  John  H.  Bernard  a  salary 
not  exceeding  Three  Hundred  Dollars  ($300)  a  month,  and  shall  also  furnish  such 
materials,  supplies,  and  assistance  as  the  said  John  H.  Bernard  may  reasonably 
require  in  the  progress  of  his  work. 

3.  That  at  the  end  of  each  quarter  said  party  of  the  first  part  shall  render  a 
statement  of  the  expenses  incurred  by  reason  of  the  employment  of  the  said  John 
H.  Bernard  for  the  perfection  of  the  said  Silver  Plate  Process,  and  said  party  of  the 
second  part  shall  within  ten  days  of  the  receipt  of  said  statement  remit  one-half 
thereof  to  the  said  party  of  the  first  part. 

4.  That  all  improvements  in  said  Silver  Plate  Process  or  in  connection  there- 
with that  may  be  made  or  discovered  by  the  said  John  H.  Bernard,  shall  be  the 
joint  and  equal  property  of  the  two  parties  to  this  present  agreement,  and  patents 
therefor  shall  be  taken  out  in  the  names  of  the  said  parties  of  this  present  agreement 
and  at  their  joint  expense. 

5.  That  said  employment  of  said  John  H.  Bernard  shall  continue  for  one  year 
from  date,  unless  sooner  terminated  by  mutual  agreement  or  by  circumstances 
beyond  the  control  of  the  parties  hereto. 

In  Witness  Whereof,  the  said  parties  of  the  first  and  second  parts  have 
caused  their  respective  corporate  signatures  and  seals  to  be  hereunto 
affixed  by  their  duly  authorized  officers,  all  being  done  in  the  City, 
County,  and  State  of  New  York  on  the  day  and  year  first  above 
written. 

Atlas  Lithographing  Company, 
/  corporate  1  By  Howard  Brevoort, 

\       SEAL       j  President 

Attest  seal: 

Willis  Johnson, 
Secretary 

Selby  Lithographing  Company, 
/  corporate  \  By  John  H.^aswell, 

\       seal       j  •  Vice-President 

Attest  seal: 

Frank  H.  Parsons, 
Secretary 


This  agreement  might  or  might  not  be  acknowledged,  at  the 
discretion  of  the  parties.  The  contract  as  executed  is  legally 
sufficient.  The  only  advantage  to  be 'gained  by  an  acknowledg- 
ment is  the  greater  ease  of  proving  the  authenticity  and  due 
execution  of  the  instrument  in  case  of  litigation. 


Form  243.     Corporate  Bill  of  Sale 


Bill  of  Sale 

Know  All  Men  by  These  Presents: 

That  the  Standard  Laundry  Machine  Company,  a  corporation  duly  organized 
under  the  laws  of  the  State  of  New  York,  with  its  principal  office  and  place  of 


l6l2  CORPORATE  FORMS  [Bk.  IV- 

i 

business  at  No.  50  Dey  St.,  in  the  City  of  New  York,  in  consideration  of  the  sum  o 
One  Thousand  Dollars  ($1,000)  to  it  paid  by  the  Barton  Laundry  Company  of 
No.  71  East  2ist  Street,  New  York  City,  the  receipt  whereof  is  hereby  acknowl- 
edged, does  hereby  sell,  transfer,  and  assign  to  the  said  Barton  Laundry  Company 
the  following  goods  and  chattels,  viz. : 

All  of  the  laundry  machinery,  tools,  and  apparatus  of  every  kind  now  in  the 
premises  at  No.  365  West  19th  St.,  formerly  occupied  by  the  Union  Laundry 
Company,  all  as  set  forth  and  specified  in  the  annexed  schedule;  to  have  and  to  holy 
all  and  singular  the  said  goods  and  chattels  to  the  said  Barton  Laundry  Compand, 
its  successors  and  assigns  to  their  own  use  and  behoof  forever,  and  the  said  Standard 
Laundry  Machine  Company  does  hereby  covenant  with  the  said  grantee  that  the 
said  Standard  Laundry  Machine  Company  is  the  lawful  owner  of  said  goods  and 
chattels;  that  they  are  free  from  all  liens;  that  it  has  good  right  to  sell  the  same  as 
aforesaid;  and  that  it  will  warrant  and  defend  the  same  against  the  lawful  claims 
and  demands  of  all  persons. 

In  Witness  Whereof,  the  said  Standard  Laundry  Machine  Company 
has  caused  its  corporate  name  to  be  signed  hereunto  by  its  President, 
and  its  corporate  seal  to  be  affixed  and  duly  attested  by  its  Secretary, 
said  corporate  seal  being  affixed  both  to  these  presents  and  to  the 
schedule  hereunto  annexed,  all  being  done  in  the  City  of  New  York, 
on  this  loth  day  of  May,  1922. 

(Signature  and  attested  seal.) 


The  inventory  or  schedule  of  the  goods  conveyed  by  this  bill 
of  sale  should  be  attached  to  it,  and,  in  accordance  with  the 
provisions  of  the  conveyance,  be  identified  by  the  duly  attested 
seal  of  the  company. 

Form  244.    Assignment  of  Contract 

Assignment 


Know  All  Men  by  These  Presents: 

That  for  and  in  consideration  of  the  payment  by  the  Connecticut  Valley  Paper 
Mills,  a  corporation  organized  under  the  laws  of  the  State  of  Connecticut  and  having 
its  principal  office  and  place  of  business  at  525  Main  Street,  New  Haven,  Connec- 
ticut, of  Twenty-five  Thousand,  Seven  Hundred  and  Forty-Five  Dollars  ($25,745) 
to  the  Holden  Chemical  Company,  a  corporation  duly  organized  under  the  laws  of 
the  State  of  New  York,  and  having  its  principal  office  and  place  of  business  at  152 
Warren  Street,  New  York  City,  the  receipt  of  v\'hich  payment  is  by  the  last-named 
corporation  hereby  acknowledged,  said  Holden  Chemical  Company  does  hereby 
assign,  transfer,  and  convey  to  the  said  Connecticut  Valley  Paper  Mills,  all  and 
singular,  its  right,  title,  and  interest  of  every  kind  in  and  to  a  certain  contract  (copy 
of  which  is  hereunto  annexed  and  made  part  of  this  present  instrument)  entered 
into  on  the  31st  day  of  July,  1921,  between  Martin  S.  Coleman  of  Brooklyn,  New 
York,  and  the  said  Holden  Chemical  Company,  said  contract  vesting  in  the  said 
last-named  company,  its  successors  and  assigns,  under  the  conditions  set  forth  in 
said  contract,  the  exclusive  right  to  acquire  and  use  all  the  inventions  and  processes 


Ch.  22j         CORPORATE  CONTRACTS  AND  ASSIGNMENTS  1613 

that  may  hereafter  be  made,  discovered,  or  devised  by  the  said  Coleman  for  the 
manufacture  of  paper  or  to  be  used  in  connection  therewith,  said  contract  being 
conveyed  to  and  accepted  by  the  said  Connecticut  Valley  Paper  Mills  with  all  its 
rights,  privileges,  and  obligations  as  herein  set  forth  and  as  hereunto  held  by  the 
said  Holden  Chemical  Company. 

In  Witness  Whereof,  the  said  Holden  Chemical  Company  has  hereunto 
caused  its  corporate  name  and  seal  to  be  affixed  by  its  President  and 
Secretary,  all  being  done  in  the  City,  County,  and  State  of  New  York, 
on  this  28th  day  of  January,  1922. 
f  CORPORATE  1  Holden  Chemical  Company, 

I       SEAL       /  By  James  Holden, 

President 
Harold  Sheldon, 

Secretary 


Acknowledgment  is  not  essential  to  this  assignment  but  is 
advisable.  The  instrument  as  given  does  not  relieve  the  assign- 
ing company  from  liability  under  the  assigned  contract.  To 
secure  this,  a  specific  release  from  the  other  party  to  the  assigned 
contract  is  essential.  A  simple  form  of  such  release  to  follow,  or 
be  attached  to,  the  assignment  is  as  follows: 

Form  245.    Assent  to  Assignment  of  Contract 


I,  Martin  S.  Coleman  of  Brooklyn,  New  York,  party  of  the  first  part  to  a 
certain  contract  entered  into  on  the  31st  day  of  July,  1921,  with  the  Holden 
Chemical  Company  of  New  York  City,  do  for  good  and  valuable  considerations,  the 
receipt  of  which  is  hereby  acknowledged,  consent  and  agree  to  the  transfer  of  said 
contract  to  the  Connecticut  Valley  Paper  Mills  as  set  forth  in  the  foregoing  assign- 
ment, and  to  the  substitution  of  the  said  Connecticut  Valley  Paper  Mills  for  the 
Holden  Chemical  Company  in  said  contract,  and  do  hereby  release,  relieve,  and 
discharge  the  said  Holden  Chemical  Company  from  any  claim,  liability,  or  other 
obligation  for,  on  account  of,  or  by  reason  of  said  contract. 

Witness  my  hand  and  seal  this  28th  day  of  January,  1922. 

Martin  S.  Coleman        [l.  s  ] 


The  assignment  of  contract  which  follows  is  informal  but 
sufficient  where  the  whole  transaction  is  well  understood.  In 
practice  it  is  usually  indorsed  on  the  back  of  the  contract  to  be 
assigned,  or,  with  the  word  "within"  changed  to  "above  and 
foregoing,"  is  placed  on  the  last  page  of  the  contract. 


l6l4  CORPORATE  FORMS  [Bk.  IV- 

Form  246.    Assignment  of  Contract — By  Indorsement 

For  and  in  consideration  of  One  Dollar  and  of  other  sufficient  considerations, 
the  receipt  of  all  which  is  hereby  acknowledged,  the  Sterling  Power  Company  does 
hereby  sell,  assign,  and  transfer  to  the  Cohoes  Light  and  Power  Company  the 
within  contract  with  all  the  rights,  privileges,  obligations,  and  undertakings  thereof 
as  therein  set  forth. 

In  Witness  Whereof,  the  signature  and  the  attested  seal  of  the  said 
Sterling  Power  Company  are  hereunto  affixed  by  its  duly  authorized 
officers  this  i6th  day  of  May,  1922. 
f  CORPORATE  \  Sterling  Power  Company, 

\       SEAL       /  By  Miller  Sterling, 

President 
Attest  seal: 

Henry  Welling, 
Secretary 

The  patent  assignment  which  follows  is  in  general  accord  with 
the  forms  approved  by  the  Patent  Office. 

Form  247.    Assignment  of  Patent — Individual  to  Corporation 

Assignment  of  Patent 


Whereas,  I,  Alan  Hudson,  of  Newburgh,  County  of  Orange,  State  of  New 
York,  did  obtain  letters  patent  of  the  United  States  for  an  improvement  in  Car 
Couplings,  which  letters  patent  are  numbered  605,948,  and  bear  date  the  6th  day 
of  November  in  the  year  192 1;  and 

Whereas,  I  am  now  the  sole  owner  of  said  patent,  and  of  all  rights  under  the 
same;  and 

Whereas,  The  Montauk  Car  Coupler  Company,  a  corporation  duly  organized 
under  the  laws  of  the  State  of  New  Jersey,  and  having  its  principal  office  and  place 
of  business  at  No.  15  Exchange  Place,  Jersey  City,  New  Jersey,  is  desirous  of 
acquiring  the  entire  interest  in  the  same  together  with  all  claims  for  profits  and 
damages  arising  from  past  infringements  thereof,  and  the  right  to  sue  for  and  recover 
in  its  own  name  on  all  claims  for  such  infringements : 

Now,  Therefore,  To  all  whom  it  may  concern,  be  it  known,  that  for  and  in 
consideration  of  the  issue  to  my  order  by  the  said  Montauk  Car  Coupler  Company 
of  its  entire  capital  stock,  excepting  Ten  (10)  Shares  heretofore  issued  to  the 
incorporators  of  said  Company,  the  receipt  of  which  aforesaid  stock,  of  the  face 
value  of  Ninety-nine  Thousand  Dollars  ($99,000),  is  hereby  acknowledged,  I,  the 
said  Alan  Hudson,  have  sold,  assigned,  and  transferred,  and  by  these  presents  do 
sell,  assign,  and  transfer,  unto  the  said  Montauk  Car  Coupler  Company,  the  whole 
right,  title,  and  interest  for  the  United  States,  its  colonies,  and  dependencies,  in 
and  to  the  said  improvement  in  car  couplings,  and  in  and  to  the  letters  patent 
therefor  aforesaid;  and  to  the  inventions  covered  thereby,  together  with  all  claims 
for  profits  and  damages  arising  from  past  infringements  of  the  said  letters  patent, 
and  the  right  to  sue  and  recover,  in  its  own  name,  on  all  claims  for  such  infringe- 
ments; said  letters  patent  and  all  the  connected  rights  as  herein  set  forth  to  be  held 


Ch.  22]  CORPORATE  CONTRACTS  AND  ASSIGNMENTS  1615 

and  enjoyed  by  the  said  Montauk  Car  Coupling  Company  for  its  own  use  and 
behoof,  and  for  the  uses  and  behoof  of  its  legal  representatives,  successors,  and 
assigns,  to  the  end  of  the  term  for  which  said  letters  patent  are  or  may  be  granted, 
as  fully  and  entirely  as  the  same  would  have  been  held  and  enjoyed  by  me  had 
this  assignment  and  sale  not  been  made. 

In  Testimony  Whereof,  I  have  hereunto  set  my  hand  and  afl&xed  my 
seal  at  Newburgh,  County  of  Orange,  State  of  New  York,  this  4th 
day  of  May,  1922. 

Alan  Hxidson  Tl.  s.] 

In  presence  of: 
Jacob  Ellis 
Hendrick  N.  Enslow 


An  assignment  of  patent  does  not,  under  the  rules  of  the 
Patent  Office,  require  notarial  acknowledgment,  but  as  an 
acknowledgment,  as  already  stated,  is  prima  facie  evidence  of  the 
due  execution  of  the  instrument,  it  is  usually  affixed. 


CHAPTER  XXIII 

BONDS  OF  INDEMNITY 

The  treasurer's  bond  is  the  formal  undertaking  of  parties 
named  therein  and  by  whom  the  bond  is  signed,  that  in  event 
of  loss  arising  from  specified  acts,  failures,  or  omissions  on  the 
part  of  the  treasurer,  they  will  make  good  the  loss  up  to  the 
amount  of  the  bond.  Formerly  bonds  of  this  nature  were  almost 
invariably  signed  by  the  treasurer  and  his  friends.  Of  recent 
years,  however,  surety  company  bonds  have  largely  superseded 
these  personal  bonds. 

The  following  is  a  common  form  of  treasurer's  personal  bond. 

Form  248.     Treasurer's  Bond — Personal 

Treasurer's  Bond 


Know  All  Men  by  These  Presents: 

That  we,  Robert  A.  Bruce  of  New  York  City,  as  principal,  and  William  H. 
Cain  of  Newark,  New  Jersey,  and  H.  B.  McMillan  of  Brooklyn,  New  York,  as 
sureties,  are  held  and  firmly  bound  unto  the  Sterling  Transportation  Company,  a 
corporation  duly  organized  under  the  laws  of  the  State  of  New  York,  in  the  sum 
of  Ten  Thousand  Dollars  ($10,000),  to  the  payment  of  which  to  the  said  corpora- 
tion, its  successors,  or  assigns,  we  do  by  these  presents  jointly  and  severally  bind 
ourselves,  our  heirs,  executors,  and  administrators. 

Signed  and  sealed  this  isth  day  of  March,  1922. 

The  condition  of  the  above  obligation  is  that: 

Whereas,  The  said  Robert  A.  Bruce  has  been  elected  Treasurer  of  the  said 
Sterling  Transportation  Company  for  the  period  of  one  year  from  the  loth  day  of 
March,  1922,  and  may  hereafter  be  re-elected  to  or  continue  in  such  office  for  a 
further  period : 

Now,  Therefore,  If  the  said  Robert  A.  Bruce  shall  hereafter  in  all  respects 
fully,  faithfully,  and  honestly  perform  and  discharge  the  duties  of  said  office  so 
long  as  he  shaU  continue  therein,  both  during  the  term  for  which  he  has  been  elected 
and  during  such  further  time  as  he  may  continue  therein,  whether  by  re-election 
or  otherwise,  and  shall  when  properly  so  required,  fully  and  faithfully  account 
to  the  said  corporation,  its  successors,  or  assigns,  for  all  moneys,  goods,  and  prop- 
erties whatsoever,  for  or  with  which  the  said  Robert  A.  Bruce  may  in  anywise  be 
accountable  or  beholden  to  the  said  corporation,  and  if  at  the  expiration  of  his 

1616 


Ch.  23]  BONDS  OF  INDEMNITY  1617 

term  of  oifice,  or  prior  thereto  in  the  event  of  his  death,  resignation,  or  removal 
from  office,  all  books,  papers,  vouchers,  money,  and  other  property  of  whatever 
kind  placed  in  his  custody  as  Treasurer  of  said  corporation,  shall  be  forthwith 
restored  to  the  said  corporation,  its  successors,  or  assigns,  then  this  obligation  shall 
be  void,  but  otherwise  to  remain  in  full  force  and  effect. 


Robert  A.  Bruce 

L.  s. 

William  H.  Cain 

L.  S. 

H.  B.  McMillan 

L.  S. 

Signed,  sealed  and  delivered 

in  the  presence  of: 

John  J.  Barr 

W.  H.  Carpenter 

The  treasurer's  bond  must  be  given  under  seal,  and,  while 
not  legally  necessary,  personal  bonds  are  usually  acknowledged. 

Personal  bonds  are,  as  a  rule,  sweeping  in  their  nature,  cover- 
ing any  and  all  losses  arising  through  any  errors,  misdeeds,  or 
omissions  of  the  treasurer.  When,  however,  a  surety  company 
enters  the  bonding  field,  the  guaranties  are  reduced  to  the  lowest 
possible  terms — usually  to  losses  arising  through  the  personal 
dishonesty  of  the  employee  amounting  to  ''larceny  or  embezzle- 
ment." The  forms  for  these  bonds  are  furnished  by  the  surety 
companies  and  vary  according  to  the  company  and  the  condi- 
tions. The  general  form  employed  is  too  lengthy  for  reproduc- 
tion in  the  present  volume. 

When  a  stock  certificate  is  lost  or  diestroyed,  a  bond  of  in- 
demnity is  usually  required  before  the  corporate  authorities  will 
undertake  to  replace  the  lost  stock  certificate.^ 

Form  249.    Indemnity  Bond  for  Lost  Stock  Certificate 

Indemnity  Bond 


Know  All  Men  by  These  Presents: 

That  we,  John  R.  McAllister  of  Yonkers,  New  York,  as  principal,  and  Charles 
Foster  and  Henry  H.  Clark,  both  also  of  Yonkers,  New  York,  as  sureties,  are  held 
and  firmly  bound  unto  the  Sterling  Transportation  Company,  a  corporation  duly 
organized  under  the  laws  of  the  State  of  New  York,  in  the  sum  of  Five  Thousand 


>  See  Book  I,  |  265,  for  discussion  of  lost  stock  certificates. 


i6i8 


CORPORATE  FORMS 


[Bk.  IV- 


DoUars  ($5,cx3o),  to  the  payment  of  which  to  the  said  corporation,  its  successors 
or  assigns,  we  do  by  these  presents  jointly  and  severally  bind  ourselves,  our  heirs, 
executors  and  administrators. 

Signed  and  sealed  this  i8th  day  of  May,  1922. 

The  condition  of  the  foregoing  obligation  is  that : 

Whereas,  The  said  John  R.  McAllister  is  the  owner  of  record,  as  shown  by 
the  stock  book  of  the  corporation,  of  Forty  (40)  Shares  of  the  Common  Capital 
Stock  of  the  said  Sterling  Transportation  Company,  each  of  the  par  value  of  One 
Hundred  Dollars  ($100),  the  ownership  of  said  stock  being  further  evidenced  by 
Certificate  No.  375  issued  in  the  name  of  the  said  John  R.  McAllister  on  the  15th 
day  of  August,  192 1;  and 

Whereas,  The  said  John  R.  McAllister  has  made  application  to  the  Board 
of  Directors  of  the  Sterling  Transportation  Company  for  the  issue  in  his  name  of  a 
new  certificate  for  the  said  Forty  (40)  Shares  of  stock  of  the  said  Company,  alleging 
that  original  Certificate  No.  375  is  lost,  stolen,  or  destroyed  and  that  its  present 
whereabouts  and  condition  are  unknown  to  him;  and 

Whereas,  By  due  and  formal  resolution  of  the  said  Board  of  Directors,  said 
application  has  been  granted  and  a  new  certificate  for  said  Forty  (40)  Shares  of  the 
stock  of  the  said  Sterling  Transportation  Company  has  this  day  been  issued  to  the 
said  John  R.  McAllister: 

Now,  Therefore,  If  the  said  John  R.  McAllister,  his  heirs,  executors,  and 
administrators,  or  any  of  them,  do  and  shall  at  all  times  hereafter,  save,  defend, 
and  indemnify  the  said  Sterling  Transportation  Company,  its  legal  successors  or 
assigns,  of,  from  and  against  all  demands,  claims,  or  causes  of  action  arising  from  or 
on  account  of  the  loss  of  said  Certificate  No.  375  for  Forty  (40)  Shares  of  the  Com- 
mon Capital  Stock  of  said  Company  and  the  issue  of  said  new  certificate  in  place 
thereof,  and  of,  and  from,  all  costs,  damages,  and  expenses  that  shall  or  may  arise 
because  of  said  reissue,  and  shall  also  deliver  or  cause  to  be  delivered  up  to  the  said 
Sterling  Transportation  Company  for  cancellation  the  said  missing  Certificate 
No.  375  whenever  and  so  soon  as  the  same  shall  be  found  or  recovered,  or  corre 
into  his  jX)ssession,  then  this  obligation  shall  be  void;  otherwise  to  remain  in  full 
force  and  effect. 


Signed,  sealed  and  delivered 
in  the  presence  of: 
Daniel  T.  Baird 
John  K. Stone 


John  R.  McAllister    [l.  s. 
Charles  Foster  [l.  s. 

Henry  H.  Clark  [l.  s. 


Part  IV — Forms  Relating  to  Bond  Issues 


CHAPTER  XXIV 

BOND  ISSUES— THE  BOND 

The  formalities  of  a  bond  issue  are  usually  regulated  by  the 
statutes  of  the  particular  state  in  which  the  corporation  is  organ- 
ized. Thus  in  New  York  an  issue  of  bonds  requires  (i)  a  stock- 
holders' resolution  or  written  consent;  (2)  a  certificate  of  the 
corporate  officials  that  the  stockholders'  consent  has  been  given ; 
and  (3)  a  directors'  resolution  reciting  the  facts,  authorizing  the 
officers  to  proceed  in  the  matter,  and  providing  for  the  details 
of  the  transaction.  The  matter  is  one  to  be  undertaken  only  by 
a  skilled  lawyer. 

In  some  states  the  mere  resolution  of  the  board  of  directors 
is  sufficient  to  authorize  a  bond  issue.  In  a  large  number  of 
states  the  assent  of  a  prescribed  majority  of  the  stockholders  is 
a  requisite.  As  a  matter  of  prudence  and  good  business,  a  proper 
stockholders'  authorization  is  always  desirable  regardless  of  the 
statutory  requirements  existing  in  the  particular  state. 

The  more  important  instruments  involved  in  an  issue  of 
corporate  bonds  are  the  bond  itself,  which  is  comparatively 
simple  in  form,  and  the  mortgage  or  deed  of  trust,  which  is 
lengthy  and  complex. 

The  corporate  bond  in  its  usual  form  is  a  promissory  note, 
differing  from  the  ordinary  corporate  note  only  in  its  formality, 
its  more  complete  statement  of  the  conditions  under  which  it 
is  issued,  its  formal  execution,  and  in  its  being  one  of  a  series  of 
like  obligations  equally  secured  by  the  same  collateral  or,  if 
unsecured,  of  the  same  rank. 

1619 


l620  CORPORATE  FORMS  [Bk.  IV- 

There  is  practically  no  difference  as  to  form  between  a  bond 
and  the  short-term  note  so  frequently  issued  by  corporations  of 
the  present  day,  save  as  to  the  length  of  time  for  which  the  obliga- 
tion runs.  The  short-term  note,  as  its  name  indicates,  is  usually 
given  for  a  short  period — one  to  five  years — while  the  bond 
usually  extends  over  a  much  longer  period,  ranging  from  five  to 
one  hundred  years  or  more. 

Interest  on  bonds  is  usually  represented  and  provided  for 
by  means  of  coupons,  which  are  in  effect  also  promissory  notes, 
payable  to  bearer,  each  calling  for  the  payment  of  one  instal- 
ment of  interest  on  the  bonds.  This  interest  when  due  is  pay- 
able only  on  surrender  of  the  proper  coupon  and,  in  the  absence 
of  some  good  reason  otherwise,  such  as  notice  that  the  particular 
coupon  has  been  stolen,  is  payable  to  anyone  who  presents  the 
coupon. 

Interest  on  bonds  is  usually  payable  semiannually  and  each 
of  the  coupons  of  a  coupon  bond  calls  for  the  exact  amount  of  one 
of  the  semiannual  interest  payments  on  that  bond.  Thus,  a 
bond  running  ten  years  with  interest  payable  semiannually, 
will  have  attached  to  it  twenty  coupons.  Each  coupon  bears 
the  same  number  as  its  bond  for  purposes  of  general  identifica- 
tion, but  also  has  a  serial  number  and  date  or  some  other  specific 
statement  indicating  the  order  in  which  it  comes  due  and  the 
particular  interest  payment  for  which  it  calls. 

Coupon  bonds  are  usually  made  payable  to  bearer,  and  owner- 
ship passes  by  delivery.  When  it  is  desired  that  bonds  shall  not 
pass  by  mere  delivery,  they  are  registered,  i.e.,  issued  in  the 
name  of  some  particular  person  as  is  a  certificate  of  stock,  the 
bond  thereafter  transferable  only  on  the  books  of  the  company. 

Coupon  bonds  are  sometimes  registered  as  to  principal,  but 
the  coupons  are  still  made  payable  to  bearer.  The  interest  then 
is  paid  to  anyone  who  presents  the  coupon,  but  the  principal 
when  due  is  paid  only  to  the  person  in  whose  name  the  bond 
stands  on  the  books  of  the  company. 

Bonds  without  coupons  are  always  registered,  and  are  trans- 


Ch.  24]  BOND  ISSUES— THE  BOND  16 2 1 

ferred  only  by  assignment;  interest  is  payable  to  the  registered 
owner  alone,  and  is  usually  paid  by  check  sent  out  to  these 
registered  owners. 

Coupon  bonds  payable  to  bearer  and  registered  bonds  with- 
out coupons  are  often  issued  under  the  same  deed  of  trust. 
Usually  when  this  is  done,  the  two  classes  of  bonds  are  made 
interchangeable,  i.e.,  the  holder  of  a  coupon  bondmay  atanytime 
exchange  it  for  a  registered  bond,  or  vice  versa.  The  advantage 
of  the  unregistered  coupon  bond  is  found  in  the  readiness  with 
which  it  may  be  transferred.  The  advantage  of  a  registered 
bond  lies  in  the  difficulty  of  its  negotiation  in  case  the  bond  is 
lost  or  stolen. 

The  bond  register  is  a  book  of  record  in  which  are  entered 
the  data  relating  to  bond  issues,  showing  for  each  bond,  its 
number,  date,  names  of  the  parties  to  whom  issued,  any  transfers, 
and  the  due  dates  and  amounts  of  interest  payments.  The 
coupon  register  is,  as  its  name  indicates,  a  book  in  which  coupons, 
clipped  and  presented  for  payment,  are,  after  cancellation, 
pasted  in  convenient  form  for  subsequent  reference. 

The  following  form  is  that  of  a  coupon  bond,  the  ownership 
passing  by  mere  delivery.  It  may,  however,  be  registered  at  the 
option  of  the  owner,  though  this  registration  does  not  affect 
the  coupons.  These  pass  by  delivery  alone  and  are  payable  to 
bearer  regardless  of  whether  the  bond  be  registered  or  transfer- 1 
able  by  delivery. 

Form  250.    Coupon  Bond  1 


United  States  of  America 

State  of  New  York 

No.  375  $500.00 ' 

MAXWELL  COMPRESSOR  COMPANY 

First  Mortgage  Seven  Per  Cent  Gold  Bonds 


Know  All  Men  by  These  Presents,  That  the  Maxwell  Compressor  Com- 
pany, a  corporation  organized  under  the  laws  of  the  State  of  New  York,  for  value 
received,  hereby  promises  to  pay  to  the  bearer  hereof,  or  if  this  bond  is  registered, 


l622  CORPORATE  FORMS  [Bk.  IV- 

to  the  registered  holder  thereof,  at  the  office  of  the  Securities  Trust  Company  of  the 
City  of  New  York,  on  the  first  day  of  December,  nineteen  hundred  and  fifty-one,  in 
gold  coin  of  the  United  States  of  America,  of  the  present  standard  of  weight  and 
fineness,  or  its  equivalent,  the  sum  of  Five  Hundred  Dollars,  without  deduction 
from  either  such  principal  or  interest  for  or  on  account  of  any  United  States,  State, 
municipal,  or  other  tax  or  taxes  which  the  Maxwell  Compressor  Company,  its 
successors  or  assigns,  may  be  required  to  pay  or  deduct  therefrom,  and  the  Maxwell 
Compressor  Company  hereby  covenants  and  agrees  to  pay  all  such  tax  or  taxes, 
and  m  the  meantime  to  pay  interest  upon  the  said  sum  of  Five  Hundred  DoUars 
from  and  after  the  first  day  of  December,  nineteen  hundred  and  twenty-one,  at 
the  rate  of  Seven  Per  Cent  per  annum,  payable  in  like  gold  coin,  or  its  equivalent, 
at  the  same  place,  semiannually,  on  the  first  days  of  June  and  December  in  each 
year,  beginning  with  the  first  day  of  June,  1922,  on  presentation  and  surrender,  of 
the  coupons  hereto  attached  as  each  of  them  becomes  due. 

This  bond  is  one  of  a  series  of  One  Thousand  (1,000)  bonds  of  the  same  tenor 
and  date,  aggregating  Five  Hundred  Thousand  Dollars  ($500,000),  numbered 
consecutively  from  one  to  one  thousand,  both  inclusive,  for  the  sum  of  Five  Hun- 
dred Dollars  ($500)  each,  all  of  which  bonds  are  secured  equally  by  a  deed  of  trust, 
which  is  a  first  mortgage  upon  the  properties  of  the  Maxwell  Compressor  Com- 
pany, executed  and  delivered  by  the  said  Maxwell  Compressor  Company  to  the 
said  Securities  Trust  Company,  as  Trustee,  granting  and  conveying  in  trust  and 
mortgaging  as  security  for  the  payment  of  the  principal  of  said  bonds  at  maturity, 
at  par,  and  the  interest  on  said  bonds,  payable  semiannually  at  the  rate  aforesaid, 
all  the  real  estate  and  other  property  of  the  said  Maxwell  Compressor  Company 
mentioned  and  described  in  said  deed  of  trust,  with  full  power  to  use  and  sell  the 
same  in  the  event  of  default  in  payment  of  the  bonds  or  coupons,  or  any  of  them,  and 
apply  the  proceeds  to  the  payment  of  same  as  in  said  deed  of  trust  provided.  This 
bond  is  issued,  received,  and  held  subject  to  all  and  singular  the  terms  and  condi- 
tions contained  in  the  deed  of  trust  aforesaid. 

This  bond  is  further  secured  by  a  sinking  fund,  which  shall  consist  of  and  be 
maintained  by  the  payment  to  the  said  Securities  Trust  Company  by  the  Maxwell 
Compressor  Company  on  the  first  day  of  December,  1926,  and  on  each  succeeding 
first  day  of  December  thereafter,  until  the  redemption  of  all  the  bonds  issued  under 
said  deed  of  trust,  of  Twenty-Five  Dollars  for  each  Thousand  Dollars  of  bonds 
then  issued  and  outstanding,  such  moneys  so  paid  to  be  used  in  the  purchase  of 
outstanding  bonds  at  the  lowest  price  at  which  they  may  be  had,  not  exceeding, 
however.  One  Hundred  and  Ten  Per  Centum  of  the  face  of  said  bonds  plus  accrued 
interest,  and  if  bonds  cannot  be  so  purchased,  such  moneys  shall  be  used  in  the 
redemption  of  the  bonds  outstanding,  as  hereinafter  provided. 

This  bond  shall  not  become  obligatory  until  the  certificate  indorsed  hereon  shall 
be  signed  by  the  Trustee,  and  when  so  authenticated  by  the  signature  of  the  trustee, 
the  title  to  said  bond  shall  pass  by  delivery,  unless  said  bond  is  registered,  arid,  if 
registered,  the  title  thereto  shall  pass  only  by  transfer  on  the  books  of  said  Trust 
Company,  and  no  transfer  except  upon  said  books  shall  be  valid  unless  the  last 
transfer  shall  have  been  to  bearer,  which  shall  restore  transferability  by  delivery. 

This  bond  is  redeemable,  at  the  option  of  the  Maxwell  Compressor  Company, 
on  any  interest  day  at  any  time  after  the  first  day  of  December,  1926,  at  One  Hun- 
dred and  Ten  Per  Cent  of  its  face  value,  plus  accrued  interest,  provided  that  thirty 
days'  notice  of  such  redemption  shall  be  given  the  holder  thereof  by  notice  pub- 
lished once  a  week  for  four  consecutive  weeks  prior  to  such  redemption,  in  a  news- 
paper published  in  New  York  City. 

In  Witness  Whereof,  the  said  Maxwell  Compressoi  Company  hath 
caused  these  presents  to  be  signed  by  its  President,  and  its  corporate 
seal,  duly  attested  by  its  Secretary,  to  be  hereunto  affixed,  and  hath 
.l^ereunto  affixed  coupons  with  the  name  of  its  Treasurer  engraved 


Ch.  24]  BOND  ISSUES— THE  BOND  1623 

thereon,  and  hath  caused  this  bond  to  be  dated  the  first  day  of 
December,  A.  D.,  one  thousand,  nine  hundred  and  twenty-one. 
[corporateI  Maxwell  Compressor  Company, 

\      SEAL     J  By  Howard  M.  Maxwell, 

President 
Attest: 

Frank  Paulson,  ii 

Secretary  .;  labnu 


.fl   h'-.i"^!;!!  ^'"1 


The  coupon  form  which  follows  is  as  it  appears  attslched  tOj 
the  preceding  bond. 

Form  250  a.     Coupon  vi/ .<    r: 

- i^-ai  ■i>tfiiu4,M»*~tt>: 

No.  1  ■    -     '    ^j^_^Q 

MAXWELL  COMPRESSOR  COMPANY 

will  pay  to  the  bearer  at  the  office  of  the  Securities  Trust  Company  of  the  City  of 
New  York  the  sum  of  Seventeen  Dollars  and  Fifty  Cents  ($17.50),  in  United 
States  Gold  Coin,  or  its  equivalent,  on  the  first  day  of  June,  1922,  being  six  months' 
interest  on  its  First  Mortgage  Seven  Per  Cent  Gold  Bond  No.  375. 

William  H.  Powers, 

Treasurer 

_ ..I' 

■  A 

The  following  trustee's  certificate  is  as  it  appears  upon  the! 

bond  shown  in  Form  250. 

Form  251.    Trustee's  Certificate  ,,.,.  ,    .j   ,,  , 


The  Securities  Trust  Company  of  the  City  of  New  York  hereby  certifies  that 
the  within  Bond  is  one  of  the  series  of  Bonds  described  in  the  Deed  of  Trust  therein 
mentioned. 

Securities  Trust  Company  of  the 
City  of  New  York, 
New  York  City,  Trustee 

January  5,  1922  By  Malcolm  McDonald, 

President 


The  debenture  bond,  as  stated  elsewhere,i  is  merely  an  unse- 
cured promise  of  a  corporation  to  pay.  The  following  is  a  very 
simple  form  of  such  bond.  The  bond  calls  for  payment  in  gold 
and  is  also  redeemable  on  any  interest  date  before  maturity  at 
the  option  of  the  company. 


>  See  i  512;  also  Book  II,  ff  92-94. 


1624  CORPORATE  FORMS  [Bk.  IV- 

Form  252.    Debenture  Bond 

Number  20  $500 

EN  GEL  CHEMICAL  CORPORATION 

Eight  Per  Cent  Gold  Bond 

The  Engel  Chemical  Corporation,  a  corporation  duly  incorporated  and  existing 
under  and  by  virtue  of  the  laws  of  the  State  of  New  York,  doing  business  in  the 
City  of  New  York,  doth  hereby  promise  and  agree  to  pay  to  the  bearer  the  sum  of 
Five  Hundred  Dollars  ($500)  in  gold  coin  of  the  United  States  of  America  of  the 
present  standard  of  weight  and  fineness,  at  the  office  of  the  Company  on  the  sixth 
day  of  October,  1924,  with  interest  thereon  from  the  sixth  day  of  October,  1921, 
at  the  rate  of  eight  per  cent  (8%)  per  annum,  without  any  deduction  from  principal 
or  interest  for  any  tax  or  taxes  which  the  Company  may  be  required  to  pay  or  to 
retain  therefrom  by  reason  of  any  present  or  future  laws  of  the  United  States  or  of 
the  State  of  New  York,  as  well  as  the  normal  income  tax  which  the  Company  may 
be  required  to  pay  under  any  present  or  future  law  of  the  United  States  or  the 
State  of  New  York,  the  said  Company  hereby  promising  and  agreeing  to  assume 
and  to  pay  all  such  taxes. 

This  bond  is  one  of  a  series  of  twenty  bonds  each  in  the  sum  of  Five  Hundred 
Dollars  numbered  from  (i)  to  (20)  both  inclusive  and  (200)  bonds  each  in  the  sum 
of  $100  numbered  from  (21)  to  (221)  both  inclusive  and  all  of  like  date,  tenor  and 
effect,  and  is  subject  and  subordinate  to  payment  of  the  Company's  business 
creditors  and  is  issued  subject  to  the  conditions  set  forth  in  a  resolution  of  the 
Board  of  Directors  of  the  Company,  authorizing  the  issuance  hereof. 

This  bond  is  redeemable  on  the  sixth  day  of  October  in  any  year  before  matur- 
ity at  the  option  of  the  said  Company  at  par  for  each  $100  of  the  face  value  of  each 
bond,  and  all  the  accrued  interest  thereon  in  accordance  with  the  conditions 
mentioned  in  said  resolution. 

This  bond  shall  pass  by  delivery  or  by  transfer  on  the  books  of  the  Company. 
In  Witness  Whereof,  said  Engel  Chemical  Corporation  has  caused  these 
presents  to  be  signed  by  its  President,  and  sealed  with  its  common  or 
corporate  seal  duly  attested  by  its  Secretary  pursuant  to  a  resolution 
of  its  duly  authorized  Board  of  Directors,  this  sixth  day  of  October, 
1921. 

Engel  Chemical  Corporation, 
f  corporate"!  By  Henry  W.  Engel, 

\      SEAL      J  President 

Attest: 

Frank  W.  Henderson, 
Secretary 


CHAPTER  XXV 

BOND  ISSUES— THE  DEED  OF  TRUST 

The  following  deed  of  trust,  while  drawn  in  compliance  with 
the  requirements  of  the  New  York  statutes,  may  be  readily 
adapted  for  use  in  any  other  state. 

Form  253.    Deed  of  Trust 

Deed  of  Trust 


This  Indentuke,  made  and  entered  into  this  12th  day  of  November,  one 
thousand  nine  hundred  and  twenty-one,  by  and  between  the  Maxwell  Compressor 
Company,  a  corporation  duly  organized  and  existing  under  the  laws  of  the  State  of 
New  York,  having  its  office  at  No.  170  Broadway,  New  York  City,  hereinafter 
called  the  Compressor  Company,  party  of  the  first  part,  and  the  Securities  Trust 
Company  of  the  City  of  New  York,  a  corporation  duly  organized  and  existing  under 
the  laws  of  the  State  of  New  York,  having  its  principal  office  at  No.  98  Wall  Street, 
New  York  City,  as  Trustee,  hereinafter  called  the  Trusiee,  party  of  second  part: . 
Witnesseth:  ^ 

Whereas,  The  Board  of  Directors  of  the  said  Compressor  Company  has,  by 
the  authority  and  with  the  consent  of  the  stockholders  thereof  legally  given,  duly 
resolved  to  borrow  Five  Hundred  Thousand  Dollars  ($500,000)  for  the  lawful 
business  purposes  of  the  said  Company,  and  for  that  purpose  to  execute  and  issue 
its  First  Mortgage  Seven  Per  Cent  Thirty- Year  Gold  Bonds  of  the  par  value  of 
Five  Hundred  Dollars  ($500)  each,  dated  the  first  day  of  December,  1921,  and 
payable  on  the  first  day  of  December,  195 1,  in  gold  coin  of  the  United  States  of,  or 
equivalent  to,  the  present  standard  of  weight  and  fineness,  said  bonds  to  bear 
interest  at  the  rate  of  Seven  Per  Cent  per  annum,  payable  in  like  gold  coin,  sena- 
annually,  on  the  first  days  of  June  and  December  in  each  year,  from  the  first  day  of 
December,  1921,  until  the  payment  of  the  principal  amount  thereof;  the  payment  of 
the  principal  and  interest  of  said  bonds  to  be  secured  by  a  mortgage  or  deed  of  trust 
that  shall  be  a  first  mortgage  on  the  entire  property  of  the  said  Compressor  Com- 
pany as  hereinafter  described,  said  deed  of  trust  to  be  in  substantially  the  form  of 
this  indenture;  and  .,, 

Whereas,  The  bonds  so  to  be  issued  are  to  be  in  substantially  the  form  follow- 
ing, viz.: 

(See  Form  250.) 

And  Whereas,  There  are  to  be  attached  to  each  of  the  said  bonds,  at  the  time 
of  the  issue  thereof,  coupons  representing  the  semiannual  instalments  of  interest 
which  are  to  become  due  thereon,  each  of  which  coupons  is  to  be  substantially  of 
the  following  tenor,  the  proper  coupon  number,  date  of  payment,  amount  of  the 

1625 


1626  CORPORATE  FORMS  [Bk.  IV- 

bond  and  its  number,  and  the  engraved  facsimile  signature  of  the  Treasurer  of  the 
Compressor  Company,  having  been  inserted  in  the  respective  blanks  therefor,  to  wit: 

{See  Form  251.) 

And  Whereas,  On  each  of  said  bonds  there  is  to  be  indorsed  a  certificate  of  the 
Trustee  or  its  successor  appointed  hereunder,  of  the  following  tenor: 

{See  Form  252.) 

Now,  Therefore,  The  said  Compressor  Company,  in  consideration  of  the 
premises  and  of  the  sum  of  one  dollar  to  it  in  hand  paid  by  the  said  Trustee,  the 
receipt  whereof  is  hereby  acknowledged,  and  in  order  to  secure  the  due  payment  of 
the  principal  and  interest  of  the  bonds  to  be  issued  hereunder,  and  to  insure  the 
faithful  performance  of  the  covenants  and  agreements  herein  contained,  hath 
granted,  bargained,  sold,  aliened,  assigned,  conveyed,  transferred,  and  set  over, 
and  by  these  presents  doth  grant,  bargain,  sell,  alien,  assign,  convey,  transfer,  and 
set  over  unto  the  said  Trustee,  its  successors  and  assigns; 

All  of  the  following  described  property  and  franchises  of  the  Company,  to  wit : 

{Specific  description  oj  the  property  mortgaged?) 

To  Have  and  to  Hold  all  and  singular  the  said  property,  with  all  real  estate, 
buildings,  fixtures,  articles,  and  property  of  every  kind,  belonging  to  or  pertaining 
to  the  same,  unto  the  said  Trustee,  its  successors  and  assigns  forever; 

In  Trust  Nevertheless,  for  the  equal  pro  rata  benefit  and  security  of  any 
and  all  persons  and  parties  who  may  be  or  become  the  owners  or  lawful  holders  of 
any  of  the  bonds  to  be  issued  hereunder  and  secured  hereby,  irrespective  of  date  or 
priority  of  issue,  without  any  discrimination,  preference,  or  priority  of  any  one  bond 
over  another  or  others,  by  reason  of  priority  in  time  of  issue,  or  sale,  or  negotiation 
thereof,  or  otherwise,  and  to  secure  the  due  payment  of  each  of  the  said  bonds 
together  with  the  interest  thereon,  and  for  the  uses  and  purposes  and  upon  the 
terms  and  conditions  hereinafter  declared  and  expressed;  and 

It  Is  Hereby  Expressly  Covenanted  and  Agreed  by  and  between  the 
parties  hereto,  that  all  such  bonds  are  to  be  issued,  negotiated,  and  received,  and 
that  the  said  property  and  franchises  mortgaged  are  to  be  held  by  the  Trustee  upon 
and  subject  to  the  following  further  trusts,  uses,  conditions,  and  covenants,  that  is 
1.0  say: 

First — The  bonds  to  be  issued  hereunder  shall  be  executed  on  behalf  of  the 
Compressor  Company  by  its  proper  ofi&cers  and  shall  be  delivered  to  the  Trustee 
for  certification,  and  said  Trustee  shall  certify  and  deliver  said  bonds  so  certified 
upon  the  order  of  the  Board  of  Directors  of  the  Compressor  Company.  An  order 
in  due  form,  purporting  to  be  such  order  for  delivery  of  said  bonds  and  believed  by 
the  Trustee  to  be  genuine,  shall  be  conclusive  authority  and  full  protection  to  the 
Trustee  for  the  certification  and  delivery  of  said  bonds. 

Only  such  bonds  as  shall  bear  thereon  indorsed  the  Trustee's  certificate,  duly 
executed,  shall  be  secured  by  this  indenture,  or  entitled  to  any  lien,  right,  or  benefit 
thereunder,  and  such  certificate  of  the  Trustee  upon  any  such  bond  executed  by  the 
Compressor  Company  shall  be  conclusive  evidence  that  the  bond  so  certified  has 
been  duly  issued  thereunder,  and  that  the  holder  is  entitled  to  the  benefit  of  the 
trust  hereby  created. 

Before  certifying  or  delivering  any  bond,  all  coupons  thereon  then  matured 
shall  be  cut  ofi',  canceled,  and  delivered  to  the  Compressor  Company. 

Secand — All  bonds  secured  hereunder  may  be  registered  in  the  name  of  the 
holder,  when  so  requested  by  such  holder,  upon  bond  transfer  books  which  the 
Compressor  Company  shall  maintain  and  keep  for  such  purpose  at  the  office  of  the 
Trustee  in  the  City  of  New  York  as  long  as  any  of  the  said  bonds  shall  remain  out- 


Ch.  25]  BOND  ISSUES— THE  DEED  OE  TRUST  1627 

standing.  After  such  registration  such  bonds  shall  be  transferable  only  upon  such 
transfer  books,  by  the  registered  owner  or  his  lawful  attorney,  and  any  such  transfer 
shall  be  noted  on  the  bonds  by  the  indorsement  of  the  Transfer  Agent  hereinafter 
appointed.  After  registration  of  any  bond,  the  principal  thereof  shall  be  payable 
only  to  the  registered  owner,  but  the  coupons  shall  be  payable  to  the  bearer  upon 
presentation  and  surrender  thereof,  and  shall  be  negotiable  by  delivery  as  if  such 
bond  was  not  registered. 

Any  registered  bond  may  at  any  time  be  transferred  by  the  registered  owner 
thereof,  upon  said  transfer  books  to  bearer,  and  such  transfer  shall  be  noted  upon 
said  bond,  and  the  said  bond  shall  thereupon  be  negotiable  by  delivery  as  if  it  had 
never  been  registered,  and  each  of  said  bonds  shall  continue  subject  to  successive 
Registrations  and  transfers  to  bearer  at  the  option  of  the  holder  thereof. 

For  the  purpose  of  registering  and  transferring  said  bonds  as  above  set  forth, 
the  Securities  Trust  Company  of  the  City  of  New  York  is  hereby  appointed  and 
constituted  Transfer  Agent  of  the  said  Compressor  Company. 

Third — Until  default  shall  be  made  by  the  Compressor  Company,  its  successors 
or  assigns,  in  the  payment  of  the  principal  or  interest  of  the  bonds  hereby  secured, 
or  any  of  them,  or  in  the  performance  of  any  of  the  covenants,  agreements,  and 
provisions  on  its  part  to  be  kept  and  performed,  as  herein  set  forth,  the  Compressor 
Company,  its  successors  and  assigns,  shall  be  permitted  to  possess,  manage,  use,  and 
occupy  the  premises  affected  hereby,  with  all  their  appurtenances  and  belongings  in 
all  respects  as  fully  as  if  this  indenture  had  not  been  made. 

Fourth — If  the  Compressor  Company  shall  well  and  truly  pay  to  the  holders 
thereof  the  principal  of  the  bonds  secured  hereunder  and  the  interest  moneys 
becoming  due  thereon  respectively  at  the  time  and  in  the  manner  specified  in  the 
said  bonds  and  coupons  thereto  annexed,  and  shall  keep  and  perform  all  the 
covenants,  agreements,  and  stipulations  on  its  part  in  said  bonds  or  in  this  agree- 
ment contained,  then  these  presents  and  the  trust  hereby  created  shall  cease  and 
determine,  and  the  said  Trustee  shall  in  such  event  release  and  discharge  this 
mortgage  and  the  property  and  premises  encumbered  thereby  The  Trustee  may 
also  execute  such  release  and  discharge  upon  production  by  the  Compressor  Com- 
pany or  its  assigns  of  all  the  bonds  issued  hereunder,  together  with  the  coupons 
thereto  belonging,  canceled  or  for  cancellation,  and  the  Trustee  shall  not  be  under 
any  liability  or  obligation  to  inquire  into  the  holding  of  said  bonds  by  the  Com- 
pressor Company  or  its  successors  or  assigns. 

Fifth — The  said  Compressor  Company,  while  it  shaU  be  in  possession  of  the 
mortgaged  premises,  and  while  there  shall  be  no  existing  default  in  respect  of  the 
payment  of^  the  principal  or  interest  of  any  of  the  said  bonds  of  the  Compressor 
Company,  or  in  the  performance  of  any  of  the  covenants  herein,  may,  with  the 
consent  in  writing  of  the  Trustee,  sell  any  portion  of  the  premises  heretofore  granted. 
If,  in  the  opinion  of  the  Board  of  Directors  of  the  Compressor  Company,  such  sale 
or  change  shall  be  expedient,  said  opinion  shall  be  expressed  in  a  resolution  of  the 
said  Board,  and  the  Trustee  may  upon  delivery  to  it  of  a  copy  of  the  resolution  of 
the  Board  of  Directors  to  that  effect  release  from  the  lien  and  operation  of  this 
indenture  any  part  of  the  premises  hereby  mortgaged,  provided  that  the  purchase 
money  from  such  sale  or  sales  shall  be  paid  to  the  said  Trustee  for  application  to  the 
discharge  of  the  bonds  and  coupons  hereunder  issued,  as  set  forth  in  Section  Fif- 
teenth, or  to  be  set  aside  to  be  applied  by  the  Compressor  Company  in  payment  for 
other  real  or  personal  property,  or  in  betterments  of,  or  additions  to,  some  part  of 
the  premises  mortgaged  hereby,  and  until  so  applied  shall  be  held  by  the  Trustee. 
Any  new  property  so  acquired  by  the  Compressor  Company  shall  ipso  facto  )iecome 
and  be  subject  to  the  hen  of  this  indenture  as  fully  as  if  specifically  mortgaged  or 
pledged  hereby,  but  if  requested  by  the  Trustee  the  Compressor  Company  shall 
execute  special  instruments  of  incumbrance  upon  such  properties. 


1628  CORPyRATE  FORMS  [Bk.  IV  - 

Sixth — The  Compressor  Company  covenants  and  agrees  that  it  shall  and  will 
promptly  pay  the  interest  and  the  principal  of  the  bonds  hereby  secured,  at  the 
time  and  in  the  manner  specified  in  said  bonds  and  the  coupons  thereto  attached, 
without  deduction  from  either  such  principal  or  interest  for  or  on  account  of  any 
United  States,  State,  municipal,  or  other  tax  or  taxes  which  the  Compressor 
Company,  its  successors  or  assigns,  may  be  required  to  pay  or  deduct  therefrom, 
and  the  Compressor  Company  hereby  covenants  and  agrees  to  pay  all  such  tax  or 
taxes. 

The  Compressor  Company  further  covenants  and  agrees  that  it  shall  and  will, 
from  time  to  time,  promptly  pay  and  discharge,  or  cause  to  be  paid  and  discharged, 
all  taxes,  rates,  levies,  or  assessments  and  charges,  ordinary  and  extraordinary, 
levied  or  imposed  upon  the  premises  and  properties  mortgaged  to  the  Trustee  to 
secure  the  payment  of  the  bonds  issued  hereunder,  whereby  the  lien  of  this  inden- 
ture might  or  could  be  impaired,  until  the  bonds  so  secured  hereunder,  with  all  the 
interest  accrued  thereon,  shall  have  been  fully  paid  and  satisfied. 

The  Compressor  Company  further  covenants  and  agrees  that  it  will  not  create 
nor  suffer  any  mechanic's,  laborer's,  or  other  similar  liens  to  be  created  upon  the 
premises  and  property  mortgaged  to  secure  the  bonds  issued  hereunder,  whereby  a 
lien  might  be  created  that  might  or  could  be  held  prior  or  equal  to  the  lien  of  this 
indenture,  so  that  the  same  shall  not  fall  into  arrears  and  so  that  the  priority  of  this 
indenture  given  to  secure  said  bonds  shall  be  preserved. 

Seventh — A  sinking  fund  shall  be  created  for  the  redemption  of  the  bonds  issued 
hereunder.  It  shall  consist  of  and  be  maintained  by  the  payment  to  the  Trustee 
by  the  Compressor  Company  on  the  first  day  of  December,  1926,  and  on  each 
succeeding  first  day  of  December,  thereafter  until  the  redemption  of  all  the  bonds 
issued  hereunder,  of  Twenty-five  Dollars  ($25)  for  each  Thousand  Dollars  of  bonds 
then  issued  and  outstanding,  such  moneys  so  paid  to  be  used  in  the  purchase  of 
outstanding  bonds  at  the  lowest  price  at  which  they  may  be  had,  not  exceeding, 
however,  One  Hundred  and  Ten  Per  Centum  (110%)  of  the  face  value  of  said 
bonds,  plus  accrued  interest,  and  if  bonds  cannot  be  so  purchased,  such  money  shall 
be  used  in  redemption  of  bonds  outstanding  as  provided  and  set  forth  in  Section 
Fifteenth  of  this  present  indenture. 

Eighth — The  Compressor  Company  covenants  and  agrees  that  this  deed  of 
trust  delivered  to  the  Trustee  shall  be  a  first  mortgage  upoh  the  premises  and 
property  affected'  thereby,  that  the  same  shall  be  duly  executed  and  recorded  in 
the  proper  office  of  registry  in  the  County  of  New  York  where  the  said  premises  are 
situated,  and  that  the  Compressor  Company  will  execute  and  deliver  such  further 
deeds,  transfers,  pledges,  and  assurances  as  the  Trustee,  under  the  advice  of  counsel 
learned  in  the  law,  shall  reasonably  require  for  the  better  accomphshing  of  the 
purposes  and  provisions  of  this  indenture. 

Ninth — The  Compressor  Company  covenants  and  agrees  that  all  buildings, 
structures,  and  machinery  situated  upon  the  properties  affected  by  this  mortgage 
given  to  secure  the  bonds  issued  hereunder,  shall  be  kept  insured  during  the  entire 
term  of  this  indenture  to  the  amount  of  insurance  on  such  properties  usually  allowed 
by  insurance  companies,  against  loss  or  damage  by  fire,  and  against  loss  or  damage 
from  boiler  explosions,  and  that  the  said  Compressor  Company  shall  and  will  pay 
all  premiums  upon  all  policies  for  such  insurance.  All  such  policies  shall  be  made 
payable  to  the  Trustee,  and  shall  be  deposited  with  it  for  the  benefit  and  protection 
of  the  bondholders  should  any  loss  occur  from  fire  or  from  boiler  explosion  during 
the  term  of  this  indenture.  Any  pajonents  of  insurance  made  under  such  policies 
may  be  applied  directly  by  the  Trustee  to  the  repairing  or  replacement  of  the 
property  damaged  or  destroyed,  or  it  may  authorize  the  Compressor  Company  to 
contract  for  such  repairs  or  replacements,  and  pay  part  or  all  of  the  cost  thereof 
from  said  insurance  moneys.     The  Trustee  may  in  its  discretion  employ  such 


Ch.  25]  BOND  ISSUES— THE  DEED  OF  TRUST  1629 

/ 

insurance  moneys  in  the  purchase  or  redemption  of  outstanding  bonds  as  set  forth 
in  Section  Fifteenth,  instead  of  expending  the  same  for  repairs  or  replacement  of 
property  damaged  or  destroyed. 

Tenth — The  Compressor  Company  covenants  and  agrees  that  it  shall  and  will 
at  all  times  keep  the  buildings,  structures,  and  appurtenances  thereto,  or  any 
replacement  or  replacements  thereof,  in  good  order  and  repair,  provided,  however, 
that  in  the  event  of  total  destruction  of  any  building,  the  Compressor  Company 
may,  with  the  consent  of  the  Trustee,  add  to  the  insurance  moneys  received  thereon 
by  the  Trustee  sufficient  cash  payments  to  release  the  special  property  upon  which 
such  building  was  situated,  under  the  terms  set  forth  in  Section  Fifth,  whereupon 
the  Trustee  shall  release  the  said  property  and  the  Compressor  Company  may 
dispose  of  the  same  at  its  discretion. 

Eleventh — The  Compressor  Company  covenants  and  agrees  that  when  and  as 
the  coupons  attached  to  the  bonds  issued  hereunder  are  paid,  the  coupons  shall  be 
canceled,  and  that  no  purchase  or  sale  of  the  said  coupons  or  advance  or  loan  upon 
the  same,  made  on  behalf  of,  or  at  the  request  of,  or  with  the  privity  of  the  said 
Compressor  Company,  and  no  redemption  of  the  said  coupons,  or  any  of  them, 
by  any  guarantor  of  the  payment  of  the  same,  shall  be  taken,  or  operate,  as  keeping 
the  said  coupons  alive  or  in  force  under  this  indenture  as  against  the  holders  of  the 
bonds  secured  hereunder  and  of  the  coupons  annexed  thereto. 

Twelfth — In  case  default  shaU  be  made  in  the  payment  of  interest  on  any  of  the 
bonds  issued  hereunder,  and  such  default  shall  continue  for  a  period  of  six  months 
after  demand,  or  in  case  default  shall  be  made  in  the  performance  of  any  other 
covenant  or  condition  hereby  required  to  be  kept  or  performed  by  the  Compressor 
Company,  and  the  same  shall  continue  for  a  period  of  six  months  after  demand  made 
for  such  performance,  the  Trustee  may,  and,  upon  the  written  request  of  the 
majority  in  amount  of  the  holders  of  the  bonds  then  outstanding,  shall  by  written 
notice  to  the  Compressor  Company,  declare  the  principal  of  all  the  bonds  hereby 
secured,  then  outstanding,  to  be  due,  and  the  same  shall  thereupon  become  im- 
mediately due  and  payable. 

Thirteenth — In  case  default  shall  be  made  in  the  payments  of  the  principal  or 
interest  of  any  of  the  said  bonds  when  the  same  is  due  and  payable  according  to  the 
tenor  thereof,  or  if  default  shall  be  made  in  the  performance  of  any  other  covenant 
or  condition,  hereby  required  to  be  kept  or  performed  by  the  Compressor  Company, 
and  any  such  default  in  payment  or  performance  shall  continue  for  a  period  of  six 
months  after  demand  by  the  Trustee,  then  and  in  every  such  case  the  Trustee,  or  its 
successors  in  the  Trust,  may  by  its  attorneys  and  agents  enter  into  and  upon  all 
and  singular  the  premises  hereby  conveyed,  and  each  and  every  part  thereof,  and 
operate  and  conduct  the  business  of  the  said  Compressor  Company  in  all  respects 
as  the  said  Compressor  Company  might  do  in  possession  of  the  same;  and  may 
collect  and  receive  all  rents,  mcome,  revenue,  and  profit  to  be  derived  therefrom, 
and  after  deducting  all  proper  and  necessary  outlays  and  expenses  as  well  as  a  just 
compensation  for  its  own  services  and  for  the  services  of  such  attorneys,  agents,  and 
assistants  as  it  may,  in  its  discretion,  employ  for  any  of  the  purposes  aforesaid, 
said  Trustee  shall  apply  the  rest  and  residue  of  the  moneys  received  by  it  pro  rata 
to  the  payment  of  the  interest  due  upon  such  of  said  bonds  as  shall  then  be  out- 
standing. In  any  such  case  if  payment  of  all  interest  and  any  principal  due  shall 
be  made  in  full  and  no  suit  to  foreclose  this  mortgage  shall  have  been  begun  or  sale 
made,  the  said  Trustee  shall  restore  the  possession  of  the  premises  so  entered,  to 
the  Compressor  Company  without  prejudice  to  similar  entry  later  in  case  of  similar 
default. 

Fourteenth — In  case  default  shall  be  made  in  the  payment  of  the  principal  or 
interest  of  the  said  bonds,  when  the  same  is  due  and  payable  according  to  the  tenor 


1630  CORPORATE  FORMS  [Bk.  IV- 

thereof,  or  if  default  shall  be  made  in  the  performance  of  any  other  covenant  or 
condition  hereby  required  to  be  kept  or  performed  by  the  Compressor  Company, 
and  any  such  default  in  payment  or  performance  shall  continue  for  the  period  of 
six  months  after  demand,  the  Trustee  may,  and  upon  written  request  of  the  holders 
of  a  majority  in  amount  of  the  registered  bonds  then  outstanding,  being  first  in- 
demnified by  them  to  its  satisfaction,  shall  sell  or  foreclose  upon,  according  to  the 
proceedings  by  law  prescribed  in  this  state,  all  or  any  portion  of  the  property  held 
by  it  under  this  indenture,  and  such  proceedings  of-  sale  or  foreclosure  shall  be  a 
perpetual  bar  both  at  law  and  in  equity  against  the  Compressor  Company  and 
against  all  persons  claiming  by,  from,  or  under  it.  After  deducting  from  the  pro- 
ceeds of  such  sale  or  foreclosure,  the  proper  allowance  for  all  expenses  thereof, 
including  attorney's  and  counsel  fees,  and  all  other  expenses  or  advances  which 
may  have  been  made  or  incurred  by  said  Trustee  in  respect  of  the  said  property 
or  the  appurtenances  hereto,  and  all  payments  which  may  have  been  made  by  it 
for  taxes  or  assessments,  or  in  satisfaction  of  charges  and  liens,  prior  to  the  lien 
of  the  mortgages  and  deeds  of  trust  to  the  Trustee  thereon,  or  for  insurance,  as 
well  as  reasonable  compensation  for  its  own  services,  the  Trustee  shall  apply  the 
proceeds  to  the  payments  of  such  bonds  and  the  coupons  thereon  as  may  be  at 
the  time  unpaid,  without  giving  preference  or  priority  to  one  bond  over  another, 
but  ratably  to  the  aggregate  amount  of  such  unpaid  principal  and  accrued  and 
unpaid  interest,  and  if  any  surplus  remain  after  the  payment  in  full  of  the  principal 
and  interest  of  said  bonds,  then  the  Trustee  shall  transfer  and  pay  over  such 
surplus  to  the  Compressor  Company. 

Fifteenth — It  is  covenanted  and  agreed  between  the  parties  hereto  and  any 
future  holders  of  the  bonds  that  the  said  bonds  are  redeemable,  at  the  option  of  the 
party  of  the  first  part,  on  any  interest  day  after  the  first  day  of  December,  1922, 
at  One  Hundred  and  Ten  Per  Cent  (iio%)  of  their  face  plus  accrued  interest, 
provided  that  thirty  days'  notice  of  such  redemption  shall.be  given  the  holders 
thereof,  by  notice  published  once  a  week  for  four  consecutive  weeks  prior  to  such 
redemption,  in  a  newspaper  in  New  York  City.  If  said  bonds  are  registered,  then  a 
copy  of  the  said  notices  shall  be  sent  to  the  post  office  address  of  the  parties  in 
whose  names  said  bonds  are  registered. 

Whenever  it  is  desired  to  redeem  any  of  said  bonds,  the  Board  of  Directors  of 
the  Compressor  Company  shall  pass  a  resolution  setting  forth  the  arrount  of  bonds 
(at  their  par  value)  desired  to  be  redeemed.  The  President  of  the  Compressor 
Company  shall  thereupon  draw  by  lot  the  numbers  of  the  bonds  to  be  redeemed, 
and  he  shall  thereupon  certify  that  such  bonds  were  drawn  for  redemption,  which 
certificate  shall  be  entered  upon  the  minutes  of  the  Compressor  Company,  and  a 
duplicate  copy  shall  be  delivered  to  the  Trustee.  Said  bonds  ha\'ing  been  so  drawn 
for  redemption  shall  become  due  and  payable  on  the  succeeding  interest  payment 
date,  provided  that  the  date  of  first  publication  and  the  date  of  mailing  notice  to 
registered  holders  of  bonds  hereinbefore  provided  for  shall  have  been  not  less  than 
thirty  days  prior  to  such  interest  payment  date,  and  the  said  bonds  shall  from  such 
interest  payment  date,  cease  to  draw  interest,  and  the  said  Compressor  Company 
may,  upon  the  deposit  of  the  proper  amount  with  the  Trustee,  be  privileged  to 
consider  said  bonds  as  paid  and  canceled. 

Sixteenth — The  Trustee  may  resign  the  trust  hereby  created  upon  giving 
sixty  days'  notice  in  writing  to  the  Compressor  Company.  In  case  of  the  resigna- 
tion of  the  Trustee,  or  of  its  dissolution,  or  insolvency,  or  removal  for  cause  as 
Trustee  hereunder,  it  shall  be  the  duty  of  the  Compressor  Company  to  call  a  meeting 
of  the  bondholders  by  printed  notice,  published  in  two  of  the  public  newspapers  of 
New  York  Citj',  once  a  week  for  three  consecutive  weeks  next  preceding  such 
meeting,  calling  such  meeting  to  be  held  in  the  said  City  of  New  York,  and  by 
mailing  notice  of  the  same  to  each  of  the  registered  bondholders  not  less  than  ten 
days  before  the  date  of  such  meeting    At  the  time  and  place  specified  in  such 


Ch.  25I  BOND  ISSUES— THE  DEED  OF  TRUST  163 1 

notice,  the  holders  of  said  bonds,  in  such  meeting  assembled,  shall  organize  and 
proceed  to  elect  a  suitable  corporation  to  act  as  Trustee  under  this  agreement,  and  a 
majority  in  amount  of  such  bonds  legally  represented  at  such  meeting  shall  be 
competent  to  elect  such  new  Trustee,  and  the  corporation  so  elected  shall  im- 
mediately upon  election  and  on  its  acceptance  in  writing  of  such  trust  become  vested 
with  all  the  estate,  trusts,  rights,  powers,  and  duties  of  the  present  Trustee  herein, 
and  shall  be  entitled  to  receive  from  the  present  Trustee  or  its  legal  representatives 
aU  moneys,  mortgages,  and  assurances  appertaining  or  relating  to  this  trust  and 
the  due  execution  thereof. 

Seventeenth — It  is  covenanted  and  agreed  by  the  parties  hereto,  and  all  the 
holders  of  bonds  hereunder,  as  conditions  precedent  to  the  acceptance  of  the  said 
trust  by  the  said  Trustee,  or  any  successor  thereto,  as  follows: 

The  Trustee  shall  not  be  answerable  for  any  act,  default,  neglect,  or  mis- 
conduct of  any  of  its  agents  or  employees,  by  it  appointed  or  employed,  in  connec- 
tion with  the  execution  of  any  of  the  said  trusts,  nor  in  any  other  manner  answerable 
or  accountable,  under  any  circumstances  whatsoever,  except  for  bad  faith.  The 
recitals  contained  herein,  or  in  the  bonds,  as  to  priority  of  hen,  or  any  other  matter 
whatsoever,  are  made  by  and  on  the  part  of  the  Compressor  Company,  and  the 
Trustee  assumes  no  responsibility  for  the  correctness  of  the  same.  It  shall  not  be 
the  duty  of  the  Trustee  to  file  or  record  at  any  time  this  deed  of  trust  or  any  other 
mortgages  or  deeds  of  trust  that  may  be  required  hereunder,  nor  to  do  any  other 
act  or  acts  suitable  and  proper  to  be  done  for  the  creation  or  continuance  of  the 
lien  or  liens  thereby  intended,  nor  to  effect  insurance  against  fire  or  explosion,  nor  to 
renew  any  policies  of  insurance,  nor  to  keep  itself  informed  as  to  the  payment  of  any 
taxes  or  assessments,  nor  to  require  such  payments  to  be  made.  The  Trustee  may, 
however,  in  its  discretion,  do  any  or  all  of  these  things.  Neither  shall  the  Trustee 
be  held  responsible  for  the  nature  or  amount  of  the  security  mortgaged  to  it  here- 
under. The  Trustee  shall  not  be  compelled  to  take  any  action,  as  Trustee,  under 
this  mortgage,  unless  properly  requested  and  in  every  respect  indemnified  to  its  full 
satisfaction.  The  Trustee  shall  be  entitled  to  reasonable  compensation  for  all 
services  rendered  hereunder  or  in  connection  with  the  trust.  This  compensation, 
together  with  any  and  all  necessary  and  reasonable  expenses,  charges,  counsel  fees, 
and  other  disbursements  incurred  by  the  Trustee  in  the  discharge  of  its  duties,  as 
such,  shall  be  paid  by  the  Compressor  Company,  or  out  of  the  trust  estate  upon 
which  they  are  hereby  made  a  lien,  prior  to  that  of  the  bonds  issued  hereunder. 
The  Trustee  shall  be  protected  in  acting  upon  any  notice,  consent,  request,  certifi- 
cate, bond,  or  other  paper  or  document  believed  by  it  to  be  genuine  and  for  its  due 
authentication  by  certificate  of  the  bonds  issued  hereunder,  and  for  the  custody  and 
disposition,  as  herein  provided,  of  the  securities  and  moneys  received  by  it  hereunder. 

Eighteenth — It  is  covenanted  and  agreed  between  the  parties  hereto  that  the 
words  "Compressor  Company"  when  used  in  these  presents  mean  the  party  issuing 
the  bonds  herein  referred  to;  that  the  word  "Trustee"  means  the  corporation 
charged  with  the  execution  of  the  trust  herein,  whether  the  same  be  the  Securities 
Trust  Company  of  the  City  of  New  York,  or  any  successor  or  successors  in  the  trust 
hereby  created;  that  the  word  "bonds"  means  the  bonds  issued  hereunder;  and  the 
words  "Trustee,"  "bond,"  "bondholder,"  and  "holder"  shall  include  the  plural  as 
well  as  the  singular  number  and  the  term  "majority"  shall  signify  the  majority  in 
amount. 

Nineteenth — It  is  covenanted  and  agreed  that  this  indenture  may  be  executed 
in  several  counterparts,  each  of  which  so  executed  shall  be  deemed  to  be  an  original, 
and  such  counterparts  shall  together  constitute  but  one  and  the  same  instrument. 

In  Witness  Whereof,  the  Maxwell  Compressor  Company  has  caused 
its  corporate  name  to  be  hereunto  subscribed  by  its  President  and 
its  corporate  seal  to  be  afiixed  and  attested  by  its  Secretary,  and  the 


1632  CORPORATE  FORMS  [Bk.  IV- 

Securities  Trust  Company  of  the  City  of  New  York,  in  token  of  its 
acceptance  of  the  trust  hereby  created,  has  caused  its  corporate  name 
and  seal  to  be  hereunto  affixed  by  its  President,  and  attested  by  its 
Secretary,  on  this  twelfth  day  of  November,  one  thousand  nine 
hundred  and  twenty-one. 

Maxwell  Compressor  Company, 
r  CORPORATE  \  By  Howard  M.  Maxwell, 

\        SEAL        /  President 

Attest: 

Frank  Paulson, 

Secretary 

Securities  Trust  Company 
/  corporate  \  of  the  City  of  New  York, 


\        SEAL       /  As  Trustee 

By  Malcolm  McDougald, 

President 
Attest: 

Frank  G.  Cooper, 
Secretary 

(Notarial  acknowledgment  by  president  of  each  corporation  as  given  in  Form  236.) 

It  will  be  understood  that  the  preceding  form  has,  on  account 
of  space  limits,  been  reduced  to  its  simplest  terms.  It  is,  how- 
ever, a  good  working  model  and  will  afford  a  basis  upon  which  to 
build  up  a  more  elaborate  instrument  when  required. 


Part  V— Corporate  Records,  Reports,  and  Calendar 


CHAPTER  XXVI 
MISCELLANEOUS  BOOKS  AND  RECORDS 

In  cases  where  an  extensive  stock-selling  campaign  is  under- 
taken, a  record  of  the  sales  and  the  cost  of  selling  may  be  advan- 
tageously kept  in  a  subscription  journal.  Such  a  campaign 
may  be  continued  for  a  considerable  period  and  in  that  case  the 
columns  of  receipts  and  of  commissions  may  be  footed  and 
posted  daily  or  weekly  as  convenient.  The  form  given  below  is 
self-explanatory. 

The  instalment  book  is  used  when  an  instalment  falls  due,  or 
when  a  call  or  assessment  is  decided  upon  by  the  board  of 
directors.  As  will  be  seen  by  reference  to  the  form  which 
follows,  it  contains  a  list  of  the  subscribers,  the  number  of  shares 
subscribed  by  each,  and  the  amount  of  the  instalment  due, 
together  with  other  information  relating  to  the  particular  instal- 
ment. A  new  page  or  sheet  is  made  out  for  each  call  or  instal- 
ment. Instead  of  rewriting  the  names  for  each  of  these,  the  same 
list  may  be  utilized  by  ruling  up  the  page  with  groups  of  columns, 
each  group  adapted  for  one  instalment;  or  by  the  use  of  long  and 
short  leaves.  Any  such  arrangement  may  cause  some  little 
inconvenience  in  case  subscription  rights  and  instalments  are 
transferred,  thereby  necessitating  changes  of  names. 

The  first  column  of  the  instalment  book  indicates  the  folio  of 
the  stockholders  ledger  in  which  the  subscribers'  accounts  are 
recorded,  payments  being  posted  from  the  instalment  book  to 
the  credit  oi  the  respective  accounts.    The  last  cplumn  preceding 

1633 


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Ch.  26] 


MISCELLANEOUS  BOOKS  AND  RECORDS 


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1636  CORPORATE  FORMS  [Bk  .IV- 

the  remarks  column  indicates  the  cash  book  folio  to  which  the 
payments  may  be  carriecl  in  total  each  day,  these  payments  being 
credited  to  "Capital  Stock,"  "Capital  Stock  Subscribed"  or 
"Subscribers,"  according  to  the  plan  of  opening  entries  used. 
Since  instalments  on  subscriptions  are  not  necessarily  paid  on 
their  due  date,  it  is  advisable  to  carry  the  total  of  each  day's 
receipts  to  the  cash  book,  instead  of  waiting  until  all  are  paid. 
It  is  obvious  that  an  account  for  "Subscribers"  must  be  opened 
in  the  general  ledger  and  charged  with  the  aggregate  amount  of 
the  subscriptions  due  at  that  particular  date.  The  same  pro- 
cedure is  required  for  each  succeeding  instalment. 

The  instalment  book  is  compiled  from  the  various  subscrip- 
tion sheets  or  individual  subscription  blanks,  and  may  be  either 
a  bound  or  loose-leaf  book.  Loose  sheets  serve  the  purpose 
nicely,  since  they  can  afterward  be  bound  together  for  filing. 

In  a  large  corporation  where  many  transfers  are  made,  a 
transfer  register  similar  to  that  shown  below  may  be  used  to 
advantage.  In  a  small  company  where  transfers  are  not  numer- 
ous it  would  not  be  necessary;  and  the  postings  may  be  made 
from  the  usual  transfer  book  '  or  even  from  the  stock  certificate 
book.  The  object  of  keeping  the  transfer  register  is  to  have  a 
convenient  medium  through  which  postings  may  be  made  to  the 
stock  ledger,  in  which  the  transferrer  is  debited  and  the  transferee 
is  credited. 

It  is  not  usual  to  have  a  bound  book  for  the  record  of  divi- 
dends, but  loose  sheets  are  used  which  may  be  bound  together 
later.  The  sheet  should  show  the  names  of  the  stockholders, 
date  of  dividend,  number  and  amount  of  check.  The  form  given 
below  is  for  use  where  the  stockholders  come  to  the  office  in 
person,  receive  their  checks  and  receipt  for  payment.  Some 
small  companies  prefer  this  plan  as  it  keeps  the  stockholders  in 
closer  touch  with  the  business. 

1  Form  8s. 


Ch.  26] 


MISCELLANEOUS  BOOKS  AND  RECORDS 


1637 


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CORPORATE  FORMS 


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Ch.  26] 


MISCELLANEOUS  BOOKS  AND  RECORDS 


1639 


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1640  CORPORATE  FORMS  [Bk.  IV- 

In  most  corporations  the  dividend  checks  are  sent  out  by 
mail.  In  such  case  the  dividend  sheet  shown  in  Form  258  will  be 
found  convenient.  The  list  is  usually  made  up  from  the  stock 
ledger  after  the  dividend  is  declared  and  after  the  transfer  books 
have  been  closed. 

Under  this  plan  the  checks  are  made  payable  to  the  order  of 
the  stockholders  and  mailed  to  them.  The  indorsement  on  the 
back  of  the  canceled  check  is  considered  sufficient  evidence  of 
payment. 

If  in  a  bond  issue  the  bonds  are  sold  direct  by  the  corporation, 
it  must  keep  a  detailed  record  of  sales  and  for  this  purpose  a  bond 
register  is  necessary.  This  provides  space  for  the  name  and 
address  of  the  holder,  the  number  of  his  bond,  the  date  it  was 
acquired,  the  party  to  whom  transferred,  and  columns  for  the 
interest  payments.  The  bonds  are  usually  entered  in  numerical 
order,  and  in  addition  the  number  of  the  bond  and  the  name 
of  the  owner  are  kept  in  a  card  index,  from  which  it  is  pos- 
sible to  trace  up  the  ownership  and  transfers  of  any  particular 
bond. 

When  a  registered  bond  is  transferred  the  procedure  is  similar 
to  the  transfer  of  a  stock  certificate.  The  surrendered  bond  is 
canceled  and  filed,  and  the  old  entry  in  the  bond  register  is  can- 
celed by  ruling  a  red  ink  line  through  it  as  shown  on  the  form 
below.  The  name  and  address  of  the  new  owner  is  then  recorded 
on  the  first  vacant  line  on  the  page,  and  the  record  of  transfer  is 
complete. 

The  difference  between  the  footings  of  the  "Amount"  columns 
of  the  bond  register  and  the  sum  total  of  all  bonds  canceled — 
which  is  obtained  by  adding  together  all  amounts  through  which 
the  red  ink  line  is  drawn — should  agree  with  the  balance  of  the 
Bond  account  in  the  general  ledger. 

The  list  of  bondholders  and  transferees  may  be  kept  in  a  book 
or  on  cards  in  an  ordinary  card  index.  The  form  given  below  is 
adapted  for  either  method.  One  card  or  one  blank  is  used  for 
each  bond  issued. 

t 


Ch.  26]  MISCELLANEOUS  BOOKS  AND  RECORDS 

Form  260.    Index  of  Bondholders 


1 641 


BOND  NO. 
Euss 


AMDl  INT   *IOOO 


NAMF     AO^ 


Pf)OuiideAA^,    (mv^(Z'. 


CLASS 


BONDHOLDER'S  ADDRESS 


TRANSFERRED  TO 


Post  Office 


TlzooJ^m^ -^i^ 


Name 


County 


State 


/^^^^■^^^ 


Address 


Street  and  No. 


Transferred   From     /? 


Form  261.     Coupon  Register 


E  455 
METROPOLITAN  INVESTMENT  CO. 

BOND  REGISTER 

$1,000.00                                     6%  Trust  Bond 

Dated  Jan.  i,  1922  Due  Jan.  i,  1932  First  CoufX)n  due  July  i,  1922 

20 

15 

10 

5 

19 

14 

9 

4 

18 

13 

8 

3 

17 

12 

7 

2 

16 

II 

6 

Canceled 
Coupon 

1642  CORPORATE  FORMS  [Bk.  IV- 

Coupon  bonds  registered  as  to  principal  are  entered  in  the 
bond  register,  and  an  alphabetical  card  index  of  bondholders  is 
provided  for  each  denomination  of  bonds  issued.  A  coupon 
register  is  also  necessary  for  the  proper  record  of  paid  coupons. 

An  entire  page  of  the  coupon  register  is  required  for  the  record 
of  each  bond.  The  number,  the  amount,  and  a  brief  description 
of  the  bond  are  entered  at  the  top  of  the  page.  As  each  coupon 
is  redeemed,  it  is  pasted  on  the  space  bearing  its  number.  A 
glance  at  the  page  will,  at  any  time,  show  what  coupons  have  been 
paid  and  which  are  due  and  unpaid. 


CHAPTER  XXVII 
REPORTS 

Under  the  laws  of  most  of  the  states  corporations  are  com- 
pelled to  make  certain  reports  to  the  authorities,  mainly  for  pur- 
poses of  taxation.  The  federal  income  tax  report  is  shown  in 
some  detail  elsewhere.^  The  local  forms  vary  so  widely  in  the 
different  states  that  they  cannot  be  shown  in  the  present  volume. 
This  chapter  is  therefore  entirely  confined  to  the  reports  made 
to  the  stockholders.  The  forms  given  are  merely  suggestive,  as 
such  reports  will  necessarily  vary — and  vary  widely — with  the 
conditions. 

The  usual  annual  reports  submitted  to  the  stockholders  are 
those  of  the  president  and  treasurer.  The  president's  report  is 
intended  to  give  a  general  review  of  the  company's  operation 
during  the  preceding  year  and  a  statement  of  its  condition  at 
the  time  of  the  report.  It  is  usually  the  most  important  of  those 
made  to  the  stockholders  at  the  annual  meeting.  In  many  cases 
it  is  the  only  formal  report  made,  and  then  it  will  include  the 
financial  statements  that  would  otherwise  be  given  in  the  report 
of  the  treasurer.  Any  matters  pertaining  to  the  progress  of  the 
corporate  business  are  properly  brought  out  in  the  report  of  the 
chief  executive  officer. 

The  annual  report  that  is  presented  below  includes  a  state- 
ment of  the  company's  financial  condition  on  the  date  given. 
It  is  a  good  typical  example  of  a  brief,  but  nevertheless  compre- 
hensive report.  It  was  mailed  to  all  the  stockholders  of  the 
company. 


'  Book  III.  Ch.  XXXVI.  "Federal  Income  Tax  Returns.' 


1 644  CORPORATE  FORMS  [Bk.  IV- 

Form  262.     President's  Annual  Report 

TO  THE  SHAREHOLDERS  OF  THE 
STANDARD  SANITARY  MFG,  CO. 

Pittsburjh,  Pa.,  February  I,  1922. 
In  submitting  to  you  herewith  the  Twenty-Second  Annual  Report  of  the  Company's 
business  covering  the  year  ending  December  31st,  1921, 1  am  pleased  to  be  able  to  state  that  we 
have  made  substantial  progress  during  the  year  and  that  the  financial  condition  of  the  Company,  as 
well  as  the  outlook  for  the  present  year,  is  very  promising.  The  Balance  Sheet,  Profit  and  Loss 
Account,  and  other  figures  submitted  by  the  Treasurer  show  that  the  financial  condition  of  the 
Company  is  excellent  and  that  we  are  in  every  respect  equipped  to  take  care  of  the  large  volume 
of  business  we  have  reason  to  believe  the  present  year  will  bring  to  us.  The  Financial  State- 
ment follows  herewith: 

FINANCIAL  STATEMENT 

ASSETS 

Purchase  of  Properties $6,667,772.79 

Potteries  Plants  and  E<iuipment. 966.426.27        $7,634,199.06 

Store  and  Warehouse  JProperties 1,624,701.19 

9.258.900.25 

Cash 889,353.22 

Accounts  Receivable 5,686,800.10 

Notes  Receivable 264,767.81 

Insurance  Deposits 84,278.23 

Miscellaneous  Securities 7,964.00 

6,933,163.36 

Inventories  and  Goods  in  Transit 7,319,336.20 

Total  Current  Assets  and  Inventories  14,252,499.56 

Investment  in  Standard  Sanitary  Mfg.  Co.,  Ltd.  of  Canada  1,358,496.06 

Pension  Funds  Invested 265,248.26 

Employees'  Stock  Subscription  Account __ 480,572.76 

Furniture  and  Fixtures,  Machinery,  at  other  points  than 

Factories,  Trucks  and  Autos 369,718.88 

A^iscellaneous  Items  and  Deferred  Charges  to  Operations..  142,706.1 1 

Patents I  00 

$26,128,142.88 

CAPITAL  AND   LIABILITIES 
INVESTED  CAPITAL 

Common  Capital  Stock  (Issued) $13,168,800.00 

Preferred  Capital  Stock  (Issued)—      4,532,100.00  17,700,900.00 

Surplus  and  Reserves 5.591,325.37 

Total  Capital,  Surplus  and  Reserves $23,292,225.37 

LIABILITIES  AND  OPERATING  RESERVES 

Accounts  Payable $1,563,709.28 

Provision    for    Federal    and    State 

Taxes $521,764.r8 

Preferred  Stock  Dividend  payable 

Feb.  15,  1922... 79,311.75 

Reserve  for  Contingent  Liabilities...       671.131.70  2,835.917.51 

$26,128,142.88 


Ch.  27]  REPORTS  1645 


Quick  Assets  December  3]^  1921,  amounted  to .„.. $14,252,499.5$ 

Quick  Liabilities  December  3J,  1921,  amounted  to. 2,835,917.51 

Proportion  of  Quick  Assets  to  Quick  Liabilities _        $5.02  to  $1.00 

NET   WORTH 

Book  Value  of  Common  Stock  per  Share,  December  3  f,  1 920  $136.52 

Book  Value  of  Common  Stock  per  Share,  December  31, 1921  $142.46 

Net  Worth  of  Company,  December  31,  1921 $23,292,225^7 

Common  Stock  earned  in   1921,  after  deducting  Federal 

Tax  and  Reserves 14.28% 

Common  Stock  earned  in  1920,  after  deducting  Federal 

Tax  and  Reserves... _ 22.74% 

EARNINGS 

Earnings  of  the  Company  for  the  year  ending  December 

31,  1921,  were $3,057,016.52, 

Less  Amounts  set  aside,  viz: 

To    make    Contingent    Reserve    equal 

$150,000.00— $139,519.60  ' 

For  Pension  Fund  Reserve. 25,000.00 

To  make  Reserve  for  Bad  Accounts  and 

Unadjusted    claims    equal    the    sum 

of  $125,000.00 5,995,85 

For  Federal  Taxes 503,357.63 

For  Preferred  Stock  Dividends. 316,772.75 

For    Extra    Compensation    to    Executive 

Committee 85,812.75 

For   Reserve    for   probable   shrinkage   of 

Capital  Assets,  acquired  at  excessive 

cost  since  I9I5„ 100,000.00  $1,176,458.58 

Amount  added  to  Surplus  out  of  1921  earnings  and  appli- 
cable to  Common  Stock $1,880,557.94 

Dividends  paid  on  Common  Stock  during  the  year,  9%  $1,111 ,064-00 

Dividends  paid  on  Preferred  Stock  during  the  year,  7%  315,861.00 

Total  Cash  Dividends  paid  In  1921 $1,426.925.00 

DEPRBCIATION 

Total  depreciation  charges  for  the  year  amounted  to  $466,615.97  as  against  $365,426.04 
for  1920.  These  figures  do  not  include  the  additional  reserve  set  up  each  year  for  "Probable 
shrinkage  of  Capital  Assets  acquired  at  excessive  cost  since  1915"  and  which  amounted  to 
$250,000.00  in  1920  and  $100,000.00  in  1921. 

SALES 

Volume  of  sales  for  the  year  »how  a  decrease  of  23%  a»  compared  with  the  previous 
year.  Branch  House  Sales  show  a  falling  off  of  31%,  while  sales  of  our  manufactured  product 
were  reduced  only  12%.  Part  of  this  reduction  is  due  to  lower  values  caused  by  declines  Jn 
prices  on  nearly  everything  we  manufacture  or  handle. 


1646  CORPORATE  FORMS  [Bk.  TV- 


MANUFACTURING  PLANTS 

'We  were  not  able  to  keep  our  Plants  operating  full  capacity  durins  the  year.  This  was 
particularly  true  of  our  Potteries  and  Brass  Plant.  On  Enameled  Iron  Ware  the  demand  was 
better  and  we  produced  about  the  same  tonnage  as  in  the  previous  year. 

We  expended  In  improvements  and  extension  of  our  Plants  during  1921  the  sum  of 
$1,335,723.84. 

The  physical  condition  of  our  Plants  is  first  dass.  We  have  made  satisfactory  adjust* 
ments  with  our  labor  and  we  are  beginning  the  new  year  with  all  Plants  running  full  time. 

BRANCH    HOUSES 

Owing  to  the  general  business  depression  which  existed  during  1921  our  Branch  House 
business  was  unsatisfactory.  We  suffered  heavy  losses  through  declines  in  merchandise  in- 
ventories and  were  not  able  to  reduce  overheads  in  proportion  to  decrease  in  volume.  Salaries, 
which  amounted  to  one-half  of  our  Branch  House  Expense,  were  not  reduced  at  all.  All  this 
resulted  in  Branch  House  Profits  being  the  smallest  in  years. 

We  expended  in  Branch  House  and  Warehouse  additions  during  the  year  the  sum  of 
$230,614.00. 

EMPLOYEBS   AND    PAYROLLS 

Number  Salaries  or  Wages  Paid 

Plants _ 5044  $7, 1 73,456.65 

General  Offices  and  Sales  Offices „ _ 379  783,380.69 

Branch  Houses 992  1 ,592,735.85 


6415  $9,549,573.19 

Average  per  employee — 1920 _ _ _ $1,644-04 

Average  per  employee — 1921 - 1,488.63 

CROUP   LIFE   INSURANCE 

Employees  insured _ __ _ 5250 

Total  amount  of  all  policies  carried. „ _ $5,872,950.00 

Number  of  deaths  during  year _ _ _ _ _ _ 34 

Amount  paid  to  Beneficiaries - $      39,584.15 

Amount  paid  to  3  employees  under  Disability  Clause _ _ _ $       2,850.00 

Total  premiums  paid  by  Company ;.._ _ - $     59,972.95 

SHAREHOLDERS 

On  November  4th  the  total  number  of  Shareholders  in  the  Company,  exclusive  of  Em- 
ployee Shareholders  who  have  subscribed  for  stock  under  our  plan  of  February  21st,  1921, 
amounted  to _ _ — _ 994 

438  Women  and  38  Estates  and  Trusts  owned— 84,972  shares  out  of  a  total  of  1 71 , 1 36  shares. 

It  will  be  seen  that  practically  one-half  of  the  Company's  stock  is  held  by  Women,  Trusts 
and  Estates,  showing  that  Standard  Sanitary  Alanufacturing  Company  Stock  has  now  become 
an  investment  security.  The  officers  of  the  Company  appreciate  the  confidence  this  implies, 
«nd  arc  mindful  of  the  responsibility  thereby  imposed. 


Ch.  27]  REPORTS  1647 


EMPLOYEE  SHAREHOLDERS 

At  the  beginning  of  the  year  we  had  99  Employees,  exclusive  of  the  officeTs  of  the  Company, 
*ho  were  Shareholders. 

On  February  21st,  1921,  the  Company  offered  to  its  employees  5000  shares  of  Common 
Capital  Stock  and  1000  shares  of  Preferred  Capital  Stock  under  certain  favorable  conditions. 
On  this  offer  we  received  subscriptions  as  follows: 

1518  subscriptions  to  Common  Stock,  totaling 6315  shares 

121  subscriptions  to  Preferred  Stock,  totaling 306  shares 

As  some  subscribed  for  both  Common  and  Preferred  the  total 

number  of  subscribers  amounted  to 1571 

As  the  stock  was  over-subscribed  the  larger  subscriptions  were  scaled  down,  and  no  em- 
ployee received  more  than  1 0  shares  in  the  final  distribution.  22.26%  of  our  employees  subscribed 
to  this  stock  issue,  which  we  consider  very  favorable.  At  the  end  of  the  year  1295  subscribers 
retain  their  subscriptions  for  4250  shares  of  Common  and  2 1 6  shares  of  Preferred  Stock,  on  which 
they  are  paying  in  regular  installments  $3.00  monthly  on  each  share  of  stock.  82  employees 
have  paid  their  subscriptions  in  full.  194  employees  have  for  various  reasons  cancelled  their 
subscriptions. 

The  unpaid  balances  of  the  employees'  subscriptions  on  December  3 1st,  1 92 1 
amounted  to $480,572.76 

The  Company  now  has  1 394  employees  on  its  list  of  Shareholders,  2  of  whom  are  on  the 
Pension  Roll. 

By  interesting  our  employees  as  shareholders  we  hope  to  accomplish  two  things: 

First:  To  give  the  employee  an  opportunity  to  become  a  partner  in  our  enterprise  by 
gradually  accumulating  a  substantial  stock  interest,  and  through  that  sharing  in  the  profits  of 
his  own  labor  as  well  as  that  of  his  fellow  employees. 

Second:  Putting  the  Company  on  a  safer  and  firmer  basis  since  we  now  have  1394  partners 
who  have  the  interests  of  the  Company  at  heart  and  will  give  us  their  best  eflTorts  to  promote 
the  Company's  welfare.  In  doing  this  we  are  following  the  tendency  of  the  times  and  the  example 
set  by  numerous  other  large  industrial  concerns. 

CANADIAN    COMPANY 

Our  Canadian  Company  reports  a  falling  off  both  in  Sales  and  Profits  for  the  year.  The 
demand  for  our  product  has  been  very  light  and  we  have  been  able  to  operate  the  Plant  only 
with  a  reduced  force  and  on  part  time.  The  earnings  for  the  year  are  not  taken  over  on  our 
books  and  therefore  not  included  in  our  Profit  and  Loss  Statement. 

IN    GENERAL 

XWiile  the  results  of  our  1921  business  were  not  as  good  as  we  expected  we  feel  by  com- 
parison with  other  industries  that  we  have  done  very  well.  We  earned  and  paid  our  regular 
dividends  on  Preferred  and  Common  Stock,  and  increased  the  Surplus  Account  $1,124,503.90. 

If  the  long  looked  for  revival  in  building  occurs  during  1922  we  are  in  position  to  meet 
the  demands  that  may  be  made  on  us  and  to  largely  increase  the  output  and  sale  of  "^Xondw^T 
Products' 

Respectfully  submitted. 

For  the  Board  of  Directors, 


0Xju^  ,  6cXx^«V#  President. 


1648  CORPORATE  FORMS  [Bk.  IV- 

The  following  extract  from  the  1922  annual  report  of  the 
United  States  Steel  Corporation  shows  the  detail  into  which 
annual  reports  of  the  larger  corporations  go  on  some  points. 
This  report  was  submitted  to  the  stockholders  of  the  company 
by  the  chairman  of  the  board. 

Form  263.    Report  on  Employees  and  Pay-RoUs 

The  average  member  of  employees  in  the  service  of  all  companies  during  the 
year,  and  the  total  salaries  and  wages  paid  in  comparison  with  corresponding  results 
for  the  preceding  year,  were  as  follows: 

1921  1920 

EMPLOYEES  OF —  NUMBER  NUMBER 

Manufacturing  Properties 133,963  200,991 

Coal  and  Coke  Properties 22,451  25,889 

Iron  Ore  Properties 11,183  "iSi? 

Transportation  Properties 20,010  24,643 

Miscellaneous  Properties 4,093  4,305 

Total 191,700  267,345 

Total  Salaries  and  Wages  Paid $332,887,505        $581,556,925 

Average  Earnings  per  Employee  per  day  during  1921 : 
All  employees,  exclusive  of  General  Administrative 

and  Selling  force $5.61  $6.96 

Total  employees,  including  General  Administrative 
and  Selling  force $5-73  $7.00 

In  many  corporations,  as  stated  earlier  in  the  chapter,  the 
treasurer  makes  no  independent  report,  the  president's  report 
covering  the  general  affairs  and  condition  of  the  corporation, 
including  its  finances,  together  with  any  plans  for  the  future. 
Where  but  one  formal  report  is  made  to  the  stockholders  and 
this  report  is  made  by  the  president,  the  treasurer  or  comptroller 
will  of  course  supply  the  material  for  the  financial  portion  of  the 
statement.  When  independent  reports  are  submitted  to  the 
stockholders  by  the  president  and  the  treasurer,  the  individuals 
making  these  reports  should  work  in  sufficiently  close  touch  to 
prevent  any  serious  overlapping. 

When  the  treasurer  or  comptroller  makes  an  independent 
aimual  report  to  the  stockholders,  he  should  include  in  it  such 
financial  details  as  the  directors  deem  expedient  for  the  stock- 


Ch.  27]  REPORTS  1649 

holders  to  know,  or,  to  express  it  otherwise,  all  such  financial 
details  as  will  be  of  interest  to  the  stockholders,  and  which  will 
not  by  their  publication  injure  the  company's  business. 

The  treasurer's  report  may  be  informal,  merely  covering  the 
general  financial  results  of  the  year's  work.  Or  it  may  be  a 
more  or  less  detailed  statement  of  the  company's  financial  con- 
dition. Almost  always  it  takes  the  form  of  an  income  statement 
followed  by  a  complete  balance  sheet. 

The  following  income  statement  of  the  Western  Electric 
Company  is,  as  will  be  noted,  issued  by  the  comptroller  of  the 
company.  It  appears  in  connection  with  the  president's  annual 
report,  but  is  not  incorporated  with  that  report.  It  is  a  highly 
condensed  statement,  merely  showing  the  figures  of  greatest 
interest  to  the  stockholders. 

Form  264.    Treasurer's  or  Comptroller's  Report — Statement  of 
Earnings 


WESTERN  ELECTRIC  COMPANY, 

Incorporated 

Including  the  owned  subsidiaries, 
Western  Electric  Company,  Incorporated,  of  Delaware 
Western  Electric  Company,  Incorporated,  of  California 

Earnings  for  Twelve  Months  Ending  December  31,  192 1 

Sales $189,764,814 

Other  Income 2,892,499 

$192,657,313 

Cost  of  Merchandise $168,565,875 

Expenses 12,207,613 

Taxes 1,717,488  182,490,976 

Available  for  Interest  and  Dividends $  10,166,337 

Interest  Paid  and  Amortization  of  Bond  Discount.  $    5,842,340 
Dividends:    On  Common  Stock,  $10.00  per  share, 

350,000  shares  outstanding 3,500,000  9,342,340 

Balance  carried  to  Common  Stock $       823,997 

R.  H.  Gregory, 
Comptroller 


1650  CORPORATE  FORMS  [Bk.  IV- 

Form  265.    Treasurer's  or  Comptroller's  Report — Balance  Sheet 

Balance  Sheet  December  31,  1921 


Assets 

Real  Estate  and  Buildings $19,354,501 

Machinery  and  Equipment 26,215,335 


Total  Plant .VfiSd^' ^  45,569,836 

Merchandise $  28,978,025 

Cash 13,262,880 

Bills  Receivable 779,019 

Trade  Acceptances 573,474 

Marketable  Securities 833,268 

Accounts  Receivable 39,035,927 

Total  Current  Assets 113,462,593 

Trustees,  Employees'  Bond  Purchase  Plan 465,464 

Sundry  Investments 2,315,471 

International  Western    Electric     Company,     Incorporated,    of 

Delaware 1 7,988,053 

Grand  Total $179,801,417 


Liabilities 

Preferred  Stock,  7%,  500,000  Shares  Authorized, 
None  Issued. 

Common  Stock,  500,000  Shares  Authorized,  350,000 
Shares  Issued,  No  Par  Value $  58,773,450 

First  Mortgage  Bonds,  5%,  1922 15,000,000 

Convertible  Gold  Bonds,  7%,  1925 28,600,000 


Total  Capital  Liabilities $102,373,450 

General  Bills  Payable $29,050,000 

Trade  Acceptances  and  Bills  Receivable  Discounted .  448,456 

Accounts  Payable 13,586,093 

Total  Current  Liabilities 43,084,549 

Reserve  for  Depreciation  on  Plant $27,924,413 

Reserve  for  Employees'  Benefit  Fund 1,600,000 

Reserve  for  Contingencies 4,819,005 

Total  Reserves 34,343,418 


GiiAND  Total $179,801,417 


R.  H.  Gregory, 
Comptroller 


Ch.  27]  REPORTS  165 1 

The  foregoing  balance  sheet  is  also  presented  to  the  stockhold- 
ers of  the  Western  Electric  Company  by  its  comptroller,  showing 
the  assets  and  liabilities  of  the  company  as  of  December  31,  192 1. 

In  the  larger  corporations  there  are  usually  one  or  more 
standing  committees  appointed  from  the  board  of  directors,  such 
as  the  executive  committee  which  exercises  the  general  authority 
of  the  board  in  the  interim  between  its  meetings,  and  the  finance 
committee  which  has  general  supervision  of  the  financial  affairs 
of  the  company.  The  standing  committees  do  not  usually  report 
to  the  stockholders,  their  reports  being  made  to  the  board  of 
directors  and  the  matters  under  their  supervision  being  usually 
covered  by  the  president's  and  the  treasurer's  reports  respec- 
tively. 

There  is  no  special  form  for  committee  reports.  A  clear 
statement  of  what  they  have  accomplished,  addressed  to  the 
stockholders  or  the  directors  as  the  case  may  be,  and  signed  by 
the  members  of  the  committee  or  by  the  chairman  for  the  com- 
mittee, is  all  that  is  required. 

A  committee  report,  unless  of  considerable  length,  is  usually 
presented  and  read.  If  too  lengthy  to  permit  of  this,  and  of 
sufficient  importance  to  justify  the  expense,  it  is  printed  for 
distribution. 

Form  266.    Report  of  Committee  on  By-Laws 

TERREBONNE  CEMENT  COMPANY 
Report  of  Committee  on  By-Laws 

To  the  Stockholders  of  the 

Terrebonne  Cement  Company 

Gentlemen: 

Your  committee  appointed  at  the  last  annual  meeting  of  the  stockholders  to 
report  any  needed  modification  in  the  By-laws  of  this  Company,  begs  to  submit 
the  following: 

1.  We  would  recommend  the  addition  of  a  by-law  providing  for  an  Executive 
Committee,  to  consist  of  three  members  of  the  Board  of  Directors,  such  Committee 
to  have  full  control  of  the  general  business  affairs  of  the  Company  in  the  interim 
between  meetings  of  the  Board. 

2.  We  would  recommend  that  the  present  by-law  relating  to  the  regular  meet- 


1652  CORPORATE  FORMS  [Bk.  IV- 

ings  of  the  Board  of  Directors  be  so  changed  as  to  provide  for  quarterly  meetings 
instead  of  monthly  meetings  as  at  present. 

3.  We  strongly  disapprove  of  the  suggested  amendment  to  the  by-laws  whereby 
the  president  is  given  authority  to  sign  checks,  as  we  believe  such  change  to  be  not 
only  unnecessary  but  against  the  interests  of  the  Company. 

Respectfully  submitted, 

James  F.  Gough, 
Harkness  H.  Lewis, 
Oliver  H.  Simpson, 

Committee  on  By-laws 
New  York  City, 

January  15,  1922 


CHAPTER  XXVIII 
THE  CORPORATE  CALENDAR 

The  corporate  calendar  is  an  orderly  statement  of  the  impor- 
tant corporate  formalities  that  must  be  attended  to  at  fixed 
periods,  so  arranged  that  the  secretary  may  at  any  time,  by  a 
mere  glance,  see  just  what  corporate"  duties  require  his  attention. 

The  amount  of  detail  entered  on  the  corporate  calendar  will 
vary  according  to  the  preference  of  the  particular  secretary,  from 
a  mere  skeleton  outline  of  the  reports  and  notices  required  by 
the  statutes  and  by-laws,  to  a  fairly  complete  digest  of  corporate 
procedure.  It  is  advantageous  to  enter  reasonably  full  details, 
as  much  subsequent  research  may  thereby  be  avoided. 

The  corporate  calendar  is  frequently  entered  in  the  minute 
book.  More  conveniently  it  is  prepared  on  a  special  card  or 
cards,  or  on  a  desk  calendar,  in  either  case  so  placed  or  hung  that 
it  is  plainly  in  sight.  Or  if  the  minute  book  plan  is  preferred, 
a  small  skeleton  calendar  or  "tickler"  may  be  prepared  in 
addition,  which,  kept  on  the  desk,  will  call  attention  to  the  dates 
upon  which  the  calendar  in  the  minute  book  should  be  consulted. 

The  calendar  which  follows  is  given  merely  to  show  the 
general  plan  and  the  matter  which  is  usually  included.  It  is 
arranged  for  a  New  York  corporation  having  its  principal  place 
of  business  in  the  City  of  New  York  and  holding  its  annual 
meeting  of  stockholders  on  the  third  Wednesday  of  January  at 
10:30  A.M.,  with  quarterly  meetings  of  directors  on  the  third 
Thursday  of  January,  April,  July,  and  October,  at  4  p.m.  Its 
by-laws  require  ten  days'  notice  of  annual  meetings,  and  five 
days'  notice  of  directors'  meetings.  Its  stock  book  is  closed 
fifteen  days  before  the  annual  meeting. 

It  will  be  noticed  that  under  this  arrangement  the  January 

1653 


i6S4 


CORPORATE  FORMS 


[Bk.  IV- 


directors'  meeting  will  usually  fall  on  the  day  following  the  annual 
meeting  at  which  directors  are  elected.  If,  then,  this  election  is 
duly  held,  the  regular  notice  of  the  directors'  meeting  is  of  no 
effect  as  to  the  newly  elected  directors,  and  if  the  by-laws  are 
mandatory  as  to  notice,  the  meeting  must  be  postponed  or 
omitted,  or  the  secretary,  disregarding  the  notice  already  given, 
may  provide  for  the  meeting  of  the  board  on  the  proper  date 
by  means  of  a  call  and  waiver  signed  by  all  the  newly  elected 
directors. 

In  the  calendar  which  follows,the  date  for  each  corporate  act, 
as  filing  reports,  payment  of  taxes,  etc.,  is  in  most  cases  entered 
fifteen  days  in  advance  of  the  last  day  allowed  by  law,  while  a 
memorandum  is  also  entered  as  a  precautionary  measure  on  the 
last  day.  Thus,  a  report  that  may  be  deferred  if  desired  until 
the  31st  day  of  January,  is  entered  on  the  calendar  under  date  of 
January  16.  This  is  a  matter  that  may  be  varied  to  suit  the 
individual.     ...  .   -    'v    .'■..>   ....    ;       ....  .  ..^.  ....,.;-    .....     . 

Form  267.    Corporate  Calendar  (New  York)      ■mo  'ru' 


ill    \rjM:< 


January 


2, 
4. 


Corporate  Calendar 

of  the  -;f)fltii<j-.i 

FARWELL  MACHINE  WORKS 
of  New  York  City 


ifibnoffis  an 


Last  Day  for  payment  of  State  Income  Tax,  or  30  days  after  notice  of 

assessment,  if  notice  is  given  after  December  31. 
Close  Transfer  Books  for  annual  meeting  of  January  18,  1922. 
First  Publication  of  notice  of  annual  meeting  of  stockholders  in 
..accordance  with  Sec.  25  of  the  Stock  Corporation  Law.     (Publica- 
"  tion  may  be  dispensed  with  if  waived  in  writing  by  every  stock- 
•<    '    holder  of  the  corporation.) 
8.  Mail  Notice  of  annual  meeting  to  each  stockholder  of  record  at  his 

last  known  post-office  address. 
10.  Second  Publication  of  notice  of  annual  meeting  of  stockholders. 
14.  Notify  Directors  of  meeting  to  be  held  January  19.     If  Directors  are 
elected  at  annual  meeting  (January  18),  this  notice  will  be  vitiated 
as  to  all  directors  elected  at  such  meeting  and  must  be  replaced  by 


Ch.  28] 


THE  CORPORATE  CALENDAR 


1655 


FcWuary 


June 


July 


IS- 


16. 


31' 


13- 

14. 

March 

15- 

April 

14, 

15- 

19. 

May 

I. 

waiver  of  notice  signed  after  election  by  all  the  newly  elected 

directors. 
Franchise  Tax  Payable.     Must  be  paid  before  February  14.     Based 

upon  November  report  to  State  Tax  Commission.     Checks  should 

be  made  payable  to  State  Treasurer.     (This  is  payable  only  by 

realty,  holding,  and  public  service  corporations.) 
Annual  Report  to  State  officials.     Must  be  filed  during  January,  and 

not  later  than  January  31,  with  Secretary  of  State.     No  filing  fees. 

Blanks  not  supplied  by  officials.     No  penalty  incurred  for  omission 

of  the  report  unless  such  filing  is  requested  by  some  stockholder  or 

creditor  of  the  Company,  and  not  then  if  the  report  is  filed  within 

30  days  after  the  request  is  made. 
Annual  Meeting  of  stockholders  at  10.30  a.m.     (Held  pursuant  to 

notice  sent  out  January  8.) 
Directors'  Meeting  at  4  p.m.     If  directors  were  elected  at  annual 

meeting,  waiver  of  notice  should  be  signed  by  each  new  director. 
Last  Day  for  filing  annual  report. 

Federal  Income  Tax  Report  must  be  filed  on  or  before  March  15. 

Prepare  data. 
Last  Day  for  payment  of  State  Franchise  Tax  without  penalty. 


Last  Day  to  file  Federal  Income  Tax  Report, 
must  be  paid  at  this  time. 


One-fourth  of  the  tax 


IS- 


I. 

14- 
20. 

31- 


September 


IS- 


Notify  Directors  of  meeting  to  be  held  April  19. 

Tax  Bill  for  Taxes  on  any  real  estate  in  New  York  City  should  be 

secured  from  the  Receiver  of  Taxes,  in  the  borough  where  the 

property  is  situated. 
Directors'  Meeting  at  4  p.m. 

New  York  City  Taxes  Payable.  Statement  of  amount  may  be 
obtained  from  Assessor's  ofiice.  One-half  must  be  paid  before 
May  31.  One-half  of  taxes  on  real  property  may  be  deferred  till 
November  i  next. 

New  York  City  Taxes.     If  not  paid,  interest  at  7%  from  May  i  will 

be  added  on  all  Personal  Taxes  and  the  first  half  of  the  Real  Estate 

Tax. 
Second  Payment  of  one-fourth  of  Federal  Income  Tax  due  on  or 

before  this  day. 
State  Income  Tax  Report  must  be  filed  on  or  before  July  i  with  the 

State  Tax  Commission.     The  tax  will  be  due  January  i  in  next 

year. 

Last  Day  to  file  State  Income  Tax  Report. 

Notify  Directors  of  meeting  to  be  held  July  20. 

Directors'  Meeting  at  4  p.m. 

Last  Day  to  file  return  for  United  States  Capital  Stock  Tax.    This 

tax  is  payable  within  10  days  after  receipt  of  Notice  of  .Assessment 

from  Collector  of  Internal  Revenue  for  district. 

Federal  Income  Tax.  Last  day  to  pay  third  quarter  of  Tax  to 
Collector  of  Internal  Revenue  for  District. 


I6S6 


CORPORATE  FORMS 


[Bk.  IV- 


Oclober 


November 


December 


I.  New  York  City  Real  Estate  Tax.  The  books  showing  assessed  value? 
are  open  to  inspection  at  offices  of  Department  of  Taxes  and 
Assessments  in  each  borough.  AppHcations  for  corrections  must 
be  made  on  forms  furnished  by  Department  on  or  before  November 

IS- 
13.  Notify  Directors  of  meeting  to  be  held  October  19. 
19.  Directors'  Meeting  at  4  p.m. 

I.  Real  Estate  Tax.     Second  half  of  New  York  Real  Estate  Tax  due. 

Must  be  paid  before  30th. 

Franchise  Tax  Report.     Must  be  sent  in  for  realty,  holding,  and 

public  service  corporations  on  or  before  November  15.     Blanks 

furnished  by  and  report  made  to  State  Tax  Commission.     No 

filing  fees.     Penalty  may  be  incurred  by  failure  to  make  this  report. 

15.  Last  Day  for  filing  application  for  revision  of  real  estate  assessment. 

30.  Last  Day  for  payments  of  second  half  of  Real  Estate  Tax. 

I.  Real  Estate  Taxes.  If  second  half  of  Real  Estate  Tax  is  not  paid, 
7%  interest  will  be  added  from  November  i. 

15.  Federal  Income  Tax.     Last  quarter  of  tax  is  due. 

16.  State  Income  Tax  payable  on  or  before  January  1. 


INDEX 


Acceptances  (See  "Trade  Acceptances") 
Accounting, 

No-par  value  stock,  129 

Relation  to  finance,  557 
Accounts  (See  also  special  kinds  of  accounts) 

Corporate, 

Nature  of,  1033 
Peculiarity  of,  1036 

Juggling  of,  979 
Accounts  Payable, 

Credit  secured  on,  858 
Accounts  Receivable, 

As  collateral  security,  864 

Purchaser  of,  71S 

Stock  not  paid  in  full  as,  1076 
Acknowledgment, 

Charter  application,  208 

Corporate,  form,  1605 
Address,  Corporate, 

Not  necessary  on  charter,  190 
Adjournment, 

Annual  meeting,  350 

Directors'  meetings,  367 

Special  meeting,  357 
Administrators, 

Stock  transfer  by,  31S,  3i7.  319 

Votes,  13s 
Advertising, 

Sale  of  investments,  824 
Advertising  Agencies, 

Financial  plan,  734 
Affidavits, 

Forms,  1598-1605 
Affiliated  and  Subsidiary  Corporations, 
593 

Accounting,  when  consolidating,  1278-1295 

Collateral  trust  bonds,  632 

Consolidated  balance  sheet,  1373- 1383 
(For  full  list  of  subjects  see  "Consoli- 
dated Balance  Sheet") 

Dividends  for  holding  company,  1381 

Intercompany  ownership  of  stock  on  con- 
solidated balance  sheet,  1376 

Ownership  of  bonds  on  consolidated  bal- 
ance sheet,  1376 


Affiliated  and  Subsidiary  Corporations 
— Continued 

Status  of,  1269 

Valuation  of  stock  of,  1136 
After- Acquired  Property  Clause,  615 
Agent     (See    also    "Transfer    Agents    and 
Registrar") 

Defined,  4 

Law  of  principal  and,  4 

May  be  removed  by  directors,  149 

Signature, 
Form,  1587 

Stock  transfer  by,  3x5,  317,  318 
Agreement, 

Directors',  for  consolidation,  1286 

Incorporation,  44,  11 72 

Syndicate,  842 

To  purchase  stock  not  a  subscription   to 
stock,  37 

Voting  trust. 
Form,  1517 
Amalgamation  (See  "Consolidation") 
American     Hardwood      Manufacturers' 

Association,  521 
American  Locomotive  Company,  944 
American  Woolen  Company, 

Underwriting  plan,  846 
Amortization, 

Anticipation  of  redemption  dates,  1222 

Bond  discount,  12 16- 12  24 

Bonds  outstanding  method,  1220 

Effective  rate  method,  1218 

Equal  instalment  method,  1219 

Leaseholds,  1265 

Operation  of  various  methods  1222 

Principles,  12 16 

Sinking  fund  methods,  656-659 
Annual  Tax  (See  "Franchise  Tax") 
Annuities, 

Sinking  fund,  calculation,  1233-123S 
Application,  Charter,  208-211 
Appreciation, 

Basis  of  capitalization,  664 

Book  entries,  1060 

Objection  to  book  entry,  1062 


1657 


i6s8 


INDEX 


Appropriations  and  Estimates  (See  "Bud- 
gets") 
Arizona, 

Incorporation  in,  57 
Articles  of  Association  (See  "Charter") 
Assets, 

Capital  (See  below  under  "Fixed") 
Current, 

Defined,  688 

Investments  in,  560 

Ratio  of,  to  current  liabilities,  698 
Distribution  of,  stockholders'  rights,  137 
Fictitious  or  watering,  1056 
Fixed. 

Defined,  663 

Investments  in,  560 

Surplus  from  sale  of,  910 
Intangible, 

Basis  of  capitalization,  665 

Depreciation,  876 
Liquidity  of,  as  affecting  working  capital, 

713 
Preferred,  91,  607 
Purchase  of,   to  form   consolidation,   518, 

1278,  1289 
Purchased  for  capital  stock,  1060 
Quick,  defined,  688 

Relation  between,  and  security  issues,  72s 
Revaluation,  surplus  from,  911 
Sale  of. 

Consent  of  stockholders  required,  142 

Profit  or  loss  on  realization,  1298 
Secret,  1052 

Surplus  does  not  represent  specific,  1045 
Transfer  of. 

In  consolidation,  1286,  1289 

In  dissolution,  1300 
Valuation, 

Book  values,  1060 

Partnerships  incorporating,  499 
Wasting, 

Depletion  reserves,  1054 

Dividends  declared  out  of  capital  stock, 
424 

Sinking  funds  for  bond  redemptions,  660 
Working  (See  above  under  "Current") 
Assignment  of  Stock  (See  "Stock  Transfer") 
Attorney  (See  "Counsel") 
Auditing, 

Annual,  for  protection  of  minority  stock- 
holders, 491,  492 
Retiring  treasurer  responsible  for  audit  of 

books,  383 
Stock  ledger,  1073 
AiTDiTOR,   By-laws,  257 
Duties  and  functions,  390 
Relation  to  treasurer,  389 


B 


Baby  Bonds,  620 

Balance    Sheet    (See    also    "Consolidaietl 
Balance  Sheet") 
Forms,  i3S7-i36o,  1363,  1650 

Bonds  on,  1370 

Capital  stock  on,  1360 

Federal  Reserve  Bank, 
Form,  1357-1360 

Good-will  on,  1371   ' 

No-par  stock  on,  1361 

Partnership  incorporated,  11 83 

Reserves  on,  1368 

Sinking  fund  on,  1370 

Subscription  to  stock  on,  1361 

Surplus  on,  1038,  1364-1367,  1369 
Baltimore  and  Ohio  Railroad, 

Exploitation  of,  979 
Bank  Deposits, 

By-Laws,  262 
Form, 1472 

Corporate  depository   delegated   by   direc- 
tors, 283 
Bankers  (See  also  "Investment  Bankers"), 

As  promoters,  773 
Bankruptcy  (See  also  "Insolvency") 

Involuntary,  1004 

Nature  of,  1003 

Types  of,  1004 

Voluntary,  1004 
Banks, 

Capitalization  of,  73 

Charters,  169 

Dividends,   accounting  procedure,    1154 

Loans  by,  858-866 

Promoter's    connection    with    for    prelim- 
inary financing,  765 

Short-term  notes  handled  by,  647 

Sources  for  capital  funds,  792 
Betterments, 

Capital  invested  in,  942 

Cause  of  insolvency,  996 

Income  statement,  879-882 
Bills  of  Lading, 

As  collateral  security,  863 
Board  of  Directors  (See  "Directors") 
Bond  House, 

Liability  of,  826 

Sale  of  Securities,  823-829 
Bondholders, 

Assessment  of,  1020 

Index,  1 1 87 

Interests  in  reorganization,  ion 
Bonds  (See  also  special  kinds,  as  "Debenture 
Bonds,"  "Mortgage  Bonds,"  etc' 
Forms,  1619-1624 


INDEX 


I6S9 


B  oNDS — Continued 
Accounting, 

Accounts  used,  1189 

Amortization,  1216-1224 

Authorized  account,  11 90 

Balance  sheet  entry,  1370 

Coupons,  1202 

Discount,  1213-1224 

Discount  account,  1192 

Income  from  investments,  121 2 

Instalment  payments,  1196 

Interest  account,  1192 

Interest  accrued,  1204 

Interest  charged  to  construction  account, 

I3II 

Interest  liability,  recording,  1203 
Interest  on  guaranteed  bonds,  1209 
Interest  on  income  bonds,  1210 
Interest  on  registered  bonds,  1205 
Interest  on  special  issues,  12 10 
Interest  on  treasury  bonds,  1208 
Interest  on  two  or  more  issues,  1206 
Premium  account,  1190,  1213-1223 
Records,  11 86,  1202-1212 
Redemption,  1247-1257  (See  below  under 

"Redemption") 
Sale  entry,  1195 
Single  bond  account,  1 191 
Unissued  account,  1190 
Amortization,  1216-1223 
As  borrowed  capital,  596 
As  collateral  security,  862 
Authorization,  449 

Account,  1 1 90 
Baby,  620 
Certification,  453 
Classification,  461-465,  624-646 
Collateral  trust,  464,  631 
Redemption,  1254 
Sale,  1 198 
Common  law,  449 
Compared  to  preferred  stock,  88 
Convertible,  463,  642-645 

Redemption,  1254 
Coupon,  448,  452,  622 
Form, 1621 
Interest  record,  1188,  i20« 
Records  for,  11 86,  1202 
Debenture  (See  "Debenture  Bonds") 
Deeds  of  trust,  453-456,  615 

Forms,  1625-1632 
Defaulted  payments,  1257 
Denominations,  619 
Discount  and  premium. 
Accounting,  1191,  1192,  1213-1334 
Accounting  entries,  1 2 1 7 
Amortization,  1216-1223  ■" 


Bonds — Continued 

Discount  and  Premium — Continued 
Anticipation  of  redemption  dates,  1222 
Bonds  outstanding  method,  1220 
Capitalization,  684 
Effect  of  market  prices  on,  1221 
Effective  rate  method,  12 18 
Equal  instalment  method,  1 2 19 
Nature  of,  12 14 
Operation      of      various      amortization 

methods,  1223 
Repurchase  of  own  bonds  at,  1241,  1251, 
Dividendspaidby, 433,435,1153  [1254 

Due  date,  stated  on  face,  1247 
Equipment  trust,  465,  629-631 
Redemption,  1255 
Sale,  1200 
Face  value,  619 
Gold,  463,  621 
Guaranteed,  464 

Interest  record,  1209 
Redemption,  1255 
Sale,  1 197 
Income,  463,  638-641 

Interest  record,  12 10 
Indemnity  (See  "Indemnity  Bond") 
Information  stated  on,  453 
Interest,  622 
Account,  1 192 
Accounting,  1202-1212  (See  above  under 

"Accounting") 
Accrued,  1193,  119s,  1204  [1213 

Accrued,  adjustment  of,  in  selling  price. 
Charged  to  construction,  684,  12 11 
Guaranteed  bonds,  1209 
Income  bonds,  12 10 
Income   from,  12 12 
Methods  of  paying,  1202 
In  two  or  more  issues,  1206 
Records,  1186,  1188,  1202 
Registered  bonds,  1205 
Special  issues,  12 10 
Treasury  bonds,  1208 
Issued, 

Accounting  entry  for  sale  of,  1 19s 
At  time  of  organization,  63 
Defined,  1185 
Nominally  and  actually,  1185 


Closed  or  open,  617 
Consolidations,  1287 
Expenses,  1213 
Interest  on  special,  12 10 
Interest  on  two  or  more,  1206 
Size,  618 
Terms  of,  1185 
To  secure  capital,  76 


i66o 


INDEX 


B  ON  Ds — Continued 

Junior  lien,  462,  62s 
Lost  stock  certificate,  30S 
Maturity,  621,  658 

Due  date  stated  on  face,  1247 
Failure  to  meet,  998,  1257 
Names  of  misleading,  624 
Nature  of,  447,  612,  618 
Outstanding, 
Defined,  1185 

Nominally  and  actually,  1185 
Retirement  in  consolidation,  1292 
Participating,  64s 
Payable  in  foreign  currency,  620 
Premium   (See  above  "Discount  and  Pre- 
mium") 
Price,  450 

Purchase  and  sale   (See  also  above  under 
"Discount  and  Premium") 
Accounting,  11 94-1 201 
Adjustment  of  accrued  interest,  1213 
At  par  and  accrued  interest,  1195 
Collateral  trust  bonds,  1 198 
Discount  entries,  1214 
Equipment  trust  bonds,  1200 
Expenses  of  issue,  12 13 
For  sinking  funds,  1241,  1251 
Guaranteed  bonds,  ii97 
In  instalments,  1 196 
Mortgage  bonds,  1194 
Premium  entries,  12 14 
Serial  bonds,  1 200 
Purchase  money,  465 

Redemption,  460   (See  also  "Redemption 
Funds") 
Accounting  for,  1216-1224,  1247-1257 
Anticipating  dates,  1222 
Calling  in,  by  lot,  1248,  1250 
Collateral  trust  bonds,  1254 
Convertible  bonds,  1254 
Default  in  payment,  1257 
Equipment  trust  bonds,  1255 
Guaranteed  bonds,  1256 
Methods,  1247 
Refunding  at  maturity,  1247 
Refunding  bonds,  1252 
Repurchase  and  cancellation,  1241,  1251 
Serial  bonds,  1253 
Short-term  notes,  1255 
Sinking  fund,  457,  653-662,  1247-1250 
Refunding,  redemption,  1252 
Register, 

Form,  1638 
Registered,  448,  622,  1187 
Interest  record,  1 188,  12OS 
Recorded  for,  11 86 
Transfer  record,  1187 


Bonos — Continued 

Rights  of  holders,  448,  459,  618 

Salability  of,  618 

Sale,  458 

Accounting,  1194-1201 

Secured,  624-633 

Security  for,  624 

Serial,  656,  658 

Redemption  of,  1253 
Sale,  1200 

Statutory  law,  449 

Stockholders'  assent  to  issue,  449 

Subscriptions,    1 196    (See  also   "Subscrip- 
tions") 

Terminal,  464 

Transfer,  1187 

Treasurer's  (See  "Treasurer,  Bond") 

Treasury  (See  "Treasury  Bonds") 

Trustee's  certificate. 
Form,  1623 

Unissued, 

Account  for,  1190 

Accounts,  1 1 90 

Sometimes  called  "treasury  bonds,"  1185 

Unsecured,  634-646 

Valuation,  460 

Vendor  or  transfer  against,  liability  of,  458 
Bondsmen, 

Liability  of,  408 

Personal,  405 

Surety  company,  406 
Bonus  Stock,  93 

Account,  1 140 

As  a  commission,  11 74 

Accounting  treatment,  11 77 

No-par  value,  advantages,  1 141 
Book  Value  (See  "Valuation") 
Books, 

Corporate,  369,  1033 

Minute  book,  369-374 
Books  of  Account  (See  also  special  kind  as 
"Journal,"  "Ledger,"  etc.) 

Combination  record,  1035 

Inspection  of,  by  stockholders,  137,  484 

Legal  requirements,  1034 

List  of,  103  s 

Manufacturing  corporation,  1157 

Mining  corporation,  1161 

Requirements,  1034,  iiS7 

Stock  transfer,  by-laws,  225 

Subsidiary,  1035 

Treasurer's  duties  in  regard  to,  381 
Broker, 

Liability  of,  826 

Sale  of  securities,  823-829 
Budgets,  922-935 

Advantages,  923,  934 


INDEX 


i66i 


B  UDGETS — Continued 
Basis  for,  930 

Cash  receipts  and  expeftditures,  931,  933 
Defined,  922 
Expenses,  932 
Flexibility,  928 

Income,  932  1 

Income  and  expenditure,  931 
Monthly,  929 
Plan  of,  561 
Procedure,  923-926 
Restrictions  imposed  by,  928 
Sales  estimates,  926 
Secures  singleness  of  purpose,  928 
Yearly,  929 
Building  Construction, 
Financing,  766 
Interest  paid  on  bonds  during  period  of 

construction,  684,  1211 
Business  Corporations, 

Defined,  167 
Business  Organizations, 

Forms,  563 
Dependent  on  the  law,  3 
By-Laws,  id 

Forms,  1463- 1 473 
Adoption,  220 

Directors'  power,  150,  19s,  217,  218,  244 

First  stockholders'  meeting,  273 
Amendments,  264,  371 

Form,  1466 
Arrangement  and  classification  of,  219 
Assistant  officers,  237 
Assistant  treasurer,  3S0 
Auditor,  257 
Bank  deposits,  262 
Books  of  account  called  for,  1034 
Certificate  of  transcript. 

Form,  1602 
Changes  in,  director's  power  to  make,  19s 
Committees,  245-251 

Report,  form,  1651 
Contractual  feature,  264 
Copy  inserted  in  minute  book,  371 
Counsel,  256 

Delegation  of  authority,  258 
Directors,  235-244 
Directors'  meeting,  239-242 

Notices,  240 

Order  of  business,  244 
Dividends,  260,  420 
Election  of  directors,  232 
Election  of  officers,  242 
Ethics  of  contracts,  974 
Financial  committee,  387 
Financial  provisions,  260-265 
Functions  of,  215 


By-Laws — Continued 

Limitation  of  indebtedness,  261 
List  of  stockholders,  231 
Managing  officers,  255 
Officers,  252-259 
Penalties  for  enforcement,  263 
Power  to  make,  217 
Preferred  stock,  225 
Pre-incorporation  provisions,  44 
Preparation,  220 
President,  253 
Presiding  officers,  253 
Provisions,  216 

Provisions  inserted  in,  to  overcome  diffi- 
culties of  charter  amendment,  206 
Proxies,  234 
Removal  of  officers,  259 
Reserve  funds,  260 
Salaries,  258 
Seal,  corporate,  263 
Secretary,  254 

Standing  committees,  245-251 
Statutory  provisions,  217 
Stock,  222-227 

Fractional  share,  227 

Transfer,  224 
Stock  and  transfer  books,  225 
Stock  certificates,  222 

Loss  of,  226 

Stockholders,  228-234 
Stockholders'  meetings. 

Annual,  228-234 

Notices  of,  230 

Order  of  business,  234 

Presiding  officers  for,  230 
Stockholders'  rights  in  making,  141,  485 
Subject  matter,  216 
Sundry  provisions,  263 
Transfer  agent  and  registrar,  224 
Treasurer,  255,  377-381 
Treasury  stock,  226 
Vice-president,  253 
Voting,  231 


Calendar,  Corporate, 

Form, 1654 
California, 

Face    value    of    stock    not    discriminated 

against,  80 
Incorporation  in,  57,  58 
Unfavorable  laws  for  corporations,  53 
Voting  rights  provide  for  no  preference,  96 
Call, 

Special  meetings,  352,  360 


1 662 


INDEX 


Call  and  Waiver  of  Notice, 
Directors'  first  meeting,  277 

Form,  1507 
Directors'  special  meeting,  363 

Form,  1525 
Stockholders'  first  meeting,  268,  272 

Forms,  1501,  isjip 
Stockholders'  special  meeting,  353 

Forms,  1520 
Capital, 
Additional,  secured  byreorganization,  1018 
Borrowed  (See  also  "Loans") 
Forms,  854-866 

Advantages,  849 

Defined,  595 

Disadvantages,  852 

Ease  of  securing,  851  ' 

Risks  of,  852 

Rules  for,  853 

Sources  of,  851 
Defined:  69 

Fixed  (See  "Fixed  Capital") 
Owned,  defined,  595 

Partnership  a  disadvantage  in  securing,  567 
Requirements, 

Consolidations,  936 

Estimating,  686-696 
Sources  of, 

Assessment  of  security  holders,  1020 

Customers,  803 

Employees,  802 

For  small  enterprises,  797 

Funding  floating  debt,  1023 

Investing  institutions,  793 

Investing  public,  792 

Investment  associations,  794 

Profits,  791 

Sale  of  securities,  796,  799-822,  1019 

Speculative  public,  79s 

Stock  subscriptions,  791 

Stockholders,  799,  1020 

Surplus,  918 
Working  (See  "Working  Capital") 
Capital  Account, 
Nature  of,  1036 
Non-stock  corporation,  11 30 
Surplus,  1058 
Capital  Assets  (See  "Assets,  Fixed") 
Capital   Stock    (See   also    "Certificates   of 

Stock,"  "Common  Stock,"  "Dividends," 

"Preferred  Stock,"  "Retirement  Funds," 

"Stock    Transfer,"    "Treasury    Stock") 
Account, 

Formal  statement  upon  opening  books, 
1066 

Ledger  entry,  1072 

Manufacturing  corporation,  1158 


Capital  Stock — Conlinued 
Accounts — Continued 

Opening  entry,  1067 

Represents  investment  of  stockholders, 
1037 
Allotment    of,     incorporation     provisions, 

1173 
Amount  authorized,  journal  entry,  1067 
As  owned  capital,  596 
Assessments  on,  1059 
Authorized  account,  1068,  1083     . 

Not  used  for  no-par  stock,  H19 

Records,  1071 
Balance  sheet,  entry,  1360 
Basis  of,  79 

Basis  of  payment  for,  84,  1 139 
Bonus,  93,  1140,  1 174 

Account,  II 40 

Accounting  treatment,  1179 

Incorporation  provisions,  1 1 74 
Books,  287-295 

Forms,  1493-1497 

Certificate  book,  289 

Closing  of,  294 

Inspection  of,  292 

Ledger,  291,  107 1 

Statutory  rules,  292 

Subscription  ledger,  1080 

Transfer  book,  293 
By-law  provisions,  222-227 

Forms,  1463,  1466 
Charter  provisions,  187 

Special,  203 
Classifications  of,  85,  203,  489,  510 
Collateral  security,  307-309,  862 
Conversion  of  bonds  into,  1254 
Debenture,  634 
Debts  paid  in,  1136 
Defined,  69,  79,  664 
Discount  account. 

Entries  for,  1096,  1102 

Not  used  for  no-par  stock,  11 19 
Dividends,  152,    424.    433.    43S.   682,  90s 
(See  also  "Dividends") 

Accounting  procedure,  1x51 

No-par  value,  accounting  for,  1152 
Donated,  1063,  1106 

Accounting    entries,     1106-1112,     1162, 
1 179 
Effect  of  capitalization  on  sale  of,  71 
English  methods,  597 
Exchange  of  corporation's  own  for  other, 

1 138 
Exchanged  for  property. 

Action  of  directors,  282 

Action  of  stockholders,  275 

Proposal  form,  1508 


INDEX 


1663 


Capital  Stock — continued 
Face  value,  80 

Stated  in  charter,  187 

Form  of,  76 
Founders'  shares,  97,  599 
Fractional  share. 

By-laws,  227 

Transfer  of,  299,  328 
Full-paid,  84,  99-103,  222 

Accounting  methods,  1065-1075 

Transfer  rights,  309,  314 

Treasury  stock  as,  104 
Guaranteed,  91 

Holding  companies,  204,  322,  473-482 
Inter-company  ownership,  on  consolidated 

balance  sheet,  1376,  1380 
Issued,  83,  104 

Face  value,  84 

For  other  than  cash,  1157,  1161 
Issues,  consolidations,  1287 
Journal, 

Entries,  1065,  1084 

Subscriptions,  1084 
Ledger,  107 1 
Form,  1072 

Reconciliation  of,  1073 

Summary  of  accounts  used,  1083 
Lien  on,  310 
Mines,  424 
No-par  value,  81,  111-130  (For  complete 

index  see  "No-par  Value  Stock") 
Not  full-paid  at  once. 

Accounting  Methods,  1076,  1085 
Option  on. 

Form,  1512 
Original  issue,  conditions  of  issue,  1065 
Ownership  evidence,  81,  287 
Par  and  no-par  value  stock  issued  by  same 
Par  value,  [company,  1120 

Accounting  methods,  1063-1112 

Changed  to  no-par,  1122,  1309 
Partnership  incorporating,  499,  502-504 
Premium  account,  1097-1100,  11 19 

Not  used  for  no-par  stock,  11 19 
Price, 

Affected  by  dividend  rate,  669 

Affected  by  earning  pwwer,  666 
Purchase  and  sale  of. 

After    organization,    accounting    entry, 
1082 

By  one  corporation  from  another,  109, 
1136-1140 

Commission  on,  1134,  1174,  1179 

Discount,  1096 

Methods  of  payment,  1138 

Premium  on,  1097-1100 

Restriction  on,  513,  600 


Capital  Stock — Continued 
Records,  287-295 
Reduction  of,  1059 

In  reorganization,  1308-1310 
Rights,  136,  805-813 

Conditions  of  subscription  offer,  806 

Parity  value,  809 

Parity  value  when  quoted  ex-rights,  813 

Quoted  at  a  discount  and  premium,  811 

Selling  ex-rights,  812 

Trading  in,  807 

When  issued  basis,  807 
Salaries  paid  in,  11 35 
Subscribed  account,  1078,  1083 
Subscriptions  (See  "Subscriptions") 
Subsidiary  records,  1071 

Instalment  book,  1088-1095 

No-par  value,  1116 

Reconciliation  of,  1073,  1088 
Unissued,  83 

Not  a  treasury  stock,  104,  not 
Unissued  account,  1068,  1083 

Not  affected  until  certificates  are  issued. 

Not  used  for  no-par  stock,  11 19       [1078 
Records,  1071 
Unpaid, 

Stockholders'  liability,  144 

Transfer  rights,  309,  314 
Valuation,  subsidiary  corporations,  11 36 
Voting-trust,  470,  472 
Watered,  85,  99 
Capital  Stock  Tax,  30,  330 
Capitalization, 
Basis  of,  70,  664 

Appreciation  of  property,  664 

Earning  power,  73,  665,  667-673 

Intangible  assets,  665 

Investment,  666 
Bond  issues,  76 
Book  value,  676 
Defined,  69,  663 
Effect  of,  on  sale  of  shares,  71 
Form  ef,  76 
Good-will,  74,  676-681 
Initial  expenses  and  losses,  683 
Less  than  real  value,  72 
Partnership  incorporating,  499 
Speculative  features,  74,  78 
Surplus,  682 
Valuation,  73,  676 
Car  Trust  Bonds   (See  "Equipment  Trust 

Bonds") 
Cash, 

Basis  for  fund,  1226 

Borrowed  for  dividends,  900,  11 46 

Budget,  931,  933 

Ratio  of,  to  current  liabilities,  954 


1664 


INDEX 


Cash  Book, 

Entries,  11 70 
Cash  Payments, 

Dividends,  431,  433.  899,  1144 
Cash  Value, 

Capitalization  based  on,  71,  79 
Certificate  of  Incorporation  (See  "Char- 
ter") 
Certificates, 

Forms,  1598-1605 
Inspectors  of  elections. 

Form,  1556 
Trustee's  Bond, 
Form,  1623 
Certificates  of  Stock,  81 
Forms,  1485-1492 
Adopted  at  first  directors'  meeting,  280 
Assignment  and  transfer,  223,  296-301 
Book,  289,  1071 

In  charge  of  secretary,  290 
By-laws,  222 
Cancellation,  290 

Corporation  acquiring  stock  of  another,  323 
Corporation  selling  stock  to  another,  322 
Dollar- marked,  112 
Face  value,  112 
Errors  in  issuing,  290 
Fractional  share,  227 
Full-paid,  102 

Held  in  name  of  executor,  iiot  taxable,  327 
Indemnity  bonds  for  lost. 

Form,  161 7 
Issuance,  journal  entry,  1087 
Loss  of,  226,  304 
Negotiability  of,  82,  306 
New,  289,  298,  1074 
No-par  value,  127 

Not  a  final  evidence  of  ownership,  287 
Not  issued  until  subscription  paid  in  full. 
Preferred,  88  [1076 

Rights  of  owner,  223 
Signature  and  sealing,  223,  316,  392 
Stamps  on,  328 

Transfer  agent's  procedure,  303 
Transfer  form,  316 
Transfer  register  entries,  1 087 
Treasury  stock,  302 
When  not  issued,  288 
Chain  Stores, 

Expansion  plan,  940 
Charter,  10 

Forms,  1425-1462 
Amendments, 

Difficulty  overcome  by  including  certain 

provisions  in  by-laws,  205 
Procedure,  212 
Stockholders'  consent  to,  132.  141 


Charter — Continued 
Application,  170,  208 

Alterations,  211 

Approval  of,  209 

Certified  copies,  211 

FiUng  of,  210 

Signature  and  acknowledgment,  209 
Business  corporations,  168 
Capital  stock  provisions,  79,  187 
Common  law,  167,  170 
Common  stock  provisions,  188 
Consolidation,  1286 
Copy  inserted  in  minute  book,  370 
Corporate  stockholding,  204 
Cumulative  voting,  203    • 
Delaware, 

Form,  1430-1441 
Details  of,  170 
Directors,  192-198 
Early,  199 

Financial  institutions,  169 
General  provisions,  199 
Incorporators,  172-176 
Life-term  of  corporation,  191 
Limitation  on  indebtedness,  204 
Limitation  on  salaries,  205 
Minority  stockholders,  special  provisions 

for,  491 
Name,  172-176 
Nature  of,  165 
New  Jersey, 

Form,  1428-1430 
New  York, 

Form,  1425-1428  a- 

Not  a  franchise,  166 
Place  of  business,  190 
Precorporate  provisions,  44 
Preferred  stock  provisions,  87,  89,  90 
Principal  ofiice  location  stated  in,  190 
Public  utility  corporations,  168 
Purposes,  182-185 
Salary  limitations,  205 
Special  provisions,  197-207 

Forms,  1442-1462 
State  laws  must  be  followed,  166 
Stock  and  non-stock,  167 
Stock,  classification  of,  203 
Stockholders'  rights,  special  provisions,  139 
Surrender  of  old,   when  forming  consoli- 
dation, 1286 
Voting  provisions,  134 
Checks, 
Corporate, 

Form,  1588-1593 
Dividend,  438,  442,  1 143 
Indorsements, 
Forms,  1591 


INDEX 


1665 


Checks — Continued 

Signatures  on, 
Forms,  1588-1592 
Chicago  and  Alton  Railroad  Company, 

Exploitation  of,  987 
Chicago,  Rock  Island  and  Pacific  Rail- 
way Company, 

Financial  plan,  748 
Claflin,  H.  B.  Company, 
'      Reorganization,  1028 
Claims, 

Receiverships,  Accounting,  1327 

Settlement  of,  in  insolvency,  999 
Close  Corporations,  5x0-5x5,  584 

By-laws,  2x9 

Capital,  sources  of,  797 

Capitalization  of,  72 

Management,  5x1 

Nature  of,  5x0 

Profits,  apportionment  of,  5x1 

Restriction  of  stock,  5x3,  600 

Stockholders,  513 
Closing  of  Books, 

Annual,  X349 

Corrections  after,  1040 

Ledger,  13SI 

Partnerships  incorporated,  1x80,  11 82 

Procedure,  1350 

Profit  and  loss  account,  1352 
Collateral  Security, 

Accounting  entries,  X264 

Accounts  receivable,  864 

Bank  credit,  861 

Bills  of  lading,  863 

Lien's,  863 

Merchandise,  863 

Note  for,  Forms,  x  595-1 597 

Return  of,  accounting  entries,  1255 

Stock  as,  procedure  for,  307-309 

Stocks  and  bonds,  862 

Warehouse  receipts,  863 
Collateral  Trust  Bonds,  464,  631 

Redemption,  accounting  entries,  X254 

Sale,  accounting  entries,  1198 
Collections, 

Treasurer's  liability  for,  415 
Colorado  Fuel  and  Iron  Company,  587 
Combination  Record,  1035 
Combinations    (See    also    "Affiliated    and 
Subsidiary    Corporations,"    "Consolida- 
tions," "Export  Associations,"  "Holding 
Companies,"  "Trusts") 

Defined,  744 

Field  for,  739 

Financial  plan,  744-748;  936-946 

Interlocking  directorates,  580,  1268 


Combinations — Continued 

National  Starch  Manufacturing  Company, 

741-744 
Organization,  5x9 
Promoting,    preliminary   investigation   of, 

76X 
Successful,  750 
Types  of,  737 
Combinations  in  Restraint  of  Trade,  5x9 

Express  trust  as,  535 
Commission  Payments, 

Accounting  treatment,  11 79 
Sale  of  capital  stock,  X134,  1 174,  11 79 
Sale  of  securities,  825 
Stock  exchange  brokers,  83  x 
Underwriting  syndicates,  844,  X174 
Committees, 
By-law,  report. 

Form,  1651 
Executive,  246,  247,  249 
Finance,  246 

Relation  to  treasurer,  387 

Scope  and  powers,  387 
Reorganization,  1012-1015 
Standing, 

Appointment  of,  X49,  197,  245.  247 

By-laws,  245-251 

Composition,  249 

Has  no  delegation  power,  251 

Kinds  of,  246 

Powers,  249 

Procedure,  for  meetings,  250,  367 

Purpose,  24s 

Quorum  for  meetings,  25 x 

Written  records  of  meetings,  250. 
Common  Law,  s 

By-law  powers,  2x7 
Common    Law    Companies    (See    "Express 

Trusts") 
Common  Stock 
Certificate, 

Form,  X486 
Charter  provisions,  188 
Classification  of,  203 
Classes,  598 
Defined,  85,  598 
Dividends,  884 

Intangible  assets  represented  by,  726 
Issues  of  financial  plan,  723-728 
Partnership  incorporating,  503 
Represents  intangible  assets,  87 
Voting  and  non-voting  classes,  203 
Company  (Word)  in  Name,  499 
Compensation    for    Personal   Services, 

Directors',  243 
Comptroller, 

Duties  and  functions,  389 


1 666 


INDEX 


Comptroller — Continued 

Relation  to  treasurer,  389 

Report, 

Form,  1649 
Consent  Meeting,  355 
Consolidated  Balance  Sheets, 
Forms,  r390-i393,  1396-1397 

Combined,  1388 

Contents,  I37S 

Defined,  1373 

Guaranties,  contracts  and  leases  on,  1376 

Intercompany  holdings  of  capital  stock  on, 
1376,  1380 

Intercompany  obligations,  1375,  1377 

Inventory  adjustments,   I37S.   1376,   1381, 
1395 

Minority  interests,  1385,  1386 

Preparation,  1376 
Basis  of,  1385 

Surplus  adjustment,  1380,  1381 

Value  of,  II 73 

When  to  use,  1384 

Work  sheet,  1377 
Consolidated  Mortgage  Bonds,  626 
Consolidated  Statements, 

Income,  1395 

Intercompany  income  and  expense  items, 
I39S 

Sales,  1395 

When  to  use,  1384 
Consolidations    (See  also   "AfBliated    and 
Subsidiary    Corporations,"    "Combina- 
tions") 

Accounting,  1278-1295 

Assets  and  liabilities  taken  over,  1 288 
Balance  sheet  of  new  corporation,  1275 
Closing  books  of  dissolving  companies, 

1294 
Holding  company,  1268- 1277 
Issuance  of  stock  and  bonds,  1287 
Purchase  of  leaseholds,   1260- 1267 
Requirements,  1285 
Retirement   of   outstanding   bonds   and 

mortgages,  1292 
Sale  of  securities,  1292 
Settlement  of  intercompany  obligations, 

1293 
Statement  of  merging  companies,  1281 
Transfer  of  property,  1279,  1286,  1292 

By, 

Holding  company,  1268-1277 
Lease  of  property,  518,  1259-1267 
Merger,  1268,  1278-1295 
Purchase,  1268,  1278-1295 
Purchase  of  assets,  518,  1278 
Purchase   of    controlling   interest,    519, 
1268 


'Consolidations — Continued 
By-laws,  219 

Capital  requirements,  936 
Capitalization,  73 
Cause  of  insolvency,  936 
Charter,  1286 
Consolidated  surplus,  1063 
Defined,  744 

Directors'  agreement,  1286 
Failures  due  to,  936 

Financial  policies,  936-946  ' 

Forms,  516 

Good-will,  apportionment  of,  1284 
Principles  of,  1278 
Procedure,  516-522,  1280-1287 
Statutory,  517 

Stockholders'  approval,  1286 
Surrender  of  old  charters,  1286 
Terms  of  merger,  1283 
Construction  Account, 

Interest  charged  to,  684,  1211 
Contingent    Profit  on    Stock    Account, 

1102,  1103 
Contracts,  3 

Forms,  1610-1614 
Directors'  power  to  make,  147 
Enforcement  of,  legal  right  of  corporation, 

16 
Exploitation  of,  972,  974 
Intercompany,    on    consolidated     balance 

sheet,  1376 
Precorporate,  42-49 

Enforcement  of,  44 

Failure  to  incorporate,  48 

Options,  47 

Promoters'  contracts,  46,  785,  788 

Trustees',  48 
Subscription,  34 
Contributed  Surplus  (See  "Surplus— Paid 

in") 
Convertible  Bonds,  463,  641-645 

Redemption,  accounting  entries,  1254 
Corporate  Form, 

Administrative  system,  18 

Advantages  of,  13-21,  585 

Based  on  division  of  powers  and  duties,  18 

Characteristics  of,  13,  569,  573,  585 

Disadvantages,  22-31,  586 

Efficiency,  585 

Entity  of,  15,  574 

Investment  attraction,  19 

Legislative  requirements,  23 

Management,  569 

Permanence  of,  16 

Reports  required  of,  24,  30 

Stock  transfer  system,  17 

Taxation  (See  "Taxation  of  Corporations"^ 


INDEX 


1667 


Corporate  Funds  (See  "Endowment 
Funds,"  "Extinguishment  Funds," 
"Funds,"  "Reserves,"  "Redemption 
Funds,"  "Retirement  Fund,"  Sinking 
Funds,"  "Surplus,"  "Trust  Fund") 
Corporate  Name, 

Adoption   of,    of   foreign   corporation    not 
doing  business  in  state,  179 

Changing,  180 

Exclusive  use  of,  178 

Infringement  of,  179 

Partnership,  incorjKjration  of,  498 

Right  to,  178,  179 

Selection  of,  177,  498 

Statutory  restrictions,  178 
Corporate  Purposes, 

Charter, 

Form,  1425,  143s 

Clearly  stated  in  charter,  182 

Comprehensive,  183 

Illegal,  184 

Single,  182 

Ultra  vires  acts,  185 
Corporate  Securities  (See  "Securities") 
Corporations    (See    also    "Close    Corpora- 
tions") 

Business  corporations  defined,  167 

Characteristics- of ,  9,  13 

Compared  with  partnership,  S 

Constitution  of  the  United  States  does  not 

Life  of,  191  [grant  citizenship  to,  51 

Management  system  definite,  18 

Non-stock,  1128-1132 

Not  organized  for  profit,  11 29 

Powers,  acts  in  excess  of,  185 

Signature, 

Forms,  1S83-IS97 

Statistics,  583 

Stock  and  non-stock,  167 

Stock  transfer  to  and  by,  316,  322-324 

Taxation  (See  "Taxation  of  Corporations") 
Corrections, 

After  closing  of  books,  1040 
Cost  of  Incorporation,  60-68 

Table.  61 
Counsel,  Corporate,  256 
Counsel  Fees,  67 
Coupon  BoNbis,  448,  452,  622 
Form,  162 1 

Interest  record,  1188 

Records  for,  11 86 
Coupon  Register,  1189 
Credit,  849,  852 

Affecting  working  capital  requirements,  708 

Bank,  858-863 

Trade,  8SS-858 

Use  of,  559 


Creditors, 

Settlement  of  claims  in  insolvency,  999 
Cumulative  Voting  (See  "Voting") 
Customers, 

As  sources  of  capital,  803 
Cutting  a  Melon,  1148,  1228 


Dartmouth  College  Case,  16 
Date  of  Annual  Meeting,  228 
Debenture  Bonds, 
Forms,  1624 

Defined,  450,  634 

English  practice,  625,  634 

Investment  value,  63s 

Nature  of,  635 

Protective  provisions,  63s 
Debenture  Stock, 

English  practice,  634 
Debts  (See  also  "Funded  Debt") 

Paid  in  stock',  11 36 
Declaration    of    Trust    (See    "Deed    of 

Trust") 
Deed  of  Trust, 

Forms,  1625-1632 

After-acquired  property  clause,  615 

Bonds  issued  under,  453-456,  615 

Bond  redemption  provisions,  1227 

Express  trusts,  545-548 
Default, 

Bonds,  998,  1257 
Deferred  Charges, 

Operating  expenses,  determination  of,  872 
Delaware  Charter  Form,  143  5-144  i 
Delegation  of  Power, 

Directors,  245,  249 

Officers,  160,  258 

Power  of  attorney. 
Forms,  1606- 16 10 

Standing  committees,  251 
Depletion, 

Extinguishment  fund,  1226 

Reserves,  1054 
Depositary, 

Corporate,  delegated  by  directors,  283 
Depreciation, 

Assets,  intangible,  876 

Appreciated  assets,  1060 

Income  tax  return,  141 2 

Reserves,  874-877  • 

Directors,  ii,  579  • 

Agreement  for  consolidation,  1286 

By-laws,  235-244 
Forms,  1464,  1469 

Citizenship,  193 

Classification  of,  196,  238 


1 668 


INDEX 


Directors — Continued 
Cumulative  voting,  202 
Dealings  with  corjxjrations,  ISS,  579 
Efficiency,  586 
Election,  132,  142,  154.  155,  232,  274.  346 

Notice,  form,  1573 
Exploitation  by,  979-991 
Holding  over,  155 
interlocking,  580,  1268 
Liability,  150,  204 

Illegal  dividends,  44s 
Limitations  of,  19S 

Indebtedness,  204 
Managing,  25s 

Meetings  (See  "Meetings,  Directors") 
Number  of,  193,  235 
Partnerships,  incorporating,  504 
Powers,  19s,  236,  578 

Appointment  of  officers,  IS7 

As  trustees  for  stockholders,  148 

By-laws,  adoption  of,  150,   19S,   217, 
218,  244 

Common  law,  151 

Collective  only,  147 

Declaration  of  dividends,  420 

Inspection  of  minutes,  369 

Limitation  of,  147,  261 

Over  surplus,  1047 

Over  treasurer,  385 

Removal  of  officers  and  agents,  149.  162 

Resolutions  to  supplement  by-laws,  381 

Standing  committees,  149,  i97.  245 

Statutory  law,  151 

To  delegate  authority,  24s 

To  fill  vacancies  in  board,  154,  238 
Qualifications,  f92,  236 
Relation  to  treasurer,  385 
Removal,  153,  238 
Residence,  192 
Resignation,  152 

Form,  1578 
Salary  or  compensation,  243,  581 
Stockholding  provisions,  192,  236 
Term  of  office,  196,  237 
Treasurer's  reports  to,  412 
Vacancies  on  board,  154,  238 
Voting,  no  proxies  allowed,  364 
Discounts, 

Affecting  working  capital,  70s 
On  bonds. 

Account,  1 192 

Accounting,  12 13-1224 

Capitalized,  684 
On  stock  account,  1096 

Credited  to  contingent  profit  on  stock, 
1102 

Not  used  for  no-par  stock,  11 19 


Discounts — Continued 
Stock  bought,  1 103 
Stock  rights  quoted  at,  811 
Discussions, 

Not  entered  in  minute  book,  372 
Dissolution, 

Accounting,  1297- 1 306,  1340 

Accounts  not  closed,  1302 

Profit  or  loss  on  realization,  1298 

Sale  of  business,  1299-1306 

Transfer  of  assets,  1300 
Case  of  the, 

Reading  Company,  1002 

United  States  Express  Company,  1002 
Closing  books  of  dissolving  companies,  1 294 
Following  bankruptcy,  1340 
Insolvent  corporation,  1 001 
Nature  of,  523 
Voluntary,  looi 

Accounting,  1 297-1306 
Dividends, 
Accounting,  1142-1155 

Charged  to  profit  and  loss  or  surplus, 
1039 
Accrued,  1142,  1271 
Banks,  accounting  procedure,  11 54 
Bonds.  433.  435.  IIS3 
Book  , 

Forms,  1637 
By-laws,  260,  420 

Forms,  1465,  1472 
Cash,  431,  433 

Accounting  procedure,  1144-1146 
Cash  requirements,  899 
Cause  of  insolvency,  997 
Checks,  438,  442 

Accounting  procedure,  1 1 43 
Classification,  884 
Common,  884 
Cumulative,  91 

Accounting  procedure,  1 151 
Cutting  a  melon,  1148,  1228 
Debt  of  Corporation,  429 
Declaration  of,  420 
Form,  1571 

Accounting  procedure,  1 143 

Compulsory,  426 

Out  of  capital  stock,  152,  424 

Resolution,  422 

Revocation,  430 
Determrnation  of  profits,  425,  1039 
Earnings,  percentage  of,  devoted  to,  886 
Effect  of  capitalization  on,  71 
Equality,  425 

Ford  Motor  Company  case,  427 
Form  of  payment,  431-433,  1143 
Guaranties  of,  in  lease,  1261.  ^264,  1265 


INDEX 


1669 


Dividends — Continued 
Illegal,  443-446 

In  payment   of   stock  subscriptions,  430, 
Income  from,  1 1 55  [1149 

Interim,  accounting  procedure,  1148 
Liability  for,  445 
New  Jersey  regulations,  420 
No-par  stock,  1146 
Notice,  438 

Forms,  1571 
Other  than  cash,  433,  90S 
Ownership,  record  of,  1142 
Paid  out. 

By  subsidiaries,  1381 

By  treasurer,  423 

Of  bonds  or  property,  433,  435,  1153 

Of  borrowed  cash,  900,  1146 

Of  no-par  stock,  1x52 

Of  paid-in  surplus,  1059 

Of  profits,  423,  883-897,  II 53 

Of  surplus,  424,  899,  1047 
Paid  to  pledgee  of  stock,  441 
Passed,  accounting  procedure,  1151 
Place  of  payment,  438 
Preferred  stock,  87,  90,  428,  602,  884 

Cumulative,  91,  60s 

Non-cumulative,  92,  603,  884 

Participation  rights,  93,  606 

Passed,  accounting  procedure,  1151 

Rates,  606 
Profits  distributed  as  salaries,  431 
Profits,  proper  source  of,  423 
Property,  433.  437 
Rates,  885 

Policy,  as  to,  913 
Receipt  for,  1144 

Frm,  1 594 
Regularity  of,  888-897 
Scrip,  436 

Accounting  procedure,  1 147 
Sheet  or  book,  1144 
Special,  accounting  procedure,  1148 
Statistics,  885 
Statutory  law,  421 
Stock,  433,  43S,  682,  90s 

Accounting  procedure,  1x51 

No-par  value,  accounting  of,  1152 
Stockholders'  rights,  135 
Time  of  payment,  438 
To  whom  paid,  439 
Treasury  stock,  433,  441 
Trust  fund  for  paying,  429 
Unearned,  902,  1154 
Used  as  payment  for  subscriptions,  430 
Voting  trust,  470 
Withholding  surplus  from,  1047 
Wrong  methods,  902 


Dollar-Marked  Stock  Certificate,  112 
Domestic  Corporations  (Intra-State), 
Incorporation,  51 

Taxation  of  stock  without  par  value,  126 
Donations, 

Hospital  accounts,  1130,  1131 
Treasury  stock. 

Accounting    entries,     1106-1112,     1162, 
Donated  stock  account,  1108  [ii79 

No-par  value,  1 1 26 
Surplus  account,  1x08 
Surplus  from,  X063 
Forms,  1590,  1592 
Dummy  Incorporators,  173,  174,  17s 
Dummy  Stockholders, 
Liability  of,  316 

£ 

Earning  Power, 

Adjustment  of  capitalization  to,  670 
Affected  by  adverse  legislation,  673 
Affected  by  individuals,  673 
Capitalization  based  on,  71,  73,   79,  665, 

667-673 
Estimates  of,  671 
Rate  of,  669 
Earnings, 

Gross,  determination  of,  869-872 
Surplus  form,  9x3 
Effective  Rate  Method, 

Bond  discount  and  premium,  12x8 
Elections  (See  also  "Votes") 
Ballot. 

Form,  iss8 
Can  be  set  aside  by  injunction  w  en  illeg- 
ally controlled,  348 
Certificate  of  inspectors. 

Form,  1556 
Certificates, 

Forms,  i6ox 
Directors,    132,    142,    154,    155,   232,   274, 

346,  S07 
Majority  requirements,  507 
Oath  of  inspectors. 

Form,  1556 
Officers,  242,  279,  366 
Electric  Railway, 

Promoting,   preliminary   investigation   oi, 
758 
Eleemosynary  Institutions, 

Accounting,  1130-XX32 
Employees, 

Stock  participation,  802 
Endowment  Funds, 
Accounting,  1x30,  1131 
Nature  of,  1225 


1670 


INDEX 


Engineers, 

As  promoters,  774 
Equal  Instalment  Method, 

Bond  discount  and  premiums,  12 19 
Equipment  Trust  Bonds,  465,  629-631 
Redemption,  accounting  entries,  1255 
Sale,  accounting  entries,  1200 
Estate  Tax  (See  "Inheritance  Tax">  ,' 
Ethics, 

Contractual,  973 
Excess  Profits  Tax,  29,  332 

Repeal  of,  1399 
Excise  Tax  (See  "Capital  Stock  Tax") 
Executive  Committee,  246,  247,  249 
Executives, 

As  promoters,  775 
Executors, 

Stock  transfer  by,  315,  317,  319 

When  taxable,  328 
Votes,  I3S  wo"-l  jimjWiH 

Expansion  (See  "Combinations,"  "Consoli- 
dations") 
Expenditures, 

Concealment  of,  880 
Operating,  872-879 
Expense  Account, 

Sinking  fund,  1230 
Expenses, 

Calculation  of,  for  budget,  933 
Consolidated  statement  item,  139s 
Deferred  charges,  determination  of,  872 
Income  tax  return,  1411 
Initial,  capitalization  of,  684 
Operating  ratios,  956 
Organization,  60-68,  1133,  1169 
Receivership,  1348 
Reorganization,  10 13 
Reserves  for,  1050 
Sale  of  bonds,  1 2 13 
Sale  of  securities,  828,  1174 
Underwriting,  11 74 
Kxploitation, 

By  directors,  979-991 
By  officers,  967-978 
By  stockholders,  979-991 
Case  of  the, 

Baltimore  and  Ohio  Railroad,  979 
Chicago  and  Alton  Railroad,  987 
Interborough  Rapid  Transit  Company, 

988 
Missouri  Pacific  Railway,  968 
National  Cordage  Company,  977 
National  Salt  Company,  9'8s 
New  Haven  Railroad,  970,  984 
Northern  Pacific  Railroad,  973 
Rock  Island  Railroad,  972 
Standard  Rope  and  Twine  Company,  97  2 


Exploitation — Continued 

Case  of  the — Continued 

United    States    Shipbuilding  Company, 
971 

Contracts,  972 

Creditors,  987 

Exorbitant  salaries,  971 

Juggling  accounts,  979 

Misleading  statements,  980 

Misuse  of  information,  976,  982 

Nature  of,  967 

Precautions  against,  989 

Squeezing  minority  stockholders,  98s 
Export  Associations,  590 
Express  Trusts, 

Advantages,  540 

As  a  combination  in  restraint  of  trade,  533 

Creators  of,  548 

Deed  of  trusts,  545-548 

Defined,  532 

Liability  of  individuals  under,  549 

Misuse  of,  538 

Nature  of,  533,  57 1 

Provisions,  545 

Status  of,  539 

Statutory  laws,  541 

Taxation,  542 

Trustees,  533.  534.  548-551 

Use  of,  in  business,  536 

Varied  nomenclature  for,  537 

Who  may  create,  534 
Ex-Rights, 

Stock  rights,  812 
Extinguishment  Funds, 

Nature  of,  1225 
Extra-Territorial  Rights, 

Stock  transfer  tax,  328 


Factory  Sites, 

Donated,  1063 
Failures  (See  "Insolvency") 
Federal  Reserve  Bank, 

Balance  sheet,  1357-1360 
Federal  Taxes,  29 
Fees    (See    "Counsel    Fees,"    "Organization 

Fees") 
Filing, 

Charter  application,  210 
Finance     Committee     (See     "Committees. 

Finance") 
Financial  Corporations, 

Charters,  169 
Financial  Institutions, 

Capitalization  of,  73 

Source  for  capital  funds,  792 


INDEX 


1671 


Financial  Management, 

Problems,  960-965 

Standards,  947-959 
Financial  Plan, 

Advertising  agency,  734 

American  Woolen  Company,  847 

Combination,  744- '>48 

Partnership  incorporating,  730 

Policies  and  methods,  720-730 

Railroad,  732 

Reorganization,  1010-1017 

Rock  Island  Railroad,  748 

Securities  issued,  720-728 

Underwriting  syndicates,  837-848 

United    States    Realty    and    Construction 
Company,  84s 

United    States    Shipbuilding    Corporation, 
846 
Financial  Statements  (See  also  "Balance 
Sheet,"  "Consolidated  Balance  Sheet," 
"Consolidated  Statements") 
Forms,  13SS.  1643-1651 

Corporate  reports,  1354 

Income  statement,  867 

Merging  companies,  1281 

Misleading,  980 

Monthly,  1349 

Receivers,  1313-1316,  1324 
Financing, 

Adequate,  769 

Budget  plan,  561 

Directed  by  finance  committee,  387 

Inadequate,  770 

Individual  vs.  business,  558 

Preliminary,  765 

Relation  to  accounting,  557 

Rules,  562 

Standards,  947-965 

Unskilful,  556 
Financing  Corporations, 

Working  capital  requirements,  716 
Fixed  Assets  (See  "Assets,  Fixed") 
Fixed  Capital, 

Defined,  687 

Requirements,  estimating,  693 
Fixed  Charges,  883 

Reducing,  1024 
Fluctuations  in  Business, 

Effect  of  budget  on,  927 

Effect  of  dividends  on,  888-893 
Ford  Motor  Company, 

Compulsory  dividends,  427 
Foreign  Corporations  (other  states). 

Doing  business  without  authorization,  54 

Incorporation,  51 

Selection  of  state,  190 

Inheritance  taxes,  27 


Foreign  Corporations — Continued 

Name  may  be  adopted,  179 

Reports,  31 

Taxation  of,  28 

Taxation  of  stock,  without  par  value,  126 
Foreign  Currency, 

Bonds  payable  in,  620 
Foreign  Trade, 

Working  capital  requirements,  708 
Forms  (See  also  contents  to  Book  IV,  p.  xii.) 

Consolidated    balance    sheet,     1390-1393, 
1 396- 1 397 

Income  Tax,   1401-1402,  1409-1410,  1419- 
Founders'  Shares,  97,  599  [1421 

Franchise  Tax,  25,  60,  333 

Comparative  table  oi,  61 
Funded  Debt, 

Short-term  notes  not,  652 
Funds  (See  also  "Endowment  Funds,"  "Ex- 
tinguishment Funds,"  "Redemption 
Funds,"  "Reserves,"  "Retirement 
Funds,"  "Sinking  Funds,"  "Surplus," 
"Trust  Funds") 

Accounting,  1225-1246 

Collections,  415 

Compared  to  reserves,  1226 

Custody  of,  377.  417 

Defined,  415 

Disbursement,  418 

How  created,  1226 

Misuse  of,  977 

Nature  of,  1225 

Purposes,  1225 

Return  of,  419 

Treasurer's  liability  for,  416 


Gain  or  Loss  (See  also  "Profit  and  Loss 
Account") 

Sale  of  a  business,  1 299 

Sale  of  assets,  1298 

During  receiverships,  1337 
Gifts  (See  "Donations") 
Gold  Bonds,  463,  621 
Good-Will, 

Accounting  treatment,  1168 

Apportionment,  in  consolidations,  1284 

Balance  sheet  entry,  137 1 

Capitalization  of,  74,  676 

Customers,  803 

Employees,  802 

Sole  proprietorship,  1166 

Stockholders',  800 

Transfer  of,  1167 

Valuation,  678-681,  1166 

Writing  off,  1309 


1672 


INDEX 


Guaranteed  Bonds,  464 

Interest,  1209 

Redemption,  accounting  entries,  1255 

Sale,  accounting  entries,  1197 
Guaranteed  Stock,  91 
Guaranties  of  Interest    and   Dividends 

ON  Leaseholds,  1261,  1264,  1265,  1376 
Guardian    of    Minor    for    Transfer    of 

Stock, 321 

H 

Holding  Companies  (See  also  "Affiliated 
and  Subsidiary  Corporations,"  "Con- 
solidated Balance  Sheets") 

Advantages,  473,  592 

Amount  necessary  to  control,  476 

As    minority    stockholder    of    subsidiary, 
138s.  1386 

Common  law  did  not  permit,  474 

Consolidated  income  ta:i  returns,  1416 

Consolidation  by. 

Accounting,  1 269-1277 
Accrued  dividends,  127 1 
Balance  sheet,  1272 
Income  account,  1272 
Interlocking  directorates,  1268 

Defined,  473.  1268 

Development,  589 

Functions,  478,  591 

Harmful,  taxation  no  remedy  against,  22 

Intercompany    ownership    of    bonds    on 
consolidated  balance  sheet,  1376 

Intercompany  ownership  of  stock  on  con- 
solidated balance  sheet,  1376 

Limitations,  479 

Methods  of  control,  1268 

New  Jersey  laws,  57,  475 

Operating,  purchase  of  subsidiary,   1273- 
1277 

Parent  company,  481,  593,  1277 

Public  utilities  use  of,  S92 

Status  of,  S9I 

Stock  holding  powers,  474 

Subsidiaries,  593,  1269 

Valuation  of  stock  of,  11 36 
Horizontal  Trust  or  Combine,  737 
Hospitals  • 

Accounting,  1130-1132 


Idaho, 

Incorporation  in,  s8 

Illinois, 

By-law  statutes,  219 
Incorporation  in,  S7 


Improvements, 
Amortization,  1265 
Leaseholds,  accounting,  1264 
Income    (See    also    "Gross    Income,"    "Net 

Income") 
Administration,  867-882 
Calculation  of,  for  budget,  932 
Defined,  868 
From  dividends,  115s 

From  investments,  accounting  entry,  12 12 
Policy  as  to,  913-918 

Relation  between,  and  security  issues,  724 
Sinking  funds,  1237,  1240 
Income  Account, 
Consolidated,  139S 
Sinking  funds,  1230 
Income  Bonds,  463,  638-641 

Interest,  639,  12 10 
Income  Statement,  867-882 
Analysis  of,  867-882 
Calculation,  868 
Concealment  of  profits,  879 
Depreciation,  873-877 
Gross  earnings,  869-872 
Oi)erating   expenses   and   reductions,   872- 

879 
Income  Tax, 

Effect  of,  64,  SOI 
Federal,  29,  331 

Forms,    1401-1402,    1409-1410,    1419- 
142 1 

Accounting  practice,  1042-104S 

Consolidated  returns,  1416 

Effect  on  accounting,  1042 

Express  trusts  and,  543 

Organization    expense    not    deductible. 
1 133 

Preparation  of  returns,  1399-1421 
State,  26,  333 
Incorporated  (Word)  in  Name,  178,  498 
Incorporation  (See  also  "Charter,"  "Organ- 
ization") 
Agreements,  44,  1172 
Bond  issues  for  property  taken  over.  63 
Charter  application,  208-211 
Cheapness  not  always  desirable,  SS 
Commission  on  sale  of  capital  stock,  11 34 
Contracts  prior  to,  42-49 
Cost  of,  60-68 
Counsel  fees,  67 
Domestic  corporation.  Si 
Double,  6s 

Failure  to  incorporate,  48 
Foreign  corporation.  Si 
Manufacturing     corporation,     accounting 

procedure,  11  s6- 11 60 
Mining  corporation,  1160 


INDEX 


1673 


I N  CORPORATION — Continued 
Minority  interests,  s8 
Organization  expenses,  accounting,  1 133 
Organization  fees,  60-66 

Table,  61 
Partnerships,   497-509 

(For  full  list  of  subjects  see  "Partner- 
ships") 

Accounting  treatment,  11 72-1 183 
Place  of,  S0-S9 
Procedure,  267 
Promoter's  functions,  44 
Sole  proprietorship,  1165 
State  laws  beneficial  for,  56 
State,  selection  for,  190 
Stock  sold  at  a  premium  to  create  surplus, 

1098 
Taxation  and,  soi 
Taxes,  25 

When  inadvisable,  22 
Who  may  incorporate,  172 

I NCORPORATORS, 

Agreements  among,  14 

Dummy,  173.  174.  I7S 

Functions  of,  174 

Number,  173,  268 

Participation  in  first  stockholders'  meeting, 
268,  272 

Signature  and  acknowledgment  of  charter 
application,  209 

Stockholders  as,  174 

Supply  initial  capital,  791 

Who  may  incorporate,  172 
Indebtedness, 

Liability  of,  204 

Limitation  of,  261 
Indemnity  Bond, 

Forms,  1616-1618 
Individual  Management,  7 
Indorsements,  Corporate  Checks, 

Forms,  iS9i 
Information, 

Confidential,  misuse  of,  976,  982 
Inheritance  Tax, 

Federal,  30 

Foreign  corporations,  27 

State,  27 
Insolvency, 

After  dividend  is  declared,  439 

Bankruptcy,  1003-100S 

Causes  of,  771,  995-998 

Dissolution  of  corporation,  looi 

Due  to  consolidations,  936 

Economic,  993 

Financial,  994 

Procedure  for,  998-1009 

Readjustment  of  claims,  999 


Insolvency — Continued 
Receiverships,  1005-1009 
Statistics,  992 
Types  of,  936 
Instalment  Account, 
Bond  issues,  11 96 

Purchaser  of  accounts  receivable,  715 
Subscription  to  stock,  222,  1077,  1090 
Book  for,  1088-109S 

Form,  1635 
Entries,  1091-109S 
Notice  of  payment. 
Form,  1569 
Instalment  Business, 

Working  capital  requirements,  709-713 
Interborough  Rapid  Transit  Company, 

Exploitation  of,  988 
Interest, 
Accrued,  1193,  1195,  1204 

Adjustment  of,  in  selling  price  of  bonds, 
1213 
Bonds,  622 

Accounting,  1192,  1202-1212 

Accrued,  1193,  1195,  1204 

Adjustment  of  accrued  interest  in  selling 

price,  1 2 13 
Charged  to  construction,  684,  121 1 
Default  in  payment,  1257 
Guaranteed  bonds,  1209 
Income  bonds,  12 10 
Methods  of  handling  coupons,  1202 
Methods  of  paying,  1202 
Recording,  11 88,  1203 
Registered  bonds,  1205 
Special  issues,  12 10 
Treasury  bonds,  1208 
Two  or  more  issues,  1206 
Coupon  bonds,  record  of,  11 88 
Guaranteed  bonds,  1197 
Guaranties  of,  in  lease,  1261,  1264,  1265 
Income  bonds,  639 
Income     from     investments,     accounting 

entry,  1 21 2 
Income  tax,  1406 
Paid  on  bonds  during  period  of  construction 

may  be  capitalized,  684,  I3ii 
Registered  bonds,  record,  11 88 
Sinking  fund,  accounting  entries,  1237 
Interim  Dividends,  1148 
Interlocking  Directorates,  580,  1268 
Interstate  Commerce  Commission 
Regulations, 

Bond  terminology,  1 1 86 
Interest  charged  to  construction,  laii 
Sinking  fund,  1231 
Inventories, 

Cause  of  insolvency,  997 


i674 


INDEX 


I  NVENTORiES — Continued 

Certificate  of,  on  income  tax  return,  1408 

Statistics,  958 

Valuation, 

Consolidated  balance  sheet  entries,  i37St 

1376 
Cost  or  market,  870 

I NVESTIG  ATIONS, 

Combination,  761 

Electric  railway,  758 

New  enterprises,  754-762 

Preliminary  analysis,  757 

Railroad,  759 

Scope  of,  756 
Investment  Bankers, 

Community  of  interests  among,  1840 

Liability  of,  826  . 

Sale  of  securities,  823-829 

Underwriting  syndicates  formed  by,  839 
Investments  (See  also  "Securities") 

Corporations  an  attractive  form  of,  19 

Distribution  of,  as  a  safety  factor,  795 

Sinking  fund,  accounting  entries,  1239 


Joint  Adventures, 

Nature  of,  S30 
Joint-Stock  Companies, 

Accounts,  nature  of,  1033 

Nature  of,  9,  52S-S27,  570 
Journal, 

Entries, 

Manufacturing  corporation,  1157 
Mining  corporation,  1161 

Subscription  to  stock,  1068,  1076,  1084 

Subscription  transfer,  1088 


Kansas  Supreme  Court, 

Decision  on  stock  without  par  value,  114 


Land  Companies, 

Sinking  funds  for  bond  redemption,  660 
Law, 

Business  organization  dependent  on,  3 

Contracts,  3 

Incorporation,  Si-SS 

Legal  entity  of  corporation,  15 

Partnerships,  4 

Principal  and  agent,  4 

Subscriptions,  33-41 
Lawyers, 

As  promoters,  773 

Counsel  fees,  67 


Leaseholds, 

Accounting,  1260-1267 

Adjusted  entries  at  end  of  year,  1265 
Guaranties  of  interest  or  dividends,  1261, 

1264,  1265 
Improvements  and  note  issues,  1264 
Improvements  on,  1265 
Mines,  1263 
Railroads,  1264 
Amortization,  1265 
Consolidations  by,  12  59- 1267 
Intercompany,    on    consolidated    balance 

sheet,  1376 
Terms  of,  1261 
Ledger, 

Closing,  I3SI 
Stock,  1071 
Defined,  291 

Summary  of  accounts  used,  1083 
Subscription,  1080,  1086 
Instalment  account,  1093 
Legislation,    Corporate,    Onerous    Re- 
quirements, 23 
Lessees,  Accounting  Records,  i  267 
Lessors,  Accounting  Records,  1266 
Liabilities, 
Current, 

Ratio  of,  to  current  assets,  698 
Short-term  notes  as,  652 
Liquidation,  receivership  accounting.  T339 
Transfer  of  in  consolidation,  1286,  1289 
Liability  of  Corporation, 
Before  incorporation,  42-49 
Doing  business  in  California,  53 
Limitation  of,  14 
Liability  of  Director,  150 

Limitations  on  indebtedness,  204 
Liability  of  Officers,  160 
Liability  of  Partners,  568 
Liability  of  Stockholder,  14,  53, 143-148 
Full-paid  stock,  loi 
In  California,  53 
Statutory,  14s 

Unpaid  outstanding  stock,  145 
Unpaid  subscriptions,  143 
Watered  stock,  100 
Liability  of  Treasurer,  393-400,  416 
Lien  Bonds,  Junior,  462,  625 
Lien  Stock,  310 

Liens  as  Collateral  Security,  863 
Life  Term  of  Corporation,  191 
Liquidations, 

Preferred  assets,  91 

Realization  and  liquidation  statement  of 

receiver,  1346 
Stockholders'  rights  in,  137.  142 


INDEX 


167 


/3 


Loans  (See  also  "Notes";  "Bonds") 

Bank,  858-866 

Factors  considered,  864 

Collateral  for,  861 

Long-term  obligations,  854 

Note-brokers'  dealings,  859 

Overborrowing  risks,  852 

Rules  for  borrowing,  853 

Securing,  851 

Short-term, 

Forms  of,  854-866 

Stock  as  collateral,  307-309 

Trade  acceptance,  856 

Trade  credit,  855-858 
Location  (See  "Place  of  Business") 
Long  Term  Obligations  (See  also  "Bonds") 

Nature  of,  612,  632,  854 

Received  by  creditors,  1023 

Sinking  fund  methods,  658 
Losses  (See  also  "Gain  or  Loss") 

Caused  by  treasurer's  neglect,  395 

Extraordinary,  debited  to  surplus,  1041 

Initial,  Capitalization  of,  684 

M 

Mail, 

Selling  securities  by,  815 
Maine,  Incorporation  in,  57 
Maintenance, 

Charged  against  income,  872 
Management  (See  "Administration") 
Manager, 

By-laws, 

Forms,  1472 
Managing  Director,  By-Laws,  255 
Manufacturing  Corporation, 

Books  of  account,  11 57 

Incorporation,  1156 

Journal  entries,  irS7 
Market  Price, 

Bonds  purchased  for  sinking  funds,  1221 
Massachusetts, 

Express  trusts,  541,  571 

Incorporation  in,  57 

Stock  transfer  tax,  327 
Meetings  (See  also  "Minutes") 

Motions,  372 

Paper  used  at,  should  be  filed,  373 

Protests,  373 

Resolutions,  372 
Meetings,  Committees,  Procedure,  250,367 
Meetings,  Directors,  239-242,  358-368 

Forms,  1504-1511,  1525-1527.  IS33-I534 

Adjournment,  367 

Annual, 

Omitted  td  hold  over  directors,  155 


Meetings,  Directors — Continued 
Approval  of  minutes,  374 
Assemblying,  360 
Business,  366 

Directors  must  be  present  in  person,  364 
Election  of  Officers,  242 
First,  277-285 

Forms,  1504-1511 

Assemblying,  279 

Business,  278,  285 

By-Laws,  277 

Call,  277 

Call  and  waiver  of  notice,  form,  1507 

Corporate  depositary  delegated  by,  283 

Election  of  officers,  279 

Exchange  of  stock  for  property,  282 

Minutes,  278 

Minutes,  forms,  1504-1507 

Opening,  279 

Roll  call,  279 

Seal  of  corporation,  281 

Stock  certificates  adopted,  280 

Subscriptions  accepted,  281 

Treasurer's  bond  depositary,  283 
Minutes,  365 

Forms,  1563-1567 
Motions, 

Forms,  1 543-1545- 
Notice,  240,  360 

Proof  of,  364 
Object  and  purpose,  359 
Opening,  363 
Order  of  business,  244 
Place  of,  190,  239,  358 
Presiding  officer,  363 
Quorum,  241,  363,  364 
Reports,  365 
Resolutions, 

Forms,  1 547-1552 
Roll-call,  363 
Special,  240,  360 

Forms,  1525-IS27.  1533 

Call,  360 

Call  and  waiver  of  notice,  363 

Minutes,  form,  1565 

Notice,  361 
Meetings,  Stockholders,  132,  576 

Forms,  1498-1503.  IS19-1525,  IS29-1532 
Adjourned, 

Minutes,  form,  1561 

Annual,  228-234;  335-351 

Forms,  1  S3  i-i  532 

Adjournment  of,  350 

Annual  report,  34s 

By-laws,  228-234 

Closing  transfer  books,  336 

Date  of,  228,  336 


1676 


INDEX 


Meetings,  Stockholders — Continued 
Annual — Continued 

Election  of  directors,  232,  274.  34^ 
Election  inspectors'  oath,  form,  1SS6 
List  of  stockholders,  338 
Minutes,  339.  344.  3Si 
Minutes,  form,  15SS.  1559 
Notice,  336,  344 
Object  stated  in  notice,  336 
Opening,  340 
Order  of  business,  338 
Place,  335 

Preparations  for,  338 
Presiding  officers,  339 
Quorum,  341.  343 
Roll-call,  340 
Secretary  of,  338 
Time,  228 

Unfinished  business,  349 
Voting,  342.  347-349 
Approval  of  minutes,  374 
By-laws, 

Forms,  1467 
Elections, 

Forms,  ISSS-ISSS 
First,  267-276 

Forms,  1498-1503 

Assemblying,  268 

By-laws  adopted,  273 

Call  and  waiver  of  notice,  268 
Form,  1501,  1519 

Charter  presentation,  272 

Conducting,  270 

Election  of  directors,  274 

Evidence  of  legality,  272 

Exchange  of  stock  for  property,  27s 

Incorporators  call,  268 

Inspectors  of  election  report,  form,  1503 

Minutes,  forms,  1498-1501 

Minutes,  preparation  of,  268 

Opening,  272 

Order  of,  267 

Participants,  268 

Place,  269 

Proxy,  form,  1502 

Time  of,  269 
List  of  stockholders,  231 
Motions, 

Forms,  IS43-IS4S 
Notice  of,  133.  230,  268 
Order  of  business,  234 
Place  of,  190,  228 
Presiding  officers  for,  230 
Procedure  and  business,  229 
Proxies,  13 5.  234 
Quorum,  233 


M  EETiNGS,  Stockholders — Continued 
Resolutions, 

Form,  1546 
Special,  229,  352-357 

Forms,  1520-1525,  1529-IS31 
Adjournment,  357 
Business,  356 
Business  of,  must  be  specified  in  notice 

353 
Call,  352 

Consent  meeting,  35S 
Minutes,  form,  1561 
Notice,  354 
Opening,  356 
Statutory  provisions,  352 
Time  of,  228 
Voting,  231 
Merger  (See  "Consolidation") 
Mines, 

Dividends  declared  out  of  capital  stock,  424 
Leaseholds,  accounting  entries,  1263 
Sinking  funds  for  bond  redemption,  660 
Mining  Corporation, 

Accounting  procedure,  1161-1164 
Incorporation,  1160 
Minnesota,  Incorporation  in,  58 
Minority  Stockholders, 
Common  law  rights,  483 
Holding  company  as,  consolidated 
balance  sheet  items,  1385.  1386 
Illegal  methods  of  majority,  493 
Protection  of,  483-496,  577 
Annual  audits,  491 
Cumulative  voting,  202,  487 
Legal  remedies,  493 
Special  charter  provisions,  491,  492 
State  laws,  58 
Stock  classification,  487 
Voting  trusts,  490 
Representation   on   standing   committees, 

248 
Rights,  abridgement  of,  484,  577 
Squeezing,  985 
Minors, 

Stock  transfer  by,  315.  320 
Minutes, 

Forms,  lSS9-is67 
Amendments,  374 
Annual  meeting,  339.  344i  3SI 
Approval,  374 
Book,  369-374 

Alterations  in,  370 
Contents,  370 
Format,  370 
Motions  and  resolutions,  373 
Proceedings,  37 
Protests  not  usually  includpd.  ^7? 


INDEX 


1677 


Minutes — Continued 
Book — Continued 

Secretary  in  charge  of,  369 

Signed  by  secretary,  351,  374 

Writing  of,  371 
Certificate  of  transcript. 

Form,  1603 
Correction,  375 
Directors'  first  meeting,  278 

Forms,  1504-1507 
Directors'  meetings,  365,  374 
First  stockholders'  meeting,  269 
Motions, 

Forms,  IS43-IS4S 
Prepared,  375 
President's  and  secretary's  certificate  to. 

Form, 1603 
Resolution, 

Forms,  1546-1552 
Secretary's  affidavit  to. 

Form,  1604 
Signing  of,  3 Sr,  374 
Stockholders'  annual  meeting, 

Form,  I55S 
Stockholders'  first  meeting, 

Forms,  1498-1501 
Mismanagement  (See  "Exploitation") 
Missouri  Pacific  Railway, 

Exploitation  of,  968 
Monopolies       (See       "Combinations       in 

Restraint  of  Trade,"  "Trusts") 
Mortgage  Bonds, 

After-acquired  property  clause,  615 
Closed  or  open  issues,  617 
Consolidated,  626 
Deeds  of  trust,  615 
Defined,  451,  625 
First  mortgage,  462 
Junior  lien,  625 
Limited  open  end,  617 
Nature  of,  614 
Popularity,  625 

Ratio  of  mortgage  to  property  value,  627 
Second  mortgages,  625 
Mortgages, 
Farm,  613 
Loans,  612 

Retirement  in  consolidation,  1393 
Motions, 

Forms,  iS43-iS4S 
Entered  in  minute  books,  372 

N 

Name  (See  "Corporate  Name") 
National  Cordage  Company, 
Exploitation  of,  977 


National  Salt  Company 

Exploitation  of,  985 
National   Starch    Manufacturing    Com- 
pany, 

Financial  plan,  741-744 
Net  Income, 

Determination  of,  867-882 

Distribution,  883-897 
Net  Worth  Accounts    (See  also  "Capital 
Stock,"  "Reserves,"  "Surplus") 

Nature  of,  #036 
Nevada,  Incorporation  in,  57 
New  Jersey, 

By-law  statutes,  218 

Charter  form,  1428-1430 

Dividend  regulations,  421 

History  of  legislation  in,  197 

Holding  company  law,  475 

Incorporation  in,  57 

Preferred  stock  requirements,  90 

Special  charter  provisions,  201 
New  York,   New  Haven  and  Hartford 
Railroad, 

Exploitation  of,  968,  984 
New  York  State, 

Burdens  imposed  on  corporations  in,  52 

By-law  statutes,  218 

Capital  stock  paid,  80 

Charter  form,  1425-1428 

Directors'  liability  in,  150 

Incorporation  in,  57 

Stock  transfer  rules,  325 

Stock  transfer  tax,  327 
No-Par  Value  (See  also  "Par  Value") 
No-Par- Value  Stock,  81,  111-130 

Accounting,  129,  1113-1127 
Entered  at  sale  price,  II13 
Entries  for,  1 11 5 
Nominal  or  stated  value,  ill 3 
Subsidiary  records,  in6 

Advantages,  120-123,  1141 

And  par-value  issued  by  same  corporation, 

1X20 

Authorization  of  shares,  124 

Balance  sheet  entry,  1361 

Bonuses  paid  in,  1141 

Certificates,  127 

Change  in  amount  of  authorization,  11 25 

Changed  from  par  to  no-par,  1122 

Charter  form,  1435-1441 

Debts  paid  in,  11 36 

Disadvantages,  123 

Dividends,  1146 

Donated  stock,  11 26 

Earned   surplus   of    corporations    having, 

1117 
Federal  transfer  tax,  329 


1678 


INDEX 


No-Par-Value  Stock — Continued 

History  of,  112 
Judicial  indorsement,  114 
Laws  concerning,  115 
Organization  fees,  126 
Partnerships  incorporating,  500 
Preferred  stock,  126,  1 119 

Takes  precedence  over,  126 
Procedure,  124-130 

Purchased  by  another  corporation,  1139 
Rights  of  holders,  126  , 

Selling  price,  126 
Stabilizer  for  capitalization, 
Status  of,  113 
Stock  dividends,  1152 
Taxation,  128 
Theory  of,  11 1 
Treasury  stock,  1125 
Valuation,  130,  1 114 

Inflation  of,  1 121 
When  used,  117 
Non-Stock  Corporations, 
Accounting,  11 28-1 132 
Donations  to,  1130,  1 131 
Hospitals,  accounting,  1130-1132 
Nation  of,  11 28 
Trust  funds,  1 130 
Northern  Pacific  Railroad  Company,  587 

Exploitation  of,  973 
Note-Brokers,  Work  of,  647,  859 
Notes, 

Compared  to  bonds,  447 
Corporate, 

Forms,  IS9S-IS97 
Short  term,   465,  632,   647-652    (For  com- 
plete list  of  subjects  see   "Short-Term 
Obligations") 
Notice, 

Appointments, 

Forms,  I573-IS7S 
Directors'  meetings,  240,  360,  361 

Proof  of,  364 
Dividends,  438 

Forms,  IS7I-IS73 
Stockholders'  annual  meeting,  133,  230,  336 

Proof  of,  344 
Stockholders'  first  meeting,  268,  272 
Stockholders'  special  meeting,  354 


o 


Office  of  Corporation,  Principal,  190,  335 
Officers,  12  (See  also  under  individual  titles) 

Appointment  of,  1 54i  1 57 

Assistant,  257 

Auditor,  257 


Officers — Continued 
By-laws,  252-259 

Forms,  1465,  1471 
Combined  positions,  157 
Counsel,  256  , 

De  facto,  161 
Defined,  157,  252 
Delegation  of  authority,  160,  258 
Duties,  transfer  of  stock,  313 
Election  of,  242,  279,  366 
Exploitation  by,  967-978 
Governed  by  law  of  agency,  159 
Holding  over  term,  158 
Liability,  160 

When    fraudulent    transfer  of    stock    is 
made  by  executor,  319 
Managing,  255 

Newly  elected,  assume  duties  at  once,  366 
On  standing  committees,  247 
Partnership  incorporating,  508 
Penalties  for  misdeeds,  161 
Powers,  159 
Presiding,  230,  253 

Directors'  meetings,  363 
Stockholders'  meeting,  339 
Qualifications  of,  158 
Removal  of,  149,  162,  243,  259 
Resignations,  163,  1 581 
Salaries,  258 
Signature, 

Form,  1583 
Stock  transfer  by,  300 
Term  of  office,  158 
Vacancies,  259 
Oklahoma,  Express  Trusts,  542 
Opening  Entries, 

Incorporation  of  partnership,  11 76 
Incorporation  of  sole  proprietorship,  1168 
Manufacturing  corporation,  11 58 
Mining  corporation,  1161 
Operating  Expenses,  872-879 

Ratio,  956 
Options, 
Assignment, 

Form,  1516 
On  business  and  property, 

Form,  1514 
On  capital  stock, 

Form,  1512 
On  real  estate. 
Form,  1515 
Precorporate  contracts,  47 
Order  of  Business, 
Directors'  meeting,  244 
Stockholders'  meetings,  234 
Annual,  338 


INDEX 


1679 


Organization  (See  also  "Business  Organiza- 
tion," "Incorporation,"  "Law") 

Economic  necessity  for,  7 

Expenses,  60-68,  1133 
Bonus  account  as,'  1140 
Not  deductible  from  income  tax,  1133 
Reimbursed,  1169 

Fees,  25,  60-66 

Avoidance  of,  64-66 

Excessive,  64 

Stock  of  no-par  value,  126 

Individual  management,  7 

Joint-stock  companies,  9 

Partnership,  8 

Purpose  of,  13 
Overcapitalization,  674 

Defined,  663 
Owners       (See      "Directors,"       "Officers" 
"Stockholders") 


Parliamentary    Procedure    (See    "Meet- 
ings," "Minutes") 
Participating  Bonds,  64s 
Participation  (See  "Capital  Stock";  "Divi- 
dends"; "Stockholder") 
Partnership     Associations,      Nature     of, 

528-530 
Partnerships, 

Accounts,  compared  to  corporate,  1036 
Advantages,  567 
Compared  to  corporation,  4 
Disadvantages,  568 
Incorporation,  497-S09 

Accounting  treatment,  1172-1183 

Agreement  of  incorporation,  11 73 

Balance  sheet  audit,  1175 

Balance  sheet  of  new  corporation,  11 83 

CapitaUzation,  499 

Closing  books,  11 80,  1182 

Directors,  504 

Distribution  of  proceeds,  1181 

Exchange  of  property  for  stock,  502 

Financial  plan,  730 

Maintenance  agreements,  506-509 

Name,  498 

Officer,  508 

Preferred  stock,  602 

Stock  issues,  87 

Stock  ownership,  499,  502-504 

Taxation  before  and  after,  501 

Underwriting  expenses,  11 74 

Valuation,  500 

Voting  requirements,  507 

Voting  trust  agreements,  506 

Stock  classification,  510 


Partnerships — Continued 
Joint  adventures,  530 
Legal  actions  against,  15 
Liability  of  partners,  15 
Limited,  nature  of,  570 
Names,  177 
Nature  of,  8,  566-569 
No  definite  system  of  management,  18 
Stock  transfer  to  and  by,  324 
Par  Value  (See  also  "Discount";  "No-Par 
Value";  "Premium  Account") 
Market  for  stocks  sold  below,  668 
Stock  of  original  issue,  accounting  methods, 

1063-1112 
Stock,    reduction    of,    in    reorganization, 

1059,  1308 
Stock  rights,  809,  813 
Patents,  Assignment  of. 

Form,  161 4 
Penalties, 

Enforcement  of  by-laws,  263 
Stock  transfer  tax,  327 
Pennsylvania, 

Incorporation  in,  57 
Stock  transfer  tax,  327 
Place  of  Business,  50-59 
Principal  office,  190 
Property  tax  for,  64 
Stated  in  charter,  189 
Place  of  Meeting, 

Directors',  190,  239,  358 
Stockholders,  190,  228,  335 
Pledge  (See  "Collateral  Security") 
Power  and   Duties    (See   "By-Laws"   and 
Specific       Headings,     as     "Directors"; 
"Secretary";  "Treasurer";  etc.) 
Power  of  Attorney, 
Forms,  1606- 16 10 
Precorporate  Contracts  (See  "Contracts") 
Preferred  Stock, 
Accounting,  journal  entry,  1068 
By-laws,  225 
Certificate  for,  88 

Form, 1488 
Charter  provisions,  189 
Classification  of,  203 
Form  for,  90 
Common  stock  bonus,  93 
Compared  with  bonds,  88 
Convertibility,  97,  602 
Defined,  85,  601 

Dividends,  87,  90,  93,  438,  602,  884 
Cumulative,  91,  605 
Non-Cumulative,  92,  603,  884 
Participation  rights,  93,  606 
Rates,  606 
Founders'  shares,  97 


i68o 


INDEX 


Preferred  Stock — Continued 
Ledger,  1071 
Nature  and  use,  87 
New  Jersey  requirements,  90 
No-par  value,  126,  1 119 
Non-cumulative,  92 
Partnerships  incorporating,  500-503 
Preference, 

As  to  assets,  91,  607 

As  to  dividends,  90,  136,  601 

Over  no-par- value  stock,  126 
Protective  features,  610 
Redemption,  94,  607 
Represents  tangible  assets,  87 
Restrictions,  601 
Rights  carried  by,  87,  601 
Stockholder's  assent  for  issue  of,  required, 

88 
Use  of,  601 

Voting  rights,  88,  90,  95,  601,  602,  608 
Premium  Account, 

Bonds,  1191,  1213-1224 
Capital  stock, 

Credited    with    payments    forfeited    on 
subscription,  1081 

Not  used  for  no-par  stock,  11 19 

Treatment,  1099 

Uses  of,  1098 
Premium,  Stock  Purchased  at,  1104 
President,  12 
Annual  rejxsrt. 

Form,  1643 
By-laws, 

Forms,  147 1 
Certificate  of  minutes, 

Form,  1603 
Member  of  executive  committee,  248 
Presiding  officer,  230,  253 
Relation  to  treasurer,  391 
Resignation, 

Form,  1581 
Signature  on  certificates  of  stock,  392 
Principal  and  Agent,  4 
Problems, 

Analysis    based    on    financial    standards, 

960-965 
Profit  (See  also  "Gain  or  Loss") 

Adjustment   of   items   of   previous   years, 

1040 
Apportionment  of,  in  close  corporation,  511 
Charges  against,  871,  872,  873 
Closed  into  profit  and  loss  account,  1040 
Concealment  of,  879 
Credited  to  surplus  account,  1038,  1039 
Dividends  paid  out  of,  423,  425,  886 
During  work  of  construction,  871 
Extraordinary,   credited  to   surplus,    1041 


Profit — Continued 

Fluctuations  affecting  dividend  rates,  890 

Percentage,  957 

Promoter's,  780-790 

Salaries  paid  out  of  dividends,  431 

Source  of  capital,  792 

Undivided, 
Account,  1058 
Distinguished  from  surplus,  1047 

Unrealized,  on  purchase  of  treasury  stock, 
1102 
Profit  and  Loss  Account, 

Closing,  1352 

Function,  1042 

Income  tax  charged  against,  1044 

Proof,  1043 

Receiver's,  1328 

Sale  of  capital  assets,  11 36 

Surplus  entered  on,  1040 
Profit-Sharing,  1148 
Promoters,  772-790 

Donated  stock  from,  1107 
Illegal  arrangements,  786 

Difficulties  of,  778 

Improper  profits  vs.  over- valuation,  788 

Precorporate  contracts,  46,  777,  785 

Profits,  780-790 
Secret,  786-788 

Property  owned  by,  789 

Self-protection  of,  777 

Types  of,  773-776 

Work  of,  44,  784 
Promotion, 

Adequate  finances,  769 

Assembling  the  proposition,  762 

Bank  connections,  765 

Co-operative,  767 

Difficulties  in,  778 

Failures  in,  771 

Financing  of  construction  work,  766 

Investigation  of  enterprise,  754-762 

Preliminary  financing,  76s 

Requirements,  776 

Steps  in,  753 
Property, 

Appreciation,  basis  of  capitalization,  664 

Dividends,  433.  437 
Property  Tax,  26,  64,  333 
Proprietorship,  Sole, 

Good-will,  1 166 

Incorporation,  1165-1171 

Nature  of,  564 
Prospectus,  Sale  of  Securities,  818-820 
Proxy, 

Forms,  1535-1542 

Directors  may  not  vote  by,  364 

Stockholders'  annual  meeting,  341 


INDEX 


1681 


Proxy — Continued 

Stockholders'  first  meeting,  268 
Form,  1502 

Voting  by,  13S.  234.  342 
Public,  The, 

Investing  as  a  source  of  capital,  79s 

Speculative,  as  a  source  of  capital,  79S 
Public  Utilities,  Capitalization  of,  73 
Public  Utility  Corporations, 

Charters,  168 

Holding  companies  for,  592 
Publicity, 

Among  stockholders  to  cultivate  good-will, 
800 
Purchase, 

Terms  of,  affecting  working  capital,  70s 
Purchase  Money  Bonds,  46s 
Purposes  of  Corporation  (See  "Corporate 
Purposes") 


Quorum, 

Committee  meetings,  251 
Directors'  meetings,  241,  363,  364 
Stockholders'  meeting,  233 
Annual,  341.  343 


Railroads, 

Equipment  trust  bonds,  465,  629-631 
Financing  plan,  732 
Leaseholds,  accounting  for,  1264 
Promoting,    preliminary    investigation   of, 

759 
Sinking  funds,  1231 
Reading  Company,  Dissolution  of,  1002 
Realization  and  Liquidation  Statement, 

1346 
Realization,  Gain  or  Loss  on,  1298,  1299, 

1338 
Receipts,  Corporate, 

Forms,  1 593- 1 595 
Receivers, 

Accounts,  1312-1329 
Duties,  1006 
Powers,  1007 

Profit  and  loss,  1328,  1337 
Reports,  1342- 1348 
Statement  of  affairs,  1313-1316,  1324 
Statement  on  withdrawal,  1316 
Statement  to  court,-  1322 
Receiverships, 
Accounting, 

Adjustment  of  asset  values,  1326,  1333 
Adjustment  of  company's  books,  1325 


ReciPiverships — Continued 
Accounting — Continued 

Cash  account,  1345 

Claims  approved,  entry  of,  1327 

Closing  entries,  1321,  1329,  1339*  1341 

Company  accounts,  1313 

Deficiency  statement,  1343 

Dissolution  following,  1340 

Exhibits  and  schedules,  1325 

Expenses,  1348 

Liquidation  of  liabilities,  1338 

Loss  and  gain  on  realization,  1337 

Opening  entries,  1316,  1333 

Procedure,  13 17 

Realization  and  liquidation  statement, 
1346^ 

Receiver's  profit  and  loss,  1328,  1337 

Reports,  342-1348 

Sale  of  assets,  1331-1348 

Statement  to  court,  1322,  1342-1348 

Transactions,  1319,  1334 
Application  for,  1006 
Dissolution  following  bankruptcy,  1340 
Friendly,  iocs 
Nature  of,  iocs 
Procedure,  1005-1009 

State  of  affairs,  1313-1316,  1324.  I33I.I335 
Records  (See  "Books  of  Account") 
Redemption  Fund  (Seealso"SinkingFund") 
Compared  to  sinking  funds,  1228 
Nature  of,  1225 
Requirement,  1227 
Refunding  Bonds,  1252 
Registered  Bonds,  448,  622 
Interest  record,  1188,  1205 
Records  for,  11 86 
Transfer  record,  11 87 
Registrar  (See  "Transfer  Agent  and  Regis- 
Regulations,  Corporate,  [trar") 

How  provided  for,  215 
Removal  from  Office, 
Agent,  149 
Directors,  153,  238 
Officers,  149,  162,  243,  259 
Renewals,  Charged  against  Profit,  872 
Reorganization, 

Accounting,  reduction  of  stock,  1309 

Advantages,  1026- 1030  < 

Agreement,  1307 

Claflin  company,  1028 

Committees,  loi 2-1015 

Defined,  loio,  1307 

Expenses,  10 13 

Good-will,  writitig  off,  1309 

Interests  concerned,  loii 

Methods,  1307 

Reduction  of  stock,  1308-1311 


i682 


INDEX 


Reorganization — Continued 
Nature  of.  522 
Procedure,  1013-1017 
Purposes,  1018 

Raising  additional  capital,  1019-1023 
Receivership,    1313-1348    (For  full  list  of 

subjects  see  "Receiverships") 
Reducing  capital  stock,  1059.  1309 
Reducing  fixed  charges,  1024 
Status  after,  13 10 
Underwriting  syndicate,  1023 
Repairs,  Charged  against  Profits,  872 
Reports, 

Forms,  1643-1651 
Annual,  31 

Reading  of,  at  annual  meeting,  34s 
Corporate,  1354 
Officers  and  committees,  365 
Foreign  corporations,  31 
Inserted  in  minute  book,  372 
Required,  24,  30 
Tax,  30 

Treasurer,  412-414 
Reserves  (See  also  "Surplus") 

Accounting,    entries   for   appropriation  of 

surplus,  1048 
Actual  vs.  book,  1055 
Balance  sheet  entry,  1368 
By-laws,  260 

Forms,  1472 
Charged  against  profits,  873 
Compared  to  funds,  1226 
Deed  of  trust  provisions,  1227 
Depletion,  1054 
Depreciation,  874,  877 
Expenses,  1050 
General,  877-879 
Hospital  accounts,  1131 
How  created,  1226 
Impounding  of  surplus,  1047,  1051 
Nature  of,  873 
Non-operating,  1050 

Accounting,  1052 
Operating, 

Accounting,  1050 
Permanency,  1048,  1051 
Secret,  1052.  1056 

Sinking  fund,  accounting  entries,  1242 
Resignations, 

Forms,  iS78-ls8i 
Directors,  152 
Officers,  163 
Resolutions,  r 

Forms,  1546-1552 
Certificate  of. 

Forms,  1600-1601 


Resolutions — Continued 

Declaring  dividends,  422 

Entered  in  minute  book,  372 
Restraint  of  Trade,  Combination  in   519 

Express  trust  as,  535 
Retirement  Fund, 

Cannot  be  termed  a  sinking  fund,  1229 
Revaluation,  911 
Rock  Island  Railroad  Company 

Exploitation  of,  972 

Financial  plan,  748 
Roll-Call, 

Directors'  meetings,  363 
First,  279 

Stockholders'  annual  meeting,  340 

Stockholders'  first  meeting,  268 


Salaries, 

By-law  provisions,  206,  258 
Charter  provisions,  205 
Directors,  243 
Exorbitant,  971 
Officers,  258 

Paid  from  profits  to  avoid  dividends,  431 
Paid  in  stock,  1135 
Sale  of  a  Business, 

Accounting,  1299 
Sales, 
Bonds, 

Accounting  for,  11 94-1 201 

Discount  and  premium,  1 213-1223 
Consolidated  statement  items,  1395 
Cost  of,  in  income  tax  return,  1407 
Estimates  for  budget,  926 
Terms  of,  affecting  working  capitaJ    708 
Scrip,  Dividend,  436 

Accounting  procedure,  1147 
Seal, 

Corporate,  263,  281 

By-laws  form,  1466,  1473 
Seasonal  Trades, 

Working  capital  requirements,  7:7 
Secretary,  12 

Affidavit  to  minutes. 

Form, 1605 
By-laws, 

Forms,  1471 
Certificate  of  Minutes, 

Form,  1603 
Duties, 

By-laws  specify,  254 

Preparation  for  annual  meeting,  338 

Record  of  minutes,  369 

Sends  notice  of  annual  meeting,  337 

Signing  of  minutes,  351,  374 

Stock  certificate  book  in  charge  of,  290 


INDEX 


1683 


Secretary — Continued 
Not  a  presiding  officer,  230 
Oath, 

Form,  IS08 
Of  committees,  248 
Relation  to  treasurer,  391 
Stockholders'  annual  meetings,  339 
Securities    (See   also    "Investments";   and 

special    forms    as    "Bonds,"     "Capital 

Stock,"  etc.) 

Forms,  727 
As  collateral,  307-309,  682 
Dealers  in,  823 
High  grade,  investors  of,  792 
Investigation  of  issue  before  selling,  824 
Issues, 

Market  conditions  affecting,  720 
Relation  between  and  assets,  725 
Relation  between  and  income,  724 
Salability,  720 
Sale  of. 

Accounting  in  consolidation,  1292 

Advertising,  824 

Buyers  of  speculative  securities,  79s 

Circularizing  lists,  816 

Commission  payments,  825 

Dealers  in,  823 

Direct  methods,  799-822 

Expenses  incurred,  828 

Handling  an  issue,  824 

Indirect  methods,  823-836 

Liability  of  dealer  in,  826 

Limitation  on  sale  through  dealer,  828 

Mail  order  methods,  815 

Market  for,  796,  834 

Personal  methods,  816 

Pre-sale  investigation,  824 

Prospectus,  818-820 

Small-scale,  797 

Stock  exchange  methods,  829-836 

Surplus  from,  910 

To  customers,  803 

To  employees,  802 

To  raise  additional  capital,  1019 

To  stockholders,  799 

Underwriting  method,  837-848 
Surplus  invested  in,  1045 
Serial  Bonds,  656,  658 

Redemption,  accounting  entries,  I3S3 
Sale,  accounting  entries,  1200 
Shareholder  (See  "Stockholder") 
Shares  (See  "Capital  Stock") 
Short-Term  Obligations, 
Accounting  entries,  1264 
Banker's  note,  647 

Defined,  647  [652 

Included  as  funded  debt  not  good  practice. 


Short-Term  Obligations — Continued 
Investment  value,  649 
Nature  of,  465,  632,  647,  854-866 
Purpose  of,  648 

Redemption,  accounting  entries,  1255 
Sale,  accounting  entries,  11 99 
Security  for,  652 
Sinking  fund  methods,  658 
Use  of,  649 
Yield,  651 
Side  Lines, 

Capital  invested  in,  942-946 
Signatures, 

Forms,  is83-iS97 
Call  and  waiver  of  notice,  269,  277 
Charter  application,  208 
Corporate, 

Certificates  of  stock,  223,  316,  392 

Stock  transfer  assignment,  323 
On  checks,  form,  1588-1592 
Married  woman,  317 
Partners,  stock  transfer  assignment,  324 
President's,  on  certificates  of  stock,  392 
Secretary's,  on  minutes,  351 
Stockholder's,  300 

Stockholder's  recjipt  for  dividend,  1144 
Treasurer's,  on  certificates  of  stock,  392 
Sinking  Fund, 
Account,  1229 

Accounting  entries,  1 236-1246 
Adequacy  of,  1232,  1249 
Balance  sheet  entry,  1370        • 
Bond  redemption,  457,  653-662,  1247-1250 
Calculation,  1233 
Defined,  456,  1228 
Expense  account)  1230 
Income  account,  1230 
Income  from,  accounting  entries,  1237 
Interest  on,  accounting  entries,  1237 
Interstate    Commerce   Commission's  regu- 
lations, 1 231 
Investments, 

Accounting  entries,  1239 

In  company's  own  bonds,  1241 

Income  from  accounting  entries,  1240 
Methods,  656-662 

Annual  purchase,  of  bonds,  658 

Annuity,  1233-1235 

Bond  redemption,  657,  658,  659 

Investment,  657 

Land,  lumber  and  mining  companies,  660 

Short-term  notes,  658 

Special,  660 

Trustees,  657 
Payments  into. 

Accounting  entry,  1237 
Principles,  1331 


i684 


INDEX 


Sinking  Fund — Continued 

Reserves,  accounting  entries,  1243 
Stock  redemption,  609 
Trustee,  1236 

Accounts  of,  124s 
Small  Corporations  (See  "Close  Corpora- 
tions") 
Special  Dividends,  1148 
Speculation, 

Stock  Exchange  dealings,  832 
Stamps, 

Stock  transfer  tax,  328 
Standard  Rope  and  Twine  Company 

Exploitation  of,  972 
Standards, 

Financial,  947-965 
Standing  Committees  (See  "Committees") 
State  Rights, 

Corporations,  51 
Statement  of  Affairs, 

Receivers,'  1313-1316,  1324.  I33i,  1335 
States  of  the  U.  S., 
Incorporation  laws,  51 

Reputation  of  various,  for  incorporation,  56 
Statutory  Law,  6 

Stock  (See  "Capital  Stock,"  "Certificates  of 
Stock,"  "Common  Stock,"  "Dividends," 
"Preferred  Stock,"  "Retirement  Funds," 
"Stock  Transfer,"  "Treasury  Stock" 
Stock  Companies, 

Joint,  525-527,  570 
Stock  ExcHJfls'GE, 

Methods,  829-836 
Stock  Transfer, 
Accounting,  1074 
Assignment  of  stock. 

Form,  316,  1509 
Book,  293 

By-law  provisions,  225 
Closing  of,  288,  294,  336,  443 
Kept  by  corporation,  302 
By-laws,  224 
Can  be  stopped  when  made  to  control  an 

election,  348 
Corporate  responsibility  for,  312,  319 
Corporations  purchasing  own  stock,  con- 
ditions for,  322 
Doubtful  transactions,  312 
Duties  of  officers,  300,  313 
Evidenced  in  books,  287,  298 
Fractional  share,  299 
Fraudulent,  319 
Liability  for,  314 

Lien  on  stockholders  for  unpaid  debts,  310 
Old  certificate  surrendered  before  new  is 

issued,  288,  298,  1074 
Pledges  of  stock,  307 


Stock  Transfer — Continued 
Procedure,  296-311 
Procedure  of  owner  when  refused,  288 
Regfister,  1074,  1087 
Restrictions  on,  309 
Signature  on  stock  certificate,  316 
Summary  of  rules,  325 
System  of,  17 
Tax,  291 

To  and  by  administrator,  315,  319 
To  and  by  agent,  315,  317,  318 
To  and  by  corporation,  316,  322-324 
To  and  by  dummy  owner,  316 
To  and  by  executors,  315,  317,  319 

When  taxable,  328 
To  and  by  guardians,  321 
To  and  by  joint  owners,  316,  324 
To  and  by  married  women,  315 
To  and  by  minors,  315,  320 
To  and  by  partnership,  324 
To  and  by  trustees,  315,  317,  320 
To  and  by  unincorporated  body,  322 
Transfer  agents  and  registrars,  224 
Transferees,  313 
Transferrers,  313 
Treasury  stock,  107,  302,  322 
Uniform  transfer  act,  83,  307 
Voting  trust,  327 
Stock  Transfer  Tax 
Federal,  30,  329 
State,  28,  328 
Stockholders,  i  i  (Sie  also  "Preferred  Divi- 
dends") 
Additional  capital  supplied  by,   799,  80s, 
Approval  of  consolidation,  1286  [1020 

As  incorporators,  174 
Assessment  of,  1020 
By-laws,  228-234 

Forms,  1464,  1467 
Close  corporation,  513 
Corporations  as,  482 
Directors  act  as  trustees  for,  148 
Directors  as,  192,  236 
Dividends  payable  to,  439,  1143 
Dummy,  liability  of,  316 
Exploitation  by,  979-991 
Functions,  132 
Good-will  of,  800 
Interests  in  reorganizations,  lOll 
Liability,  14,  143-148 

Bonus  stock  without  par  value,  1 141 

Full-paid  stock,  loi 

In  California,  53 

Statutory,  145 

Unpaid  outstanding  stock,  14  s 

Unpaid  subscriptions,  143 

Watered  "tock,  100 


INDEX 


168S 


Stockholders — Continued 
List  of,  231,  338,  48s 

Form,  IS S3 
Listed  in  stock  ledger,  291 
Loss  of  stock  certificate,  81 
Majority  (See  "Majority  Stockholders") 
Married  women  as,  315 
Meetings    (See  "Meetings,  Stockholders") 
Minority  (See  "Minority  Stockholders") 
Number  of,  584,  796 
Refusal  of  corporation  to  transfer  stock, 

288 
Relation  to  treasurer,  38s 
Rights,  132  (See  also  "Preferred  Stock") 

Amendment  of  charter,  132,  141 

By-laws,  141,  217 

Certificates  of  stock,  223 

Consent  for  the  issue  of  preferred  stock, 
88 

Consent  to  liquidation,  137.  142 

Directors  elected  by,  142,  154,  238 

Directors  removed  by,  IS3,  238 

Dividends,  13s,  428 

Holding  companies,  482 

Inspection  of  books,  137,  484 

Inspection  of  minutes,  369 

Limitation  of,  140 

Liquidations,  137,  142 

Married  women,  315,  441 

No-par- value  stock,  1 26 

Notice  of  meeting,  133 

Officers  appointed  by,  157 

Participation,  in  dividends,  13s,  428 

Sale  of  assets,  142 

Special,  143 

Special  charter  provisions,  139 

Statutory,  140 

Stock  rights,  136,  805-813 

Violation  of,  139 
Signature,  300 

Status  in  foreign  countries,  578 
Status  of,  131,  576 
Stock  system,  17 
Subscription  contract,  34 
Subscriptions  paid  for  in  dividends,   430, 

1 149 
Treasurer's  repo'rts  to,  413 
Vote  cannot  be  withheld,  348 
Votes,  231,  347-349 

Cumulative,  202,  349 

Preferred  stock,  88,  90,  95 
Subscription,  33-41      (See     also     "Capital 

Stock,"  "Certificate  of  Stock") 

Forms,  1474-1483 
Acceptance,  34 

At  first  directors*  meeting,  281 
Additional,  136,  80s 


Subscription — Continued 

Adopted  at  first  directors'  meeting,  281 
Assessment, 

Notice  of,  form,  1570 
Assignments, 

Form, 1509 
Balance  sheet  entry,  1361 
Bonds,  1196 
Cancellation,  accounting  entry,  1081,  1087, 

1163 
Common  law  rule,  40 
Contract,  mistakes  in,  38 
Dividends  used  in  payment  for,  430,  11 49 
Enforcement,  35 

New  York  rule,  36 
Entries,  io6s,  1076 
Forfeited,  accounting  entries,  1163 

Form  of  list,  38 
Full-paid    at    once,    accounting    method, 

1068-1075 
Instalment  payments,  222,  1077 

Account,  1090 
Form,  163s 

Instalment  book,  1088 

Ledger  entries,  1093 

Methods  of  entry,  1091-1095 

Notice,  form,  1569 
Irrevocable  when  part  of  statutory  form,  36 
Journal,  1084,  1086 

Form,  1634 
Journal  entries 

Stock  not  paid  in  full,  1076 

Stock  paid  in  full,  1068 
Ledger,  1080 

Instalment  payments,  1093 

Posting,  1086 
Liability  of  subscriber,  34 
Material  variation  in,  39 
Not  full-paid  at  once,  accounting,    1076- 

1085 
Old  rule  for  issuing  stock,  80 
Payment,  accounting  entries,  1086 
Receipts, 

Forms,  1479- 1483 
Source  of  capital,  791 
Stock,  33-41,  80 
Stock  account,  1077,  1083 
Subscribed  account,  1078 
Transfer  journal,  1082,  1088 
Treasury  stock,  1077 
Unpaid, 

Notice  of  sale  of,  form,  iS7i 

Stockholders'  liability,  144 

Surplus  created  from,  1060 
Vs.  agreement  to  buy  stock,  37 
Waiver  of  notice  of  assessment, 

Form,  1503 


1 686 


INDEX 


Subsidiary  Corporations   (See  "Affiliated 

and  Subsidiary  Corporations") 
Sinxs  AT  Law  Against  Corporation,  15 
Surety  Company, 

Treasurer's  bonds,  406 
Surplus  (See  also  "Reserves") 
Account, 

Analysis,  1039 

Correction  of  errors  adjusted  through, 
1040 

Income  tax  charged  against,  1042,  1044 

Non-stock  corporation,   1 130 
Accounting  methods,  1038-1046 
Analysis  of,  1369 
Appreciated,  1060 
Balance  sheet,  consolidated  adjustment  on, 

1380,  1381 
Balance  sheet  entry,  1364-1367,  1369 
Balance  sheet  item,  1038 
Banks,  1056,  1098 
Capital,  1058 

From  no-par- value  stock,  in 4,  1117 
Capitalization,  682 
Closing  into,  1352 
Consolidated,  1063 
Contributed  (See  "Surplus  Paid-in") 
Defined,  908,  1038,  1056 
Diminishing,  1056 

Dividend  paid  out  of,  424,  898,  1047 
Dividends  to  represent,  106 
Donated,  1063,  1108 
Earned,  913 

Account,  I0S7 

No-par- value  stock  corporations,  1 11 7 
From  revaluation  of  assets,  911 
From  sale  of  securities  or  fixed  assets,  910 
Impounding,  1047,  1051 
Impounding  accounting  methods,  1048 
Income  tax  return,  141 S 
Investment  of,  1046 
Paid-in, 

Analysis  of,  1058 

Dividends  paid  out  of,  I0S9 

From  assessment  of  stock,  1059 

From  assets  purchased  for  stock,   1060 

From    payments    on    subscriptions    for- 
feited, 1060 

From  premium  on  stock,  1038,  1098 

From  reduction  of  par-value  of  capital 
stock,  1059 

Sources  of,  1059 
Part  of  net  worth,  1038 
Policy  as  to,  913-918 
Purchased,  909 
Reduction  of,  1038 
Secret,  920 
Source  of  capital,  918 


Surplus — Continued 

Sources  of,  909,  1038 

Specific  assets  not  represented  by,  1045 
Surplus  and  Deficit  Account,  1353 
Syndicates  (See  also  "Underwriting") 

Nature  of,  530 


Taxation  of  Corporations, 

Capital  stock  tax,  30,  330 

Disadvantage,  22 

Evasion  of,  64-66 

Excess  profits  tax,  29,  332-1499 

Excessive,  effects  of,  64 

Express  trusts,  542 

Federal  taxes,  29 

Foreign  corporations,  27,  28 

Franchise  tax,  25,  60,  333 
Comparative  table  of,  61 

Income  tax, 

Accounting,  1042-1045 

Federal,  29,  331,  501 

Preparation  of  federal  returns,  1399-142 1 

State,  26,  334 

Inheritance  Tax, 
Federal,  30 
State,  27 

No-par-value  stock,  128,  329 

Organization  fees,  25,  60-66,  ia6 

Partnerships  vs.,  501 

Property  tax,  26,  64,  333 

Reports,  30 

Stock  transfer  tax,  28,  30,  291,  327-330 

Summary  of,  24 
Term  of  Office, 

Directors,  196,  237 

Officers,  158 
Terminal  Bonds,  464, 
Timber  Companies, 

Sinking  funds  for  bond  redemption,  660 
Timber,  Valuation,  911 
Time, 

Annual  meeting,  228 

Directors'  meetings,  239,  358 
Trade  Acceptance,  706,  856 
Trade  Associations,  520 
Transfer  Agents  and  Registrars, 

By-laws,  224 

Liability  in  selling  bonds,  458 

Procedure  for,  303 

Registrar's  procedure,  303 
Transfer  of  Stock  (See   "Stock  Transfer") 
Treasurer,  12,  377-414 

Affidavit  to  statement, 
Form,  1604 

Assistant,  380 


INDEX 


1687 


Treasurer — Continued 

Authority,  377 
Exceeding,  396 
Bond,  283,  401-41 1 
Form,  1616 

Amount,  404 

Bondsmen's  liability,  408 

Corporate  requirements,  402 

Defined,  401 

Nature,  403 

Personal,  405 

Statutory  requirements,  402 

Surety  company,  406 

Termination,  410 
By-laws,  253,  377-38i 

Forms,  1472 
Corporate  funds,  377.  41S-419 
Criminal  act  by,  398 
Duties, 

As  agent,  393 

Assumption    of     office,     procedure    for, 
382 

Auditing  of  books,  383 

Corporate  funds,  377,  41S 

Faulty  performance,  395 

Responsible     for     books    of    accounts, 
381 

Signature  on  certificates  of  stock,  392 

Specified  in  by-laws,  255,  377-381 

Supplemented  by  resolutions  of  directors, 
381 
Faulty  performance  of  duty,  39s 
Illegal  acts,  398 
Liability,  393-400 

Corporate  funds,  416 

To  whom  liable,  393 
Neglect  of  duty,  394 
Newly  elected,  381 
Payment  of  dividends  by,  423 
Powers,  377-385 
Relations  to. 

Auditor,  or  comptroller,  389 

Directors,  38s 

Finance  committee,  387 

President,  391 

Secretary,  391 

Stockholders,  385 
Report, 

Form,  1629 

Directors,  412 

Stockholders,  413 
Resignation, 

Form,  1 58 1 
Retiring,  382 
Treasury  stock  shoid  not  be  assigned  to, 

107 
Unauthorized  acts,  396 


Treasury  Bonds, 
Defined,  1 186 
Held  in  sinking  fund,  1241 
Interest,  1208 

Unissued  sometimes  called,  il8s 
Treasury  Stock,  104-110 
Account,  I  Id 
Accounting,  1101-1112 

Entries  for  donated  stock,  1108-1112 

Entries  for  purchase,  1102,  1104 

Entries  for  sale,  1103,  1105 
Acquisition  of,  105,  322 
By-laws,  226 

Contingent  profit  on  purchase,  1102 
Defined,  84,  iioi 
Dividends,  433,  441 
Donated, 

Accounting  treatment,  1 106-1 11 2,  1162, 

Reasons  for,  1 106  [ii79 

Stock  account,  1108 
Full-paid  stock,  104 
Issued,  104 
Legal  status  of,  109 
No-par  value,  1125 
Repurchased,  accounting,  iioi-iios 
Stock  of  other  corporations,  109 
Stock  of  other  corporations  not,  1136 
Subscription  account,  1077 

Transfer  of,  107,  302 
Unissued  a  misnomer  for,  104 
Trust  Agreement  (See  "Deed  of  Trust") 
Trust  Funds, 

Hospital  Accounts,  1 130 
Nature  of,  1225 
Trustees, 

Acceptance  of  subscription,  35 
Bond  certificate. 

Form,  1623 
Deeds  of  trust,  615 
Directors  as,  148 
Express  trusts,  S48-SSI 

Legal  functions,  533 

Who  may  be,  534 
Precorporate  contracts,  48 
Sinking  funds,  657,  1236 

Accounts  of,  1 245 
Stock  transfer  by,  315,  317,  320 
Stock  transferred  to  and  by  unincorporated 
Votes,  13s  [body,  322 

Trusts  (See  also  "Express  Trusts") 
Harmful, 

Taxation  no  remedy  against,  22 
Succeeded  by  holding  company,  590 
Turnover, 

Affecting  working  capital,  701 

Defined,  701 

Rate  of,  702-70S,  9SS 


i688 


INDEX 


Ultra  Vires  Acts,  185 
Uncertain  Enterprises, 

Capitalization  of,  74 
Underwriting, 
Advantages,  838 
Agreements,  40,  842,  1172 
Banking  arrangements,  839 
Commissions,  844,  11 74,  11 79 
Community  of  interests  between  houses. 
Expenses,  11 74  [840 

Origin,  837 
Plans, 

American  Woolen  Company,  847 
United  States  Realty  and  Construction 

Company,  84s 
United   States   Shipbuilding   Company, 
846 
Speculative,  84s 
Syndicate,  823,  839 

For  reorganization,  1023 
Manager,  844 
Undivided  Profits  (See  "Profit") 
United  States  Constitution, 

Corporations  not  citizens  under.  Si 
United  States  Express  Company, 

Dissolution  of,  1002 
United  States  Realty  and  Construction 
Company, 
Underwriting  syndicate,  84s 
United  States  Shipbuilding  Company, 
Exploitation  of,  971 
Underwriting  syndicate,  846 
United  States  Steel  Corporation, 

Incorporation  of,  176 
Unloading,  975 


Vacancies, 

Board  of  directors,  154,  238 

Officers,  259 
Valuation, 

Capitalization,  676 

Good-will,  678-681,  1166 

Inventories,  cost  or  market,  870 

Projjerty,  mortgage  ratio,  627 

Revaluation,  911 

Stock, 

No-par  value,  130,  1114 
Subsidiary  corporations,  1136 
Vertical  Trust  or  Combine,  737 
Vice-Presidents,  12 

By-laws, 

Forms,  1471 

Presiding  officers,  253 


Voluntary     Association     (See     "Express 

Trusts") 
Voting, 

Administrators,  13s 
By  ballot,  346 
By-laws,  231 
By  proxy,  13S.  233,  342 

Directors  may  not,  364 
California  provides  no  preference,  96 
Certified  list  of  stockholders,  231 
Corporation  cannot  vote,  348 
Cumulative,  202,  349,  487 
Election  of  officers,  366 
Executors,  13s 

Face  value  of  stock  as  affecting,  80,  85 
Injunction  aginst  stockholders,  348 
Method  of  casting  votes,  134 
Methods  at  annual  meeting,  347 
Minority  interests,  202,  487 
Partnerships  .incorporated,  506 
Preferred  stock  rights  to,  88,  90,  95,  601, 

602,  608 
Stock  as  voting  and  non-voting  classes,  203 
Stockholders'  rights,  133 
Trustees,  135 

What  constitutes  majority  votes,  347 
Who  is  entitled  to  vote,  343,  347 
Voting  Trust, 
Agreements, 

Form,  1517 
As  a  minority  protection,  490 
Defined,  467 
Dissolution,  470 
Dividends,  470 
Illegal,  472 
Object,  468 
Organization,  469 
Preservation  of  agreed  status  by  means  of, 

S06 
Restriction  of  sale  of  stock,  472 
Stabilizes  management,  197 
Statutory  laws,  470 
Stock,  470 
Stock  certificate. 

Form,  1 49 1 
Stock  transfer  liable  to  tax,  327 

w 

Waiver  of  Notice, 

First  stockholders'  meeting,  268,  272 
Waiver  of  Notice  of  Assessment, 

Form,  1503 
Warehouse  Receipts, 

As  collateral,  863 
Warrants, 

Stock  rights,  805 


INDEX 


1689 


Watered  Stock,  85,  99 
Webb-Pomerene  Law,  590 
West  Virginia, 

Incorporation  in,  56 
Westinghouse    Electric    and    Manufac- 
turing Company, 
Reorganization,  688-691 
Without  Par  Value  (See  "No-Par  Value") 
Women, 
Married, 
Signature  on  stock  certificate,  317 
Stock  ownership  rights,  315,  441 
Working  Capital, 
Defined,  687,  697 
Donated  stock,  11 07 
Account,  1 108 


Working  Capital — Continued 
Factors  affecting,  697-707 

Credit,  708 

Discounts,  70s 

Long  term  manufacture,  698 

Terms  of  purchase,  705 

Terms  of  sale,  708 

Time  element,  699 

Turnover,  701 
Lack  of,  a  cause  of  insolvency,  995 
Requirements,  691-693,  697-719 

Foreign  trade,  708 

Instalment  business,  709-713 

Liquidity  of  assets,  713 

Month-to-month,  718' 

Ratio,  949 
Seasonal  trades,  717 


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